Fixed deposits have always remained one of the most popular investment avenues in India due to their safety, assured return, and simplicity. Life is so unpredictable; situations do arise when you need liquidity at very short notice, and that compels you to think of breaking your FD before maturity. While penalties or reduced interest rates for breaking your FD prematurely may be there, knowing how to manage this process thoughtfully will help make sure your financial goals remain intact.
In this article, we shall look at how one can break an FD without derailing one’s financial goals. First, we review implications of early withdrawals from FDs; secondly, we provide some useful considerations to meet the need for liquidity without compromising on your long-term financial goals. All calculations here are in INR for better clarity.
Why Break an FD?
In general, FDs are held to maturity, but there does come a time when a withdrawal needs to be made ahead of time due to contingencies such as medical emergencies, making major purchases, or paying off debts. You will need to apply your critical thinking and gauge the financial impact in case the FD has to be broken to balance your need for liquidity with your long-term goals.
Breaking an FD
And there are consequences of breaking your FD prematurely:
Penalty Charges: Most banks charge a penalty for early withdrawal. This usually is a nominal slice of the applicable rate of interest, at about 0.5-1% of the applicable rate.
Reduced Interest Rates: The rate of interest that you are going to get might be considerably lesser than the offered rate depending upon the timeline of your withdrawal. This happens because most banks recalculate the rate on the basis of the term completed before breaking the FD.
Locked-in Funds: Breaking an fd may disrupt your approach to budgeting for long-term investments and, in effect, could hold you back from reaching financial goals, be it towards buying property, funding higher education, or even retirement planning.
Things to Consider Before Breaking FD
There are a few factors to consider before making this final decision that may disrupt your financial stability:
1. Liquidity Requirements
Assess the urgency and importance of your liquidity requirement. Can the reason be met using alternative sources of funds such as balances in your savings accounts, mutual funds, or marketable securities? Ideally, breaking an FD should be the last resort unless there’s no other source of liquidity.
2. Penalty Charges
Calculate the actual penalty incurred before breaking the FD.
Example:
Assume that you opened a bank FD for INR 5,00,000 at an annual interest rate of 6.5% with a tenure of 5 years.
Generally, early withdrawals attract a penalty assessed at 1% of the interest rate.
If you break the FD after completing 1.5 years, the rate of interest that shall be applied shall be reduced to 5.0%, i.e., original applicable rate minus penalty.
Calculate the interest earned after 1.5 years:
Effective rate = 5.0% per year
Interest earned = INR 5,00,000 * 5.0/100 * 1.5 = INR 37,500
The amount would be credited to your account, but you also have to forgo that higher interest potential accruing over the full tenure, which is INR 1,62,500 in 5 years. See if such a trade-off is worth your immediate liquidity needs.
3. Available Alternatives
Consider the following options before breaking your FD prematurely:
Loan Against FD: Most banks offer loans against FDs. A loan against an FD provides access to funds without breaking the structure of a fixed deposit. In general, the loans bear simple interest and are charged 1%-2% over and above the rate of the FD. This avenue helps retain your deposit while providing liquidity.
Partial Withdrawal: A few banks allow for partial withdrawals. Under this facility, the bank liquidates only that portion of your deposit which you need, keeping the rest intact.
Steps to Break FD Without Affecting Financial Goals
Breaking your FD requires some strategic planning so that you don’t incur any financial loss. Following are some steps that you can follow in order to keep your financial goals intact.
Step 1: Determine Liquidity Requirements
Assess the priority of the expense for which you need to break your FD. Paying off high-interest debt is justified, for instance, in that it offsets monetary loss on account of penalties. Discretionary expenses such as purchases in the category of ‘luxury goods’ may not be good enough a reason to liquidate your FD. Knowing how to break an FD wisely helps to ensure that your short-term liquidity needs do not compromise your long-term financial goals.
Step 2: Interest Reduction vs. Alternatives
The bank levies a penalty if you break an FD before maturity and provides reduced rates of interest. Before investing, consider the financial implications of this deal as compared to other sources of liquidity.
Example: Assume your FD is valued at INR 3,00,000 earning 7% interest per year. You have completed 12 months of the tenure and you incur a 1% penalty on premature withdrawal.
How much will you lose?
Effective interest rate = 6.0% original rate of 7.0% minus penalty of 1.0%
Interest earned within 12 months = INR 3,00,000 * 6.0/100 * 1 = INR 18,000
Now, let’s compare this with borrowing INR 3,00,000 at the personal loan lending rate of 12% pa for 12 months:
Interest payable on loan = INR 3,00,000 * (12.0/100) * (1) = INR 36,000
If the cost of borrowing is higher, obviously breaking the FD would be less costly. Take decisions on such comparisons.
Step 3: Take into Account Taxation
The interest on an FD is charged to tax under the head “income from other sources” in the Indian Income Tax Act. If the amount of interest received fell under a different tax bracket, the tax treatment on your FD in case of a premature withdrawal would differ. Always check the aggregate taxable impact to avoid any surprise liability in case you fall in higher tax brackets.
Step 4: Keep Emergency Reserves
It is always prudent to keep a part of the money liquid in other instruments, such as a savings account or short-term investments, when managing liquidity. This reduces the tendency to break FDs during emergencies.
Step 5: Align with Your Financial Goals
Pre-mature breaking of an FD will impact longer-term budgeting strategies. Rethink your financial goals and make sure early withdrawal does not affect the achievement of key goals related to buying a house, retirement planning, or children’s education.
A Practical Case Study
Now, assume Mohan is an investor who deposited INR 2,00,000 in a 5-Year FD that earned interest at 6.8% per annum. Midway through the tenure, a medical emergency catches him off guard, and he decides to make a premature withdrawal.
Calculations:
Pre-mature penalty: 1%
Adjusted interest rate: 5.8% per annum
Interest accrued in 2 years = INR 2,00,000 * (5.8/100) * (2) = INR 23,200
He gets INR 2,23,200 that includes principal and interest.
But if he had approached his bank for a loan against the FD rather than breaking it:
Loan interest rate = 7.8% per annum (FD rate + 1.0%)
Loan processing charges = INR 2,000
Loan tenure = 12 months
Total cost of the loan = INR 2,00,000 * 7.8/100 * 1 + INR 2,000 = INR 17,600
In the case of opting for a loan on FD, Mohan would retain his original FD and pay INR 17,600 as a cost of loan, which is a definite advantage in achieving the long-term goals without losing the accrued interest.
Overview
Fixed deposits are one of the safest avenues for investment. At times, however, emergencies may require breaking this deposit prematurely. If you are wondering how to break FD, it’s important to understand the process and implications involved.
Pre-mature closure of FDs attracts penalties and reduction in the rate of interest, which could dent your financial goals. You basically have to weigh your liquidity needs against the options available, including loans against FDs, before considering the tax implications. The calculations regarding the cost of the penalty versus the cost of borrowing will lie at the heart of making the right decision. This, in turn, will also enable you to plan and balance immediate liquidity needs against long-term financial goals.
This article insists on calculating the financial impact in INR, researching all pros and cons before taking a decision, keeping your emergency reserves, and finding partial withdrawal options so that you don’t compromise on your finances unnecessarily.
Disclaimer:
This is only for information and investor education purposes, and investors must consider all aspects, including financial penalties, tax implications, and alternate sources of liquidity. No financial transaction is totally risk-free. Please consult your financial advisor before acting on any advice.
