Term deposits vs. High-interest bank accounts

Term deposits vs. High-interest bank accounts

Term deposits vs. High-interest bank accounts

You may have noticed a lot of advertising, especially in the last few years, around high-interest bank accounts. These are bank accounts that reward people with a higher-than-average interest rate on their deposits if they meet certain conditions. In some circles, they’re becoming more sought-after than “traditional” higher-yield term deposits. But what are the differences between them? Read on in Smallloans.com.au latest edition of Finance Explained.

What is a term deposit?

A term deposit is an amount of money that you deposit in a bank or credit union that have a fixed amount of interest over a fixed timeframe. For example, a term deposit may have an interest rate of 5% per annum (p.a.) over five years. The interest is then paid on the deposit when the deposit matures (i.e., finishes.) or annually in the case of longer deposits.
Some banks calculate interest in even shorter intervals such as monthly or even daily, and give you a choice of these interest terms. Term deposit lengths (“terms”) can range from six months to several decades (in some cases.)

What is a high-interest bank account?

A high-interest bank account does what it says on the tin – it’s a bank account that pays higher than average interest rates on deposits. This may come in the form of bonus interest when you don’t make any withdrawals and/or deposit a certain amount within a certain period (usually a month.)
Sometimes these accounts are known as “online savers,” and are not accessible at ATMs. You can only use it via your bank or credit union’s online banking service.

Basic vs compound interest

High-interest bank accounts will usually only give you basic interest, i.e., interest on the amount in your bank account. Some term deposits earn interest not only on the initial deposit, but on the interest you have already earned. This is called “compound interest” and gives you an extra “bonus” without having to deposit more money. Even so, these may vary.

So what’s better?

That depends on what financial circumstances you are in. If you have a lump sum of money and have no intention of touching it over a long period of time (several years, say) then a term deposit may be best.
The advantages of a term deposit are that your interest rate is almost always fixed and not subject to outside market pressures and official cash rates. Term deposit interest rates are usually much higher than bank accounts. If you have a significant amount to deposit, you may be able to negotiate with your bank on even better rates.
The downside is if you need to withdraw from the term deposit, your high interest payments are all but lost. This varies among different term deposit products. In some cases, if your interest rate was 7%, the penalty may be 3%, leaving you with 4% interest. Other products may have a limit of what you can withdraw without being penalised. It’s your responsibility to ask these questions when inquiring about term deposit products.

Flexibility vs. reward

High-interest bank accounts are better for people who require flexibility. Even though some of these bank accounts are “online only,” you can use your online banking facility to transfer funds into your “everyday” banking account or credit card account when needed. The downside is you will forfeit any high-rate “bonus” interest for that time period, only gaining the usual “base rate.” Also, your interest rate is influenced by official cash rates. If it goes down, so does your interest rate.
Some high-interest bank accounts also require you to deposit a minimum amount each time period to qualify for the bonus interest. If you do not deposit these funds, then you won’t get the bonus interest either.
Some high-interest bank accounts also attract fees, so you should also factor this into any savings goals you may have.