The national cash rate
The banks and financial institutions typically set their interest rates based on the cash rate determined by the Reserve Bank of Australia (RBA). Once the RBA has announced the cash rate, banks consider if they are going to hold, increase or decrease their own interest rates, both on loans and savings. They aren’t legally obliged to match any changes announced by the RBA but, in the past, the major banks have traditionally followed the RBA’s lead.
The term of your deposit
Additionally, the longer the term you choose, and the more you deposit, the higher the interest rate you’re likely to be offered. This is called a ‘tiered’ interest rate system. Interest rates rise as the size of your deposit and term length grow. For example, a bank may offer a six-month interest rate of 0.65% p.a. for a term deposit of $5,000. This may rise to 1.25% if you agree to a term deposit of one year. If you have $50,000 to deposit, the interest rate offered could be as high as 2.5% p.a. if you agree to park your funds for a minimum of two years.
The frequency of your interest payments
The frequency with which you receive your interest also affects the interest rate you receive. You have a choice as to whether you receive your interest monthly, every three months, quarterly, annually or at the maturity of your deposit. Generally, if you choose to receive your interest annually or at maturity you’ll get a better interest rate, but you’ll lose the compounding effect of earning ‘interest on interest’ if you choose to have your interest paid back into your term deposit on a more regular basis.
Where are interest rates heading?
In November 2020, Australia’s official cash rate reached its lowest level in history at 0.1% p.a. and remained there for the next 15 months. However, in May 2022, the RBA increased the official cash rate by 0.25% p.a. for the first time since early 2010, signalling that the tide has turned and interest rates may now be on their way up again (in response to a rising 5.1% inflation rate). The RBA anticipated further rate rises in 2022.
In response to this increase in the official cash rate (up to 0.35% p.a.), most banks and financial institutions raised their interest rates. This is good news for those looking to lock their money away in a term deposit, as it means their savings will likely earn a higher rate of interest.
