Premature withdrawal vs. loan against fixed deposit: How to pick what works best for you

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Fixed deposits (FDs) are among the most popular saving instruments in India, offering safety, guaranteed returns, and flexible tenures. But fate does not know when it will strike, and suddenly you may need money from your FD when it has not matured yet. In this case, normally you have two options: premature closure of the FD or taking a loan against it. Both have their merits and demerits — and depending on your financial situation, the right choice is.

Here’s how to make an informed decision.

What is premature withdrawal?

Premature withdrawal means breaking your FD before its maturity to access your funds. While most banks allow this, they typically impose a penalty — often ranging between 0.5% to 1% lower than the contracted interest rate. You’ll also only earn interest up to the date of withdrawal, not the full term.

For example, if your 2-year Fixed Deposit earns 7.5% interest but you withdraw after 12 months, you might only receive 6.5% for the 12 months — or less after fees.

What is a loan against FD?

Alternatively, banks allow you to borrow between 90% of the value of your FD as an overdraft or loan. The interest on these loans is generally between 1% and 2% above your FD rate — still less than a personal loan or credit card interest.

For instance, if your FD returns you 7%, your interest on the loan would be about 8% to 9%, and your FD continues to earn interest at the normal rate.

You can repay the loan whenever you wish within the duration, and in the event of default, the bank can encash the amount from the FD itself.

When to choose premature withdrawal

• You do not want to incur any debt, even temporarily.

• The funds are needed for a longer period, and you do not know when you'll repay.

• The FD matures soon, so the loss in interest and penalty will be very small.

• You have no alternative savings or liquid investments to resort to.

When to opt for a loan against FD

• You require funds for a short time (a few months), and do not wish to sacrifice interest income.

• You can repay sooner, keeping interest expenses low.

• You want to avoid breaking a long-term FD, especially if it was booked at a high interest rate.

• You want to maintain financial discipline and keep your investment intact.

What else to consider

• Tax impact: Interest from FD and from a loan against FD is taxable. However, breaking your FD may push your income into a higher tax bracket if the accrued interest is credited all at once.

• Bank regulations differ: There might be restrictions on partial withdrawals or more stringent penalties at some banks, so review the terms prior to making a decision.

• Alternatives: Before you withdraw from your FD, consider whether you can avail an emergency fund, swap mutual funds, or sell relatively less-interest-generating investments.

If the shortage of cash is temporary and under control, a loan against FD is generally the optimal option — you retain your investment, continue to earn interest, and pay lesser rates compared to personal loans. However, if you are in a tight financial situation or are not sure of repayment, breaking the FD might bring peace of mind, despite the penalty.

Your selection needs to be made based on your repayment potential, the quantum and duration of your need, and your remaining term of your fixed deposit. Wise choice helps your need not infringe your long-term savings goals.