Fixed deposits (FDs) are among the most popular investment instruments for Indians looking for assured returns with minimal risk. However, life is unpredictable, and situations arise where you might need to access funds locked in your FD. When that happens, you’re typically faced with two choices: prematurely break the FD or take a loan against it. Both options serve the purpose of liquidity but come with very different financial implications.
What happens when you withdraw your FD early?
Breaking your FD before maturity is simple but comes at a cost. Banks generally levy a premature withdrawal penalty of 0.5% to 1% on the interest rate that was initially agreed upon. Moreover, you may not get the contracted rate at all — the interest may be recalculated at the rate applicable for the period you actually held the FD. For example, if you booked a 5-year FD at 7.5% but withdrew it after 2 years, the bank might give you only 6% (the 2-year rate) minus penalty. That’s a significant loss, especially for large deposits.
Additionally, breaking your FD resets your savings journey. If your FD was meant for a long-term goal — such as a child’s education or retirement — accessing it early could disrupt your financial planning and reduce the compounding benefit over time.
Why a loan against FD could be a better choice
Taking a loan against your FD allows you to meet urgent financial needs without touching the principal investment. Most banks allow you to borrow up to 90% of the FD amount at an interest rate only 1% to 2% higher than the FD’s return. For instance, if your FD earns 7%, your loan rate might be 8%–9%. This is significantly cheaper than personal loans or credit cards, where interest rates can go up to 18%–24%.
What’s more, the FD continues to earn interest throughout the loan tenure. This means your overall wealth isn’t eroded, and you get to retain the maturity benefit. Also, since this is a secured loan, the documentation process is minimal — there’s no need for income proof or credit score checks.
Banks usually offer such loans in the form of an overdraft or term loan. An overdraft offers flexibility, allowing you to withdraw as needed and pay interest only on the amount used. This can be ideal for short-term or uncertain expenses.
Evaluate based on financial urgency and repayment capacity
If your financial requirement is short-term and you have a repayment plan in place, a loan against FD is almost always the smarter option. It ensures your investment stays intact, your credit score remains unaffected, and you save on premature withdrawal penalties.
However, if you’re unsure about repayment or are dealing with a long-term crisis — such as job loss or medical emergencies — withdrawing the FD may be more practical. That way, you don’t risk defaulting on a loan or paying additional interest. It’s also worth breaking the FD if the remaining term is very short or if interest rates have dropped significantly since you booked the deposit and reinvestment won’t yield much.
Tax implications matter too
Another aspect to consider is the tax treatment. Interest earned on FDs is taxable as per your income slab, whether you break it or take a loan against it. However, premature withdrawal doesn’t give you any tax benefit, while loan repayment doesn’t add to your tax burden either. You’re just paying a small extra amount to preserve your investment — and that can be a better deal in the long run.
When you should definitely avoid premature FD withdrawal
Avoid breaking your FD if you are in a high-interest rate regime and the FD was booked at a much better rate than current offerings. In such cases, losing that high-yield instrument may hurt your portfolio. It’s also unwise to break your FD if the penalty is steep or if you're close to maturity — waiting a little longer could save a substantial sum.
The bottom line
Breaking your fixed deposit should be a last resort. In most situations, a loan against FD gives you access to immediate funds at a low cost while allowing your money to continue earning interest. It's a smart liquidity solution that protects your financial goals. However, if repayment is a concern or the penalty is negligible, a premature withdrawal might still be the better path. The key is to assess your situation calmly and choose what supports your long-term financial health.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
