Loan Against FD vs Breaking FD: When you have a fixed deposit (FD) investment and suddenly need an amount for an emergency, a thought that may cross your mind is, should you break your FD investment or take a loan against it? When you break an FD, you pay a penalty. When you take a loan against an FD, you need to pay that loan along with interest in a stipulated time. There is no standard solution to this problem. In some conditions, breaking FD may benefit, while in other cases, taking a loan against FD may help save more. But if you need Rs 5 lakh from your Rs 10 lakh FD investments, which option may help you save a higher amount – breaking FD or taking a loan against FD? See calculations to understand.
What is loan against FD?
In a loan against FD, the FD deposit works as collateral for the bank. Since it’s a secured loan, the bank may give you up to 90 per cent-95 per cent of the FD amount as a loan.
An individual or joint FD holders can avail a loan against FD.
FD against the name of a minor doesn’t provide a loan against FD.
5-year tax saver FD
A loan against an FD is not available against a 5-year tax saver FD.
Breaking FD
Banks allow a premature withdrawal of FD, which is also known as breaking FD. An investor can close an FD before its maturity date.
It may come handy in case of a short-term cash crunch, but it may have its disadvantages.
The bank may charge up to 1 per cent penalty of the FD amount.
In the second condition, the effective amount loss can be larger since you also have to pay tax on the FD interest.
Loan against FD vs breaking FD: Require Rs 5 lakh? Which option to choose?
Now, take the example of a Rs 10 lakh FD at an 8 per cent interest rate for 2 years. After 1 year, you require Rs 5 lakh; which option may help you save more?
Breaking FD
If you fall in 20% income bracket
Let’s assume you fall in a 30 per cent income tax bracket; your effective FD interest rate will be 5.6 per cent. You will lose an estimated amount of Rs 28,000 in the form of interest.
If the bank is imposing a 1 per cent penalty on you, it will be Rs 10,000 (1 per cent of Rs 10 lakh).
The sum of both amounts will be Rs 38,000.
If you fall in 20% income bracket
Let’s assume you are in a 20 per cent income tax bracket, your effective FD interest rate will be 6.4 per cent. You will lose an estimated amount of Rs 32,000 in the form of interest earned.
Adding the Rs10,000 bank penalty will make it Rs 42,000.
If you fall in 10% income bracket
Let’s assume you are in a 10 per cent income tax bracket, your effective FD interest rate will be 7.2 per cent. You will lose an estimated amount of Rs 36,000 in the form of interest earned.
Adding the Rs 10,000 bank penalty will make the cumulative amount Rs 46,000.
If you fall in 0% income bracket
Let’s assume you are in a 0 per cent income tax bracket, your effective FD interest rate will be 8 per cent. You will lose an estimated amount of Rs 40,000 in the form of interest earned.
Adding the Rs 10,000 bank penalty will make the cumulative amount Rs 50,000.
Loan against FD
If you take a loan against FD, the bank is likely to charge a 2 per cent extra interest rate than FD’s interest rate.
If the FD rate is 8 per cent, the loan against FD interest rate is likely to be 10 per cent.
On a Rs 5,00,000 loan, the interest amount will be Rs 50,000.
So, in the given situation, the option of breaking FD may be more lucrative, except when you fall in the 0 per cent income tax bracket.
However, taking a loan against FD may be lucrative if your loan amount is significantly smaller than the total FD deposit.
