What is a term deposit and how does it work?

Term deposits are a low-risk financial product where you store a lump sum of your money away for a pre-determined period of time, known as the 'term'. These terms can last anywhere from less than a month to a couple of years, and you're paid an interest rate on this sum of money that varies depending on how long the term is (among other things).

Term deposits are different from savings accounts. Savings accounts let you withdraw money at any time, whereas with a term deposit, that money is locked away for good until the term is up, which is known as the term deposit's 'maturity'.

The nature of term deposits means they're a very low-risk product, preferred by investors who are happy to sacrifice potentially higher returns in exchange for safety and security.

Are term deposits a safe product?

Term deposits are a safe product, since the institutions offering them need to be Authorised Deposit-Taking Institutions, or ADIs for short. An ADI is supervised by the Australian Prudential Regulation Authority (APRA) under the Banking Act and any term deposit offered by an ADI is backed by an Australian Government Guarantee, which means you can get up to $250,000 of your money back if the institution you bank with collapses.

This is an extremely unlikely scenario which almost never happens in Australia, but it does guarantee up to a quarter of a million dollars with each institution. So should the worst happen, your money will be protected.

The downside to this is that interest rates on term deposits are often pretty low.

How often is interest paid on term deposits?

When you receive your interest payments will depend on the length of the term deposit chosen.

Short-term deposits (those under a year), for example, might simply pay interest at maturity. For example, a one-year term deposit would pay interest at the end of that year-long term, while a six-month deposit might pay interest after six months.

But this isn't always the case. There are some shorter-term deposits that might pay interest at more regular intervals, such as monthly or semi-annually for example. This is usually what happens for longer-term deposits (1+ years), which may pay interest:

  • Annuall
  • Semi-annually
  • Quarterly
  • Monthly
  • At maturity

What is a term deposit and how does it work?

Interest on term deposits might be paid at frequent intervals in some cases, but most of the time that interest is calculated using simple interest. With compound interest, your initial deposit would earn interest as well as the previous interest earned. So you earn interest upon your interest. But with simple interest, interest is just earned on the initial deposit.

Some term deposits earn compound interest but they're few and far between - the majority earn simple interest, which isn't as lucrative.

Is there a minimum amount required for investing in a term deposit?

There are minimum investment amounts on term deposits, but they vary from provider to provider, so it's difficult to say if there's a standard minimum. A common minimum term deposit investment is around $5,000. Certain term deposits with higher interest rates might require a minimum of at least $100,000.

Chances are most well-known institutions will allow you to deposit small amounts of money in a term deposit, but is this something you want to do? Interest rates on term deposits are fairly low, so a $500 deposit will only earn a couple of dollars in interest. The more the merrier.

What happens when a term deposit matures?

At maturity, one of two things will happen:

  • Your initial deposit and any remaining interest will go into your linked bank account; or
  • The term deposit will automatically roll over into a new term deposit with the same term

Your financial institution will usually notify you before your term deposit reaches maturity, and there's usually a cooling off period of about a week where you may be able to ask your provider to give you your money back if it does roll over without your knowledge.

If you do want your term deposit to rollover, then you've got a few options:

  • You can reinvest the whole amount
  • You can reinvest the initial deposit and keep the interest
  • You can withdraw the initial deposit and some of the interest while keeping a smaller amount deposited

Are there any fees on term deposits?

Term deposits are a fee-free product in most cases. With most term deposits, fees and charges usually only arise when you try to withdraw your money before the term is up. If you do decide to do this, you can be charged both a break cost and an interest rate reduction, which will vary based on how much of the term has expired. But term deposits are usually fee-free if you last till the end of the term.

Advantages and disadvantages of term deposits
Confused? Here's a quick summary of the advantages and disadvantages of term deposits:

Pros

  • They're a safe investment with almost no risk – your funds up to $250,000 are covered by the government guarantee
  • Interest rates are fixed, and can't go down until your term is over
  • There's no temptation to spend your deposit since it's locked away
  • There are usually no upfront or ongoing fees
  • They're a very low-maintenance product

Cons

  • They're a conservative product, meaning their interest rates are lower than riskier products
  • Fixed rates mean your rate also can't increase
  • They're not a flexible product - there are large interest rate reductions for early withdrawals
  • Most don't let you add extra funds until the term is over

So is a term deposit right for me?

This depends on what you're looking to gain from your money. If you're a bit of a risk-taker and want to see your investment grow faster and bigger, then you may want to consider higher risk investments like property or equity (shares).

Term deposits, on the other hand, are low risk, low reward products - you're pretty much guaranteed to get what you're promised when you put your money in. In times of increasing economic uncertainty, it might not be such a bad idea to add a term deposit to your portfolio, after you've carefully considered multiple different ones based on:

  • Their interest rates
  • The term offered
  • How frequently interest is paid and calculated
  • How big the early exit penalties are
  • What happens at maturity

Use a term deposit calculator to work out how much you could earn in interest to help make up your mind.