Unsurprisingly, term deposit rates aren't set randomly. Each authorised deposit-taking institution (ADI) uses a variety of external and internal factors when deciding what interest rates to offer, and these rates are reviewed almost daily.
The key factors that help decide term deposit interest rates are:
- The Reserve Bank cash rate
- Competition in the market
- The investment length (or 'term')
- The amount invested
- The frequency of interest payments
What affects term deposit rates: the cash rate
The cash rate - a benchmark interest rate for Australian financial institutions set by the Reserve Bank - is a big influencer of individual term deposit rates. Interest rates on most banking products, mainly home loans, term deposits and savings accounts have historically tended to follow the cash rate's movements, and we've seen an example of this recently. When the cash rate was decreased for the first time in nearly three years in June 2019, rates on the vast majority of these products fell by a similar amount.
You can see an example of the past relationship between the cash rate and term deposit rates in the infographic below.
Graph source: savings.com.au
What affects term deposit rates: your lender's financial condition
Term deposits are often an important source of funding for financial institutions. To encourage customers to take out a term deposit with them they might raise interest rates. Lenders use deposits to fund their daily operations. For example, they can provide a term deposit rate at 2.50% interest, and over the term specified, might lend that money out to a home loan customer at 3.50%, thus making a positive margin.
What affects term deposit rates: market competition
Institutions try to out-do each other with interest rates in order to entice new customers. In a positive interest rate market, institutions won't want to get left behind if everyone else is raising interest rates, so they'll probably do the same. This ties in with the above point about using deposits to lend money out - a financial institution can't lend out as much money if it doesn't have as much in deposits, and it won't attract enough deposit customers if it has sub-par rates.
The market becomes more competitive every day, which is why you should do extensive research on term deposits before signing up to one.
What affects term deposit rates: the term
The 'term' in term deposits stands for the length of time your money is invested for. Terms range from as little as one month to as much as five years, with the more common terms being between six months and two years. Each individual term will have its own interest rate. Although not always the case, longer terms usually come with higher interest rates to encourage customers to deposit their money for longer.
The infographic below shows how interest rates increase with longer terms on average. Check each of your chosen provider's terms to see if they offer higher interest rates.
Source: savings.com.au
Also be aware that withdrawing from your term deposit early can reduce your interest rate. The reduction in interest is based on how much of the term has elapsed and varies among providers, so make sure you check the T's and C's.
What affects term deposit rates: the amount invested
Although most term deposits have set interest rates with minimum amounts required (usually no more than $5,000), there are some products that offer special interest rates for deposits over a certain amount. These interest rates are usually higher than the standard rates available, but you might need to be willing to part with a few hundred thousand dollars to qualify.
What affects term deposit rates: the frequency of interest payments
Longer term deposits often pay interest more often than at maturity, which is when the term expires. These term deposits are more likely to pay interest into your linked bank account monthly or annually. Term deposit providers will often have slightly lower interest rates on term deposits with more frequent interest payments. So keep this in mind.
Whatever the reason for changing term deposit rates, know that if you already have a term deposit, that rate can't change until your term has expired. Even if there are three RBA rate cuts (which is expected to happen by the end of 2019), you'd still be locked in your initial interest rate.