Term deposits and savings accounts are very similar, low-risk products: they both allow you to deposit money with a financial institution, and this money then earns you a similar rate of interest. But unlike savings accounts, term deposits require you to deposit this money for a set period of time, during which you can't access the money without providing advanced notice or paying a fee. This period is known as the term.
Term deposits come with a wide variety of different terms, and the length of term you choose can have a significant influence over the interest you can earn on a term deposit, and you can generally classify these terms into either 'short' term deposits or 'long' term deposits.
What are short-term deposits?
Short-term deposits are considered to be term deposits with terms lasting no longer than one year. The more common term deposit terms include six, nine and 12-months, but many ADIs offer term deposits of any duration in between, be it three or four months, one month, seven months or 11 months.
Some providers classify their term deposits based on days, not months. So while some might call them, say, three-month term deposits, another provider might call their product a 90-day term deposit.
Since they last for less than a year, short term deposits are usually more likely to pay interest at maturity (aka the end of the term). Some may pay it on a more regular basis (like monthly or semi-annually), but the interest rate might be slightly reduced if they do.
What are long-term deposits?
Long-term deposits, as you might have guessed, have terms lying anywhere between that one to five year range (and longer, in rare cases). Common long-term deposit terms are terms up to two-years.
Long-term deposits can have interest paid at maturity too but are more likely to pay interest on an annual or monthly basis.
Short vs long-term deposit rates: which earns more interest?
In the majority of cases, longer-term deposits have higher interest rates than shorter ones. This is because banks want to hold your deposits for an extended period of time, so they're more likely to offer a more lucrative interest rate to attract your business. Plus, term deposit interest rates are expressed on a per annum basis, meaning a six-month term deposit interest rate is actually half that.
Looking at data from the Reserve Bank showing the average term deposit rates across the big four plus Macquarie Bank, the average term deposit rates were the following in June 2019:
- Six months: 1.67% p.a.
- 12 months: 1.76% p.a.
- Two years: 1.80% p.a.
Looking further and analysing the majority of term deposit products in the market for each of the key terms, these numbers are slightly higher, given the big four tend to offer lower term deposit rates than many other institutions. The average term deposit rates across most term deposit products in May 2019 can be seen in the infographic below.
For six-month term deposits, the average is 2.23%, whereas it's much higher for five-year term deposits at 2.38%. But you can also see longer doesn't always equal higher. For example, nine-month deposits have a lower average interest rate than six-month deposits, while four-year term deposits are lower on average than three-year term deposits.
But in most cases yes, long term deposits have higher interest rates than short term deposits. But this might not necessarily be the only factor you should care about...
So why wouldn't you pick a longer term deposit?
Long-term deposits can be useful for avoiding interest rate drops. Lots of term deposit products have had their interest rates cut following June 2019's cash rate reduction - the first in nearly three years. With another one or two rate cuts expected, term deposit rates are likely to follow suit. Locking in a higher term deposit rate for a few years can help you avoid these interest rate cuts since your term deposit rate can't be changed until the term expires.
This can be a double-edged sword too as rates can also rise during your term. But this is unlikely for the near future, based on comments from the Reserve Bank.
There are disadvantages to taking out a long-term deposit even though you're more likely to get a higher interest rate. Term deposits by nature are a fixed product - once your money is locked away it remains locked for the duration of the term. If you want to withdraw it, you'll probably have to pay an interest rate penalty, which is usually based on how much of your term has elapsed. With a longer term, people are more likely to need that money at some point. Of course, you can avoid this problem by not depositing what you can't afford to lose, but you never know what the future holds.
Pros and cons of short and long-term deposits
|Short-term deposits||Long-term deposits|
|Lower interest rates on average||Higher interest rates on average|
|Useful for shorter-term savings goals - you can earn a guaranteed rate of interest on a set amount for up to 12 months||Useful for longer-term savings goals or for securing money for the future|
|Interest isn't locked away for too long, which is good if you need to access the money||Interest is locked in for longer, meaning you can't withdraw it without penalty for longer|
|Shorter term means you experience cash rate cuts sooner||Locked interest rate means you can avoid cash rate cuts|
|Shorter term means you experience cash rate rises sooner||Locked interest rate means you can miss out on cash rate rises|
|Are a little more flexible||Are less flexible|
Both short and long-term deposits can experience rollovers at the end of their term. which means your bank automatically renew your term deposit - sometimes at a lower rate! They're obligated to notify you about this ahead of time, but if you 'set and forget' your term deposit, you could be stuck in another term deposit you didn't want.
Short-term deposits may be better suited to people with shorter-term savings goals who want to avoid spending money in the process. Long-term deposits of more than one year are probably more suited to people with longer-term ambitions who aren't afraid of having that money locked away for a long period of time, and will be able to cope without it.
For disciplined savers, you could be equally as well off by just using a high-interest savings account, which are extremely similar to term deposits but allow you to withdraw and deposit money at any time.