Uncertainty is the only certainty of life. This is indisputable. However, what is disputable is your understanding and preparation as a consequence of that understanding. For instance, raising money in a very short period of time is a task for many. Some near and dear one meets with an accident and for hospitalisation you have to pay in cash and claim for reimbursement.
Consider a situation in which your existing investments are maturing next week and you have a wonderful investment opportunity today. How do you get a bridge loan quickly. Besides a few investment opportunities available, your bank fixed deposits, which can come handy in times of emergency.
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Most people, however, do not make the most of their bank deposit option. Individuals typically jump to liquidate their bank fixed deposits. However there are some disadvantages of the same.
First, you end up getting lower rate of interest if you break the fixed deposit before the maturity date. Second, you go to the bank after say fifteen days to invest in a bank fixed deposit and the rate of interest offered to you may not be the same what was offered to you earlier.
For example, if you have invested in a three years bank fixed deposit, 12 to 18 months ago; you could have earned a rate of interest in the range of 9.5 to 10 percent. But, today, if you go to make a new fixed deposit, you end up getting a rate of interest of around 8.25 to 8.75 percent.
To avoid that, it is better to consider an overdraft against your bank fixed deposit. It is a short term loan offered by bank. The bank fixed deposits continue with the bank and keep earning interest at the rate of interest agreed by the bank at the time of making these fixed deposits.
The bank allows you to write a cheque to the extent of 90 percent of the value of the fixed deposit. You have to pay an interest above 100 basis points in excess of the interest rate payable on the bank fixed deposit for the time you have used the credit.
This can best be understood with the help of an example. Say, you have a fixed deposit of Rs 1 lakh for three years with a bank earning 9 percent rate of interest. You applied for an overdraft facility and the bank obliged. You wanted some short-term money for 10 days and wrote a cheque of Rs 10,000.
On the 10th day you have to repay Rs 10,000 along with interest at 10 percent rate of interest per annum for those 10 days only. The fixed deposit remains intact and earns interest for you in those days too and in future too at 9 percent rate of interest.
This overdraft against fixed deposit can be useful funding option for individuals. It can help you pay for medical emergencies and also can be used as a wonderful bridge loan. For example, you have invested in a fixed maturity plan last year.
The maturity of the scheme is 15 days from now. And you see a good Non-Convertible Debenture (NCD) issue offering 11 percent rate of interest which closes in the next three days.
Now you need some money today which you can return in 15 days time. In such a situation, invest in the NCD today using overdraft against fixed deposit and pay your bank after 15 days from the maturity proceeds of the fixed maturity plan.
Though this sounds as a splendid option, you should be careful of using this overdraft mechanism to raise funds for short-term trading or punting. If you lose money, you lose your fixed deposit too. If you cannot repay, the banks forfeit your fixed deposit. So, use your fixed deposits judiciously.
The author is co-founder and director of www.creditvidya.com