People save their money in Fixed Deposits (FDs). Alternatively, you probably had an FD where you were excited to receive the highest FD interest rates returns on investment and witness your savings increase. But life is unpredictable. There may be times when you need to withdraw prematurely or ‘break’ your FD before its due date. So, what is premature FD closure? How does it work, and are there any penalties associated with it?
In this article, we are going to look at the effects of early redemption of a fixed deposit and give you some necessary information.
Understanding Premature FD Closure
An FD is a type of financial product provided by banks and other financial institutions that allows investors to deposit a huge amount for any specified period at an agreed fixed rate. The fixed tenure guarantees a predictable return on investment. However, at some point, individuals may need the funds before their maturity period.
Fixed deposits generally offer premature withdrawal facilities that permit the owner of the FD to close it before its maturity. This is helpful in case of emergency fund requirements.
However, the individual needs to pay premature FD closure charges. This normally lies between 0.5 and 1%. Some banks do provide earlier withdrawal facilities, which are free of penalty charges.
However, if the FD is cancelled seven days from the day of booking, neither the bank nor the company will be liable to pay interest.
Consequences of Premature FD Closure
1. Penalties and Charges
The first thing is the penalty for premature closure of FD. The amount is different from one institution to another but usually includes the decrease of an interest rate. Banks do this to recover from the loss suffered as a result of early withdrawal.
The interest rate reduction could vary from 0.5% to 1%, and sometimes, it would be more than that. To know the penalties and charges that are applicable, it is essential to read the terms and conditions of your FD agreement.
2. Impact on Interest Earned
A big advantage of an FD is compound interest. Compound interest is a term where your interest earnings accrue and are added to your principal, thus leading to increased returns over the years.
Interest calculation varies when you withdraw your FD before time. This is because you might end up losing a fraction of the interest that would have been accrued should you hold on to the deposit until maturity.
3. Tax Implications
Another factor to consider is that the premature FD closure affects your tax liabilities. The interest on these investments is taxable, and the bank withholds the TDS component. However, on premature withdrawal, the TDS is adjusted as per the reduced interest rate applicable to such withdrawals.
This implies that the TDS can be recalculated and may result in variations towards your taxes to be paid. It’s best to seek advice from a tax specialist regarding the taxes involved and any changes you might want to implement.
4. Impact on Future Loan Eligibility
FDs are the major collateral in pledging loans. There can be an impact on your future loan eligibility when you prematurely withdraw your FD. Banks rate your creditworthiness using a range of indicators, including financial standing. Premature withdrawal history may lead to questions over your ability to be good at managing responsibilities related to money and affect possibilities for approval on a loan from a bank under given conditions.
Furthermore, banks can think of the early withdrawals as indicative of financial instability or need that may affect their assessment of your credit risk. It is important to note that a healthy financial history that includes keeping FDs until their maturity period can improve your credit profile. Moreover, you are likely to get favourable loan terms in the future.
5. Interest Loss
If you decide on premature withdrawal from FD, then you will receive a different amount mentioned while booking FD. Thus, you need to factor penalty charges into your calculations to help determine how much you will receive upon early termination.
How Do You Avoid Penalties on Premature FD Closure?
Fixed Deposit (FD) is believed to be one of the best investment instruments. You can deposit money for up to 10 years and gain interest at an attractive rate, which would help you manage your long-term financial needs.
Nevertheless, a lack of immediate cash may force you to withdraw your fixed deposit money before time, and that could entail a penalty. Therefore, to save oneself from that, there are some ways through which one can prevent the penalty of premature FD closure. These methods are as follows:
FD Laddering:
This method involves applying for different fixed deposit schemes with differing maturity periods. You can invest lumpsum and distribute it in smaller holdings by opening multiple fixed deposit accounts. For instance, if you have a lumpsum amount of Rs.5 lakh, then you may invest in five smaller FDs with maturities between one year and five years.
The laddering process assists because you may not need to make early withdrawals, and it also fulfils your immediate financial needs. But if you need to make an early withdrawal, it will be only up to the amount required. For instance, if you require an amount of Rs. 2 lakh, you can take two of your FD accounts and prematurely withdraw Rs.1 lakh from each respective account to acquire the desired amount by yourself. You can then decide to reinvest on maturity to improve cash flow.
Loan against FD:
If you need to withdraw money from your fixed deposit account earlier than the maturity period, you can apply for a loan using your deposit amount as collateral. Lenders generally provide this service, and they charge interest at the rate of 1%-2% above the interest that they are paid on the deposit.
The interest rate will vary from bank to bank, and you should contact your bank if there are any questions before using this service. Individuals can obtain up to 90% of the deposit.
Conclusion
The early closure of an FD often leads to serious implications. Hence, it is essential to do a thorough analysis of alternatives before proceeding with any rash decision-making. For developing your creditworthiness, the retention of a deposit until maturity and a healthier financial record are crucial for obtaining higher returns. Check with Wint Wealth, the investment experts, to get help and know more about the rules of FDs.
