A term deposit is an amount of money you leave with a lender for an agreed amount of time in return for an agreed amount of interest.
For example, you might make a $1,000 term deposit with a lender that lasts for 12 months and pays 3 per cent interest.
At the end of that 12-month term, the lender would return your $1,000 deposit and pay you the agreed interest.
The pros of term deposits
- Term deposits often pay higher interest rates than regular savings accounts
- The interest rate can’t change during the term
The cons of term deposits
- Most lenders will penalise you if you withdraw your money before the end of the agreed term
- A regular savings account that had a lower interest rate before you took out the term deposit might introduce a higher rate after you lock your money away
Why lenders like term deposits
The reason lenders generally pay more interest for term deposits than regular savings accounts is because they are able to profit from the high likelihood that borrowers won’t withdraw their money during the loan term.
If, for example, a lender offers to pay you 3 per cent interest for a 12-month term deposit, it’s because the lender believes it can then take your money and lend it to somebody else for more than 3 per cent during that one-year period.
This would be a risky move if you were likely to ask for your money back during those 12 months – which is why most lenders guard against this prospect by penalising customers who withdraw their money early.
A word of warning
Your lender will contact you near the end of your term deposit to ask what you’d like to do with your money.
One option will be to roll over the term deposit – that is, to put your money into another term deposit for the same amount of time.
Make sure you do your research before agreeing to this option, because while the term deposit might have been the best on the market when you first agreed to it, that might no longer be the case.