Breaking an FD or taking a loan: Which is better? How to arrange funds when needed

Here is a sensible answer to the question of whether you should break your Fixed Deposit (FD) or take a loan when you need money.

When faced with a sudden need for cash, most people struggle to decide whether to break their FD to withdraw funds or manage the situation by taking a loan. Both options have their pros and cons. Breaking an FD can impact your investment and the interest earned, whereas taking a loan involves paying interest. Therefore, it is important to understand a few key points.

What should you do?

First, determine the amount of money you need and the duration for which you need it. If the amount is small and you expect to repay it soon, breaking the entire FD is not a wise move. However, if you need a large sum and repayment might take time, you can compare the loan's EMI against the returns from the FD.

What are the downsides of breaking an FD?

Banks levy a penalty for withdrawing an FD before maturity. This means you do not receive the full interest rate originally promised at the time of booking the FD. For instance, if you opened a 3-year FD but broke it after just one year, the bank may reduce the interest payout in accordance with the deposit terms.

Can you take a loan against an FD?

If your FD is earning a good interest rate and you do not wish to break it, you can consider the option of a loan or overdraft against the FD. In this arrangement, the FD serves as security with the bank, and you can access funds up to a certain percentage of its value. The advantage here is that the FD remains intact, allowing you to continue earning interest on it. However, you are required to pay interest on the loan amount you borrow.

How do you decide?

There is no single answer to this. You need to compare the interest earned on the FD with the interest payable on the loan. If you are earning around 7% interest on your Fixed Deposit (FD) and the interest rate on a loan against that FD is lower, it makes sense to take the loan while keeping the FD intact. However, if the loan interest rate is very high and the required amount is small, it would be better to simply break the FD.

Should you take a personal loan?

While it is easy to take a personal loan when needed, the interest rate is higher than that of a loan against an FD. Additionally, there are processing fees and other charges involved. Therefore, if you already hold an FD, you should consider either breaking it or taking a loan against it, rather than opting for a personal loan.