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When looking at term deposits or other types of savings accounts, you’ll probably want to choose a product with a favourable interest rate.

Here’s a quick guide to interest rates and how to find an appropriate term deposit to meet your needs.

How do interest rates on term deposits work?

When you invest money in a term deposit, you agree on an interest rate at which your money will earn returns during the lifetime of your investment (usually between one month and five years).

Usually, a higher interest rate yields higher returns. However, the way your interest is calculated and accrued can also affect how much you’ll earn from your investment.

There are two types of interest for term deposits: simple interest and compound interest.

Simple interest example:

You invest $20,000 for five years at 3 per cent per year, with simple interest paid at the end of the term. Here, you would earn $3,000 in interest ($600 each year), giving you a total balance of $23,000 at the end of the term.

Compound interest example:

You invest $20,000 for five years at 3 per cent per year, with compound interest paid monthly. You would earn $3,232 in interest after five years, giving you a total of $23,232.

Typically, compound interest increases the amount you earn on your deposit. However, many banks offer lower interest rates for term deposits with interest paid monthly to offset the added interest.

How do banks set interest rates on term deposits?

There are a number of factors that banks and financial institutions use to determine interest rates on term deposits:

RBA cash rate – The Reserve Bank of Australia sets the official cash rate target (the rate offered on overnight loans to commercial banks) on the first Tuesday of every month (except January).

The RBA cash rate influences interest rates for term deposits as well as other products like home loans, credit cards and high-interest savings accounts.

Many banks and financial institutions adjust their interest rates in line with changes to the RBA cash rate. Usually, a lower cash rate means lower interest rates on term deposits.

Deposit amount – Generally, the more you’re willing to invest in a term deposit, the higher the interest rates you’ll be offered. For especially large deposits (e.g. over $250,000), you may even be able to negotiate a higher interest rate.

Length of term – As with the deposit amount, a longer term length usually equals a higher interest rate. This is because the longer you invest your money, the longer the bank can use it to balance their books against loans made to other customers.

How often interest is paid – You can usually choose to have interest paid on your term deposit anywhere from weekly to at the end of the term.

Thanks to the compounding effect, your earning potential is greater the more often your interest is paid. However, some banks offer a lower interest rate for term deposits where interest is paid more frequently.

Competition in the market – Banks and financial institutions may choose to set higher interest rates as an encouragement for new customers to choose their product.

Factors to consider when comparing term deposits

Choosing a suitable term deposit isn’t always just about picking one with the highest interest rate. Some of the other factors to consider include:

  • How often interest is accrued – All things being equal, a term deposit with interest paid more frequently will earn more interest over time.
  • Term length – Available terms typically range from one month to five years. Keep in mind that it’s likely you won’t be able to access your funds until the term has reached maturity.
  • Deposit requirement – Many term deposits come with a minimum and maximum deposit amount. Compare your options to choose a term deposit that suits your planned investment.
  • Fees – It’s common for banks and financial institutions to charge a fee for withdrawing any of your money before the term ends – which is known as a ‘penalty fee’. Ensure you’re comfortable with the fees and withdrawal restrictions before opening an account. Most term deposits don’t have any set-up or maintenance fees, but it’s worth checking the product disclosure statement (PDS) just in case.
  • Your financial goals – Term deposits lock your money away for an extended period at a fixed interest rate, so they aren’t for everyone. Consider your savings and financial goals to determine if a term deposit or another type of investment (such as a high-interest savings account) is right for you.
  • Government guarantee – The Australian Government guarantees deposits up to $250,000 in authorised deposit-taking institutions (ADIs) – meaning your money is protected if anything happens to the ADI. Be aware that a small number of institutions are not covered by this guarantee.

How to find a high-interest term deposit

Using RateCity’s term deposit comparison tool, you can look at the options currently on the market filtered by your preferred minimum deposit amount and term length.

Along with comparing interest rates, you can also look at features such as interest frequency, fees, returns and more.

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