Your Fixed Deposit (FD) reaches ₹10 lakh when an unexpected life event occurs. The requirement emerges where you must possess ₹5. 500,000. The emergence of the inquiry occurs naturally: is it more advisable to terminate the fixed deposit or secure a loan using it as collateral?
Upon initial examination both options present themselves as feasible choices. Which option truly enables you to maintain a greater portion of your wealth over extended periods? Examine the advantages, disadvantages, and practical computations to assist your decision-making process.
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Emergency Situations: Choosing Between FD Liquidation and FD-Backed Loan
The investment vehicle known as FDs attracts numerous investors due to its secure nature and guaranteed returns. These financial instruments include mandatory commitment durations. Before reaching maturity, individuals requiring financial access typically encounter a pair of available options:
- Premature Withdrawal (Breaking FD) – You get immediate access to your money, but with penalties and reduced interest.
- Loan Against FD – You borrow from the bank using your FD as collateral, continue earning interest on it, but pay loan interest until repayment.
There’s no universal answer to which is better, it depends on your income bracket, how much interest you’re earning, and how long the FD has been running.
Let’s unpack both options with updated figures.
What Is a Loan Against FD?
A loan against an FD represents a secured borrowing arrangement. The financial institution leverages your fixed deposit as security to potentially provide you with a loan amount reaching 90% to 95% of your deposited funds. During loan repayment you’ll still accumulate interest on the FD while paying back the loan plus interest at a typical rate of 1. The percentage rate exceeds the FD rate by a range from 5% to 2%.
Things to know:
- Available for individual and joint FDs.
- Not allowed on FDs held in a minor’s name.
- Not applicable on 5-year tax-saving FDs.
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What Does It Mean to Break an FD?
Withdrawing a fixed deposit involves taking out your funds before the maturity date. During short-term cash shortages it proves helpful yet banks might impose a penalty of 0. Interest rates shifted from 5% to 1%. The initial payment you obtain might be less than anticipated due to tax deductions from the earned interest.
Let’s Do the Math: Need ₹5.5 Lakh from a ₹10 Lakh FD?
Assumptions:
- Original FD: ₹10,00,000
- Interest rate: 7.75% p.a.
- Tenure: 2 years
- Withdrawn after 1 year
- Bank penalty for premature withdrawal: 1% of principal
- Loan interest rate: 9.75% (FD rate + 2%)
- Income tax brackets considered: 30%, 20%, 10%, and 0%
Scenario 1: Breaking the FD
1. 30% Income Tax Bracket
- Effective interest rate: 5.425%
- Interest lost (on ₹10 lakh for 1 year): ₹54,250
- Penalty (1% of principal): ₹10,000
- Total cost: ₹64,250
2. 20% Income Tax Bracket
- Effective interest rate: 6.2%
- Interest lost: ₹62,000
- Penalty: ₹10,000
- Total cost: ₹72,000
3. 10% Income Tax Bracket
- Effective interest rate: 6.975%
- Interest lost: ₹69,750
- Penalty: ₹10,000
- Total cost: ₹79,750
4. 0% Income Tax Bracket
- Effective interest rate: 7.75%
- Interest lost: ₹77,500
- Penalty: ₹10,000
- Total cost: ₹87,500
Scenario 2: Loan Against FD
Loan amount: ₹5,50,000
Interest rate: 9.75%
Loan duration: 1 year
Interest payable: ₹53,625
You continue earning full interest on the FD, which helps offset the loan cost. The FD remains intact and keeps compounding if untouched beyond the 2-year term.
Which Option Saves More?
For Individuals in Elevated Tax Categories (20% or 30%):
Victory belongs to Loan Against FD.
Why? Activating the FD breakage mechanism causes both financial penalties and tax liabilities that diminish your investment returns. The interest rates on loans typically remain below the total financial losses incurred from prematurely terminating fixed deposit accounts.
Individuals Classified as Low or No-Tax Payers (10% or 0%):
Destroying the FD could potentially yield more favorable outcomes.
In scenarios where heavy taxation does not apply, the financial burden of early withdrawal remains marginally above or potentially below loan expenses while debt accumulation is completely avoided.
Final Verdict: Think Long-Term, Not Just Quick Cash
For individuals who need to borrow a small amount from their fixed deposit and can settle the debt within a year, opting for a loan against FD proves to be more cost-effective, particularly for those in higher tax brackets.
For those unwilling to manage loan documentation or interest fees while belonging to a lower tax bracket, terminating the FD could prove more practical especially when banks impose minimal penalties or offer penalty waivers. Check our all Financial Tools
Bonus Tip
Before you make a move, ask your bank:
- What’s the exact penalty for premature FD closure?
- What’s the interest rate on a loan against FD?
- Can they waive or reduce penalties for emergencies?
Small details make a big difference in these decisions.
