Often, we find ourselves in sudden need of funds, and our options at such times are quite limited. Suppose you need ₹3 lakh. You hold a Fixed Deposit (FD) worth ₹5 lakh, earning an annual interest rate of 7%. You now have two choices: either break the FD to withdraw the money or take a loan against the existing FD.

Both options would serve your purpose, but the costs involved differ. Therefore, it is essential to understand the full financial implications before making a decision.

What happens if you break the FD?

Let’s assume you have a one-year FD of ₹5 lakh with an interest rate of 7%. If the FD runs for the full tenure, you would earn approximately ₹35,000 in interest over the year.

However, if you need ₹3 lakh after six months and decide to break the FD, the bank typically pays interest based on the rate applicable for that specific duration rather than the original FD rate. Additionally, depending on the bank's policy, a premature withdrawal penalty may also be charged.

Penalty and Interest Calculations

For instance, suppose the applicable interest rate for a six-month FD is 6%, and the bank levies a 1% penalty. In this scenario, the effective interest rate drops to 5%.

At a rate of 5%, the interest earned on ₹5 lakh over six months would be approximately ₹12,500. This represents a difference of about ₹22,500 compared to the ₹35,000 interest you would have earned had the FD run its full course.

What is the cost of taking a loan against the FD?

Now, let’s consider the second option: you do not break the FD but instead take a loan of ₹3 lakh against it. For example, suppose the bank offers the loan at an interest rate that is 1.5% higher than the FD's interest rate. This means the interest rate on the loan against the FD (at 7%) would be around 8.5%.

If a loan of ₹3 lakh is taken for 6 months, the interest payable would be approximately ₹12,750. During this period, your ₹5 lakh FD remains active, meaning you continue to earn interest on it.

Comparison of the two options

Break the FD    Loan against FD
Your requirement    ₹3 lakh    ₹3 lakh
FD    ₹5 lakh closed    ₹5 lakh continues
FD interest    Approx. ₹12,500    Approx. ₹17,500
Loan interest    —    Approx. ₹12,750
After 6 months    FD ceases to exist    FD continues
Additional benefit    —    Continue earning FD interest

If you need ₹3 lakh for 6 months, taking a loan against the FD works out cheaper in this example. However, the ₹3 lakh loan will have to be repaid later.

When is a loan against FD a better option?

If you need funds for a short period and expect to receive the money back within a few months, a loan against FD can be a viable option.

In this scenario, your FD remains intact. You can repay the loan once your need is met. It also helps avoid the loss of interest income that occurs when breaking an FD prematurely.

When might it be wise to break the FD?

If you need money for a long period and your repayment capacity is uncertain, taking a loan just to preserve the FD could prove costly.

In such cases, you should compare the cost of breaking the FD versus the total cost of the loan—especially if the loan interest rate is high.

Consider these 3 things before deciding.

First, ask the bank exactly how much money you would receive in hand if you were to break the FD today. Next, find out the interest rate and all applicable charges for a loan against the FD.

Then, calculate the total cost for both options. If the requirement is for a few months and you expect funds to come in soon, the option of a loan against FD is worth considering. If you need funds for the long term, it is crucial to compare the total costs of breaking the FD versus taking a loan.

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