Ram Kumar, a professional from Mumbai was a happy man. His daughter was all set to get married. His son was about to go to college. But, just a week before the wedding, there a thief broke into his house and stole a lot of valuables and cash worth Rs.10 lakh. Suddenly, stress and worry overshadowed Kumar’s happiness. He needed around Rs.7 lakh immediately to pay for some of the wedding expenses.

He had a Fixed Deposit (FD) of Rs.8 lakh. But, that was earmarked for his son’s education. Should he break the FD? Or, was there any other way to arrange this huge amount in such a short period? The worried father did some calculations before taking a decision.

Here is what He Figured Out:

Breaking an FD:

You invest in an FD for a fixed tenure. If you withdraw money before the end of the tenure, you ‘break’ your FD. Kumar’s FD was for five years. The interest rate was 10% per annum. At the end of the tenure, he would get Rs.11.3 lakh. This means he would earn an interest of Rs.4.3 lakh.

Now, if he broke his FD at the end of the first year, he would have to pay a penalty. Suppose he paid a penalty of 2%. He would get Rs.7.54 Lakh—not Rs.11.3 Lakh. This means he would only earn an interest of Rs 54,000 after deducting the penalty. Thus, if he broke his FD, he would have to forego a profit of Rs.3.76 lakh.

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Kumar discussed this over with a friend, who was a financial expert. His friend asked him to consider taking a loan, instead. He could either take a standalone personal loan, or opt for a loan against the FD.

Loan Against FD:

You can take a short-term loan against your FD without breaking it. Most lenders allow you to borrow up to 90% of the FD amount. The interest you pay is often a percent or two higher than your FD interest rate. Such loans do not have any prepayment charges. But, you may have to pay a small processing fee.

Suppose Kumar took a loan against his FD for four years at 12%. He would now have Rs.6.3 lakh with him. That would be 90% of the loan amount. At the end of the fourth year, his interest cost would be about Rs.1.66 lakh. This is much lower than what he would have to forego if he broke the FD. Also, such loans have a flexible repayment schedule. He could either pay in instalments, or make a lump-sum payment when the FD matured.

A standalone personal loan too works in a similar fashion. The only difference is, the loan value depends on the amount you are eligible for. It is not dependent on the value of your FD investment.

Either way, a loan—be it against your FD or a separate one—helps you meet your immediate needs while ensuring your investment continues to earn money. This helps you to reduce your net cost.

Kumar slept over the solutions his friend provided.

He did not have too many options. He needed the money at once. He weighed all the aspects. Then, he concluded that the cost of breaking his FD would be more than the cost of interest. So, he finally took a loan against the FD.

But, if you are still confused between the options, take a look at these myths related to FDs and clear your doubts:

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