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Indian investors usually opt for fixed deposits (FDs) because they are secure and provide guaranteed returns. In other situations, one may suddenly need access to the funds. This is when many think of withdrawing their FD early. But this does not prove to be the best monetary option always. Paying a loan against a fixed deposit rather than pre-withdrawing provides multiple benefits both in the form of money and money planning.

This article discusses why a fixed deposit loan can be a wiser choice than withdrawal earlier. We will discuss the concept, the eligibility for a fixed deposit loan, and explain with live examples how you can truly make good use of your FD without losing returns.

Understanding a loan on fixed deposit

Fixed deposit loan is a secured loan provided by banks and financial institutions against your current FD as security. Rather than unwinding the FD prematurely, the bank provides you with a loan amount typically up to 80-90% of the FD value. The loan leverages the security of the FD, keeping the interest rate lower than unsecured personal loans.

How it works

• The FD remains intact until maturity.
  

• Repayment tenure is normally equal to the unexpired maturity of the FD.
  

• The rate of interest on the loan is generally 1-2% more than the rate of interest on the FD.
  

• The loan is paid back in EMIs or the full amount on maturity of the tenure.
  

• If there is a default, the bank can encash the FD to realize dues.
  

This is the perfect financial product when you need to hold your FD's interest advantage and satisfy short-term liquidity requirements.

Loan against fixed deposit eligibility criteria

Applying for it requires an understanding of loan against fixed deposit eligibility. Although details differ from bank to bank, the general guidelines are:

• You should be the initial holder of the fixed deposit.
  

• The FD must have a minimum lock-in period served (typically 3-6 months).
  

• Generally, the loan amount granted is limited to 80-90% of the FD's value.
  

• Your FD must be a term deposit but not a recurring deposit or other investment plans.
  

• Banks might insist that you have a savings account with them too.
  

• There is no overdue or default in your credit record that improves eligibility.
  

Perks of a loan against fixed deposit compared to premature withdrawal

1. Still earn interest on the FD

One of the greatest advantages of availing a loan against FD is that it helps you retain your FD's interest earnings. In case of withdrawal of deposit before maturity, banks charge a lower rate of interest for premature encashment. This results in loss on the returns that could be earned.

Think of this: If your FD of Rs. 10 lakh is returning 6.5% annually and you withdraw it half a year prematurely, the bank could cut interest to 4% for the period fulfilled. This can mean a lot of loss in interest earnings.

As opposed to this, by taking a loan against fixed deposit, you get to keep the complete interest until maturity and repay a bit higher interest on the loan amount.

2. Smaller interest rates than unsecured loans

Personal loans tend to come with interest rates between 10% and 20% annually in India, based on the credit history of the borrower. Whereas, a fixed deposit loan tends to have interest rates just 1-2% above your FD rate.

For example, if your FD is giving a return of 6.5%, the interest rate for the loan can be about 7.5%. This is economically advantageous, reducing your cost of funds considerably without keeping capital back.

3. Low documentation and rapid processing

As the loan is backed by your own FD, banks have minimal paperwork and checks to do. The approval process can be rapid, enabling customers to fulfill sudden financial needs without unnecessary formalities.

4. No effect on credit score if paid on time

Loans against FDs are less likely to negatively impact your credit score when paid back in a responsible manner. This is quite different from credit cards or unsecured loans, where defaults can have disastrous effects on your CIBIL score.

Actual example showcasing the advantages

Let us examine the case of Mr. Arvind, a salaried individual from Mumbai with an FD of Rs. 5 lakh booked for 1 year at 6.75% interest.

Seven months down the line, he required Rs. 3 lakh immediately for renovation of his home. The two options before him were:

• Prematurely break the FD and withdraw Rs. 3 lakh.
  

• Take a loan against fixed deposit for Rs. 3 lakh.
  

Scenario 1: Premature withdrawal

Premature withdrawal rate of interest applicable was around 5%. He would lose 1.75% per annum interest on the amount for the balance 5 months.

Interest lost = Rs. 3,00,000 × 1.75% × (5/12) = Rs. 2,187.5 approx.

Scenario 2: Fixed deposit loan

Bank approved Rs. 3 lakh loan at 7.25% (0.5% above FD rate). Monthly interest cost would be around Rs. 1,812 on Rs. 3 lakh.

Total interest paid by Mr. Arvind in over 5 months would be Rs. 9,060, but he would still earn Rs. 3,500 every month on FD interest (Rs. 5 lakh × 6.75% /12).

Interest earned on FD for 5 months = Rs. 17,708 approx.

Net amount considering loan interest = Rs. 17,708 - Rs. 9,060 = Rs. 8,648 more than withdrawing prematurely.

This case shows how Mr. Arvind chose a loan on fixed deposit to maintain his investment yield and was cost-effective.

When to avail a loan on fixed deposit

A loan on fixed deposit works best when:

• You wish to hold on to your FD's interest advantages.
  

• Short to medium term funds are required.
  

• Lower cost of borrowing is desired.
  

• You prefer free from complexities and instant availability of funds.
  

• Your current FDs have high-interest rates committed.
  

On the other hand, if you have no urgent liquidity issues or your FD period is almost over, withdrawing the amount without penalty can be considered.

Key considerations prior to availing of a loan on fixed deposit

Verify the bank's loan period and interest rate

Every bank has its own rules regarding maximum loan period and interest rate applicable. Align the loan period with your FD maturity to incur no extra expenditure.

Assess loan amount and margin

Learn the proportion of FD amount that can be availed as a loan. The majority of institutions provide between 75% to 90%. Taking a loan higher than your need can result in unwanted debt.

Repayment flexibility

Some banks ask for bullet repayment at maturity, and some accept EMI-based repayment. Opt for a repayment method suitable for your cash flows.

Effect on FD nominee and proceeds at maturity

As the FD is collateral, in case of default, the bank encashes the FD. This impacts the proceeds your nominee can get at maturity. Be sure you have the ability to service the loan on time.

How to apply for loan against fixed deposit

Obtaining a loan against fixed deposit is easy:

• Visit the bank where you have your FD.
  

• Fill loan application form along with FD receipt.
  

• Give ID proof, address proof, and latest photo.
  

• Bank checks FD details and your worthiness.
  

• Loan amount approved and credited, usually within 24-48 hours.
  

For example, HDFC Bank and ICICI Bank offer online application for FD loans, making it more convenient.

Conclusion

Selecting a fixed deposit loan over premature withdrawal is a financially savvy choice for most fixed deposit investors in India. It enables investors to fulfill sudden liquidity requirements without forgoing their FD interest income. With lower interest rates than unsecured loans and simpler eligibility norms, this option is an effective credit facility.

Knowing loan against fixed deposit eligibility and conditions allows for improved planning and risk management. As a salaried employee or small investor, using your FD through a loan effectively helps retain your investment discipline and growth in financials. Compare terms across banks always and assess your repayment potential before you decide.