What do interest rate hikes mean for term deposits?

Earlier this month, the Reserve Bank of Australia (RBA) lifted interest rates for the second consecutive month in order to help curb rapidly rising inflation. The 50 basis point increase – the largest monthly rise in 22 years – has brought the cash rate up to 0.85%.

This rise is unlikely to be the last, with financial analysts predicting further interest rate rises over coming months. While this prediction has many mortgage holders concerned, it’s welcome news for savers, who hope to see these hikes passed on to term deposit and savings accounts.

In fact, the RBA’s decision has led to an increase in some term deposit rates – including for selected National Seniors Term Deposits. But before you consider if a term deposit is for you, let’s take a closer look at how they work and when they may make a good investment option.

Term deposits are a low-risk way to invest your money and earn interest at a fixed rate over a period of time (or term). The period of time your money will be locked away in your term deposit can range from one month to five years. The longer your term is, generally the higher your interest rate will be.

You will be required to deposit a minimum amount (which varies by bank) to open a term deposit, however most term deposits will have no set-up or account fees. If you need to withdraw your money before the term ends (also referred to as maturity), you will generally need to give 31 days’ notice and you may receive a lower interest rate.

Some institutions will ask you to open a linked transaction account to pay your interest and this linked account could charge fees when you wish to withdraw your money. However, you may be able to request for your interest to be paid into an account which does not include withdrawal fees – such as the National Seniors Money Manager. 

Term deposits are protected by the Australian Government’s Financial Claims Scheme, which will pay up to $250,000 (per person, per financial institution). 

Once your term deposit matures (or reaches the end of the term period), your provider will contact you to let you know how much interest you’ve earned and what options you have available. If you don’t do anything, it may roll over into a new term deposit, with a potentially lower interest rate.

This depends entirely on your level of risk tolerance and financial goals.

Term deposits are guaranteed to give you a return at the end, making them one of the lowest risk forms of investment. They also often offer more competitive interest rates than standard savings accounts, however they tend to return less over the long term than other investment types like shares, property, or bonds.

As you can’t easily access your money during the term, it removes the temptation for impulse spending, making it an attractive option if you want to avoid spending your savings, however you won’t be able to add money to it in this time either.

One key difference between term deposits and savings accounts is how interest is applied to your savings.

Term deposits have a fixed interest rate, which locks your interest rate in for the length of investment term. If you open a term deposit account for 18 months at 2.0% interest, for example, your interest rate will remain unchanged even if the interest rates rise or fall during that time. Many banks have already passed on the recent interest rate hikes to new term deposits, however those with term deposits already open, will not see a change.

Savings accounts on the other hand typically have a variable rate, meaning your interest rate may increase or decrease. Passing on interest rate hikes to savings accounts is at the bank’s discretion, and not every lender has passed on the recent RBA increases across all savings accounts.

If you are looking to get a term deposit or your current term deposit is nearing maturity, it pays to shop around and see who is offering the most competitive rates and terms.

When evaluating term deposit options, consider the below:

• Interest rate – How much interest will they pay and how frequently (monthly, annually or at maturity). Will the interest rate change based on how much you invest? Many banks will offer higher rates of interest on term deposits with a longer term with interest paid at maturity.
• Time period – How long will your money be locked away for? Will interest rates likely change during that timeframe?
• Investment required – How much deposit is required to open the term deposit?
• Fees – Will there be set-up or account fees? What is the interest rate adjustment if you need to withdraw your money before maturity?

The Government’s Moneysmart website warns individuals not to rely too heavily on comparison websites, as they often make money through promoted products and may not include all available options. They can be a good starting point for your research but it is best to take their advice with a grain of salt.

Sources: Moneysmart