Fixed deposits are one of the most darling instruments among investment avenues for every risk-averse investor where they park their substantial amount for a stipulated time period and get a fixed rate of interest which remains locked till the duration of their investment. But, at times, we may need some money in the wake of any financial emergency or require some funds at a short interval to meet any financial mess. In such case, personal loans can cost you around range between 18% to 24% per annum and by liquidating any fixed deposit prematurely may attract penal charges to the extent of 1% vary from bank to bank. Moreover, the interest will also be recalculated according to the period for which you have maintained the deposit which could result in notional loss of interest amount.

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Loan against Fixed Deposits

You may wonder that the cheapest option is available to take a loan against your bank fixed deposit rather than just liquidating the deposit and taking the full amount. You can easily get a loan against it without having to break it. This is similar to a personal loan but at the cost margin of 1-2% over the existing fixed deposit rate. However, the loan is structured as an overdraft facility against your fixed deposits. Interest will be charged on the amount drawn and not the limit set. Say, you have a deposit of Rs 1 lakh earning an interest of 9.5 per cent a year. At 90 per cent margin, which is the most likely, your overdraft limit is set at Rs 90,000. If you need Rs 50,000, you can withdraw it from the overdraft account at 10-11.5 per cent (0.5-2 per cent over deposit rate). The interest will be charged on Rs 50,000 and not on Rs 90,000.

Flexibility in all aspects

There is no need to set a specific tenure as you can avail of the loan till the deposit matures. If outstanding is left as unpaid till maturity, the loan would be adjusted against your fixed deposit proceeds.  Neither are prepayment penalties imposed to foreclose the loan nor any restriction on the end use of funds. It can be used to meet any financial requirements such as business and direct investment in India or for buying property. Banks may structure a flexible repayment plan, wherein the loan can be repaid in installments or lump sum. Preferred customers may also get an overdraft facility, wherein they are allowed to borrow up to a limit, and repay as when cash comes in.

Cost-benefit Analysis

Even at the cost of 1-2%, it makes more sense than liquidating the asset. To liquidate an FD, most lenders will charge you a premature withdrawal penalty; the charges vary from bank to bank. Usually, the penalty for breaking an FD is 0.5-1% and it is applicable for the period the deposit has remained with the bank.

Suppose you have an FD of Rs1 lakh for two years that earns 9.50% per annum and decide to break it after six months. If the six months FD has an interest rate of 8% and premature withdrawal penalty 0.5%, you will get an interest rate of 8% minus 0.5%, or 7.5%, on your deposit. So at the end of six months, your interest would come toRs3,785 at 7.5%.

If you had remained invested for two years, your Rs1 lakh would have grown to around Rs1.21 lakh at the end of the tenor. But if you had taken a loan of, say, Rs90,000 at the end of six months at 10.50% and repaid the principal at the end of 1.5 years, you would have paid around Rs15,280 as loan interest and the net interest income (total interest income minus cost of loan) at the end of two years would be around Rs5,555. So despite paying for the loan, there is a profit, while the principal remains intact. Hence, it definitely scores over a personal loan that you would normally look at for immediate cash needs in terms of rate of interest.

Advantage over premature liquidating FD

Banks are more comfortable offering these loans against fixed deposits as there is no fear of non-performing assets. Further, as FD is the underlying collateral, banks readily sanction loans against the deposit up to maximum 90 percent of your principal invested. The processing of loan application is so easier than taking other loans. You have to just deposit your fixed deposit receipts with your banker, after which the bank marks a lien on the fixed deposit and grants the loan at the spot. You can either borrow against the entire deposit amount or according to your requirement

Points to Ponder

Loan against fixed deposits is advisable for only disciplined individuals. This is because many people tend to misuse the funds in speculative activities such as short-term trading in shares, commodities, gold or currencies which they may make backfire. Loans are granted only against deposits which are free from lien, restraint or encumbrance and not in a minor’s name. In case of a joint holding, all holders of the deposit have to sign the loan documents. The liability to repay lies with all the holders of the deposit and interest will continue to be paid on the underlying deposit.

In the taxation angle, salaried individuals cannot get tax benefits on the interest paid on loans against fixed deposits. Only self-employed individuals using the funds for the purpose of business can deduct the interest paid as a business expense from their business income and pay tax on the remaining amount only.

Hence, by liquidating any fixed deposit to meet short term emergencies, you lose accumulated all your principal plus interest at one go but re-building of a new fixed deposit is very difficult. Hence, to access funds at short term level, you must take loan against your Fixed Deposits.     

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Suresh Kumar Narula

SEBI Investment Advisor, Founder & Principal Financial Planner at Prudent Financial Planners
Suresh K Narula is founder and Principal Financial Planner at Prudent Financial Planners. He has earned the professional CERITIFIED FINANCIAL PLANNER and got registered with SEBI as Investment Advisor. He writes on personal and financial planning articles and got published in Dainik Bhaskar, Business Bhaskar and The Financial Planner's Guild, India. He is also a member of Financial Planner's Guild India ( An association of practicing SEBI registered Investment advisers) to create awareness about Financial Planning in general public, promote professional excellence and ensure high quality practice standards. Suresh received his an M.com from Himachal Pardesh University and an MFC from Punjab University, Chandigarh. He can be reached at info@prudentfp.in
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