What you stand to lose by breaking an FD
A popular savings and investment tool is the Fixed Deposit. It has a number of features like, minimum risk, guaranteed returns, flexible tenure. All of this makes it a favourite among investors. Fixed Deposits are also known as Term Deposits since they’re opened for a specified time period. This can range from 7 days to 10 years.
While, many investors ladder their FD investments, exigencies can crop up out and your only option is to break the FD. Withdrawing an FD before maturity is known as breaking an FD.
Effects of Breaking an FD
Lowered Interest Rate
When you break the FD, you get a lower rate of interest and also pay a penalty for the premature withdrawal. Say, you opened a 1 year FD at 7.5%. If you decide to break an FD at 10 months, the interest earned on the FD will reduce by 1%. The reduced rate is applicable right from the start of the FD tenure. So, in effect you’ll earn a lower return on your investment than what you initially planned.
Banks calculate the interest on premature withdrawal as follows by using online FD Calculator;
Interest rate on premature FD withdrawal = Interest rate for the actual FD tenure prevailing at the time of investment - 1%.
In addition to a reduced interest rate, you’ll also have to pay a penalty. This can range from 0.5% to 1% on the interest. FDs with sweep-in facility and fixed deposits with periodic interest payout are charged a penalty in the event of a premature withdrawal.
So, by breaking an FD, you’ll suffer a reduction in interest and a penalty. All of this drastically lowers your return from the FD investment.
When is Breaking an FD Profitable?
If you find a reinvestment option that gives you a much higher return compared to the FD interest, it can be worthwhile to break the FD. Do the math and see if the returns from the new investment are substantially higher that the FD return after considering the penalty and reduced return. If you’re looking for when to break the FD, it’s best to do so when the FD is relatively new. This is generally a period of a few months from the time when you’ve opened the Fixed Deposit account.
Alternative to Breaking an FD
The most common reason depositors resort to breaking an FD is to use the cash to meet immediate needs. Instead of breaking the FD and lose interest, it’s wise to take a loan against the FD. Not only do you get the required funds as a loan, your FD investment continues to earn interest.
Usually, you can get a loan to the extent of 90% of the FD maturity value. The rate of interest charge will be 1% to 2% more than the FD rate. The only limitation is that the loan tenure can’t extend beyond the FD maturity date. For example, if the FD is due for maturity on 1st April, the loan tenure can’t extend beyond 1st April.
FDs are great investment options. By laddering your investments based on accurate estimates of your future cash requirements, you can avoid breaking an FD. This gives you the option to make a lot more money which can be put into other investments.