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How are interest rates calculated on term deposits

How are interest rates calculated on term deposits

If you're interested in signing up for a term deposit, it really pays to do your research to ensure you receive the best interest rate. Here’s what you need to know about interest rates on term deposits.

What is a term deposit?

A term deposit is a form of cash investment, typically organised through a bank. You invest a certain amount of money for a pre-determined period and receive a fixed interest rate over this time. These types of investments usually last anywhere from a month up to five years, and you can usually only access your money during this period if you pay a penalty fee.

This is why it’s important to make sure you understand how interest is calculated on term deposits so you can make the best investment decision.

How is interest calculated?

There are a few factors that will influence the interest rate of your term deposit. These include:

· The financial institution.

· How much money you invest.

· The length of the investment.

· Market interest rates.

· Interest payment frequency.

Let's say you choose to invest $5,000 in a 12-month term deposit with a fixed annual interest rate of 2.55%. When your term deposit matures at the end of the set period, in this instance 12 months, you can access your initial deposit along with the interest accrued. The interest is calculated as a percentage of the total term deposit amount.

So in this case it would be 2.55% of $5,000, equalling $127.50.

Some term deposits allow you to receive your annual interest via instalments, meaning you can earn smaller interest payments biannually, quarterly or monthly. Choosing a more frequent interest payment can be useful for those who require a steady cash flow, but such arrangements usually equal lower interest rates.

Why it's important to understand term deposit interest rates

Locking your money away for a set period can be a big decision, and it’s crucial to understand how interest rates work so as to make the most of your money. After all, you don’t want to invest your money for two years only to realise you’ve committed to a low rate. Rates will vary depending on the provider and there are usually incentives for leaving more money in for a longer period of time.

It can be tempting to opt for a four or five year investment to receive the higher interest rates, but you should consider your finances or speak to a professional first to make sure you can get by without that extra cash on hand.

Before you pick an investment, make an informed decision by researching the different types of term deposits available. This will help you secure the highest interest rate, without locking away your hard-earned money for longer than you have to.

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