Premature Withdrawal or Breaking of Fixed Deposit: Fixed Deposits (FD) are long-term deposits with a non-changing interest rate that gives you the accurate amount of your investment in the future. Fixed Deposits are there for a fixed period or till the maturity period. Fixed Deposits are the instruments that provide maximum safety and security and there is no risk of loss. Even if there are fluctuations in the market interest rates, it does not affect your investment. An individual/business can opt to earn the interest on his/their investment periodically. In this article, we will learn about premature withdrawal of Fixed Deposit and other topics related to premature withdrawal of Fixed Deposit.
Premature Withdrawal of Fixed Deposit
Premature withdrawal of Fixed Deposit means the withdrawal of your investment before the maturity period of the investment. This allows individuals/businesses to withdraw their money in the hour of need or if they found better investment schemes/offers somewhere else. Under the guidelines of the Reserve Bank of India(RBI), it is legal to withdraw Fixed Deposit before its maturity period.
Reasons for premature withdrawal of Fixed Deposit
An Individual or a Business may opt for premature withdrawal of a Fixed Deposit if they need money in case of an emergency or they may have found a better and higher rate of interest somewhere else. In case of market fluctuations, when/if the interest rate is higher than the prevailing rate at which the individual/business opened their recent Fixed Deposit, they may opt for premature withdrawal and then open a new Fixed Deposit to enjoy the higher interest rate returns.
Premature withdrawal of Fixed Deposit is severely discouraged by the banks and hence, they may impose a penalty on the interest rates(applicable).
Interest Rate on premature withdrawal of Fixed Deposit
In case of premature withdrawal of Fixed Deposit, interest is paid on the investment to the investor for the period between the date of deposit and the withdrawal date(before the maturity period) of the Fixed Deposit with the bank. A premature withdrawal penalty is also charged during the process.
Let us take the help of an example to understand the process thoroughly;
An individual invests in Fixed Deposits on 1st March 2014 at an 8% interest rate for 5 years. Now due to some reason, he opted for premature withdrawal of his investment after one year i.e. on 1st March 2015. Now, during this investment on Fixed Deposit kept by the bank which was withdrawn prematurely within one year, the interest applicable was 5%. Hence, he will earn only 5% per annum on his investment rather than the original rate of 8% per annum for 5 years.
In some cases, no interest is payable on the premature withdrawal of a Fixed Deposit. For instance;
The State Bank of India(SBI) states that interest of 0.50% below the applicable rate for the period with which the deposit was kept with the bank will be paid below the invested amount of 15 Lacs when there is a premature withdrawal of Fixed Deposit.
The Industrial Development Bank of India (IDBI) has a lock-in period of one year on premature withdrawal of Fixed Deposit which means no premature withdrawal of Fixed Deposit up to one year.
Premature Closure Penalty
Banks impose or charge a penalty of 0.5-1% interest on premature withdrawal of a Fixed Deposit. In case of premature withdrawal of Fixed Deposit during an emergency, few banks relinquish the penalty. The emergencies are not defined exactly by the banks and the freedom from penalty is given on a case-to-case basis. If the individual reinvests the withdrawn amount with the bank, he may get freedom from bearing the penalty.
Let us consider an example to ease up the process;
An individual invested Rs.2,00,000 in Fixed Deposit with an interest rate of 7% for 5 years. The total interest he will receive after the maturity period will be Rs.82,956. Now, the individual’s Fixed Deposit is withdrawn prematurely within 3 years and at that period, the interest rate was 5.75% per annum. Now, taking into consideration the penalty of 1%, he will earn the interest amount on the interest rate of 4.75%(5.75% prevailing rate-1%penalty) which comes to Rs.30,457. So, the total amount including the investment amount becomes Rs.2,30,457.
Penalty Rate In Different Banks On Premature Withdrawal of Fixed Deposit
The Reserve Bank of India provides the guidelines to banks through which the banks can finalize their penalty interest rates on premature withdrawal of Fixed Deposits. It is the duty of a bank to ensure and inform their depositors about the penalty rate they face on premature withdrawal of Fixed Deposit.
Penalty Charges of Some Banks are as follows;
|BANK||PENALTY ON PREMATURE WITHDRAWAL|
|State Bank of India(SBI)||0%-0.5%|
How to Withdraw Fixed Deposit Before Maturity?
An individual has to submit the certificate or receipt of Fixed Deposit duly signed by all the account holders at the branch for premature withdrawal of Fixed Deposit. If the individual does not hold the certificate or receipt of Fixed Deposit he/she has to fill in and submit the Fixed Deposit Liquidation form.
If the individual has booked through net banking, he/she can withdraw the Fixed Deposit prematurely through net banking and it is a quite easier process.
When is Breaking off a Fixed Deposit Helpful?
An individual should break off a Fixed Deposit after analyzing all the aspects and factors related to the Fixed Deposit at that particular time. The individual should not just go for a premature withdrawal of Fixed Deposit after noticing a higher rate of interest. Let us study 2 cases that will prove that doing the math to analyze the returns on an investment is crucial.
CASE-1 (Breaking off an older Fixed Deposit)
A person has invested Rs.20,000 to open a Fixed Deposit at a 4% rate of interest for 1 year. Compound interest of 5.25% is earned which comes to Rs.1,050. He withdraws the invested amount within 7 months when the rate of interest was 5%. So, after a penalty rate which is 1%, he will earn an interest amount on the interest rate of 4% which comes to Rs.677. The total value received including invested amount becomes Rs.20,467.
Now, the individual reinvests the amount Rs.20,467 for the remaining 5 months at a higher interest(which is exactly what he went for) rate of 7%. The interest amount he will earn is Rs.602. So, the total amount including the invested amount becomes Rs.21,069.
But, the amount which the individual would have received Rs.21,872(Rs.20,812+Rs.1,050) if he/she didn’t withdraw the Fixed Deposit before maturity. This is the sum of the total value of Fixed Deposit after one year at 4% which comes to Rs.20,812 and the compound interest earned which comes to Rs.1,050. Therefore, an individual should always do his/her math to analyze and interpret all the facts and figures before the premature withdrawal of his/her Fixed Deposit.
CASE-2 (Breaking off a new Fixed Deposit)
An individual has invested Rs.1,00,000 for 4 years at a 5% rate of interest. Now, he withdraws the invested amount within 6 months at a 7% rate of interest. The penalty rate is 1%. He will earn an interest amount on the interest rate of 6% which comes to Rs.3,000. Now, the new Fixed Deposit interest rate is 8% and the new Fixed Deposit duration will be 3.5 years. The new interest amount comes to Rs.33,279 + Rs.3,000 = Rs, 36,279. So, the total amount including the invested amount comes to Rs.1,36,279. If the premature withdrawal didn’t occur, the value of the Fixed Deposit after maturity would have been Rs.1,21,989. Therefore, the individual would have made a profit of Rs.14,290.
Conclusion After Analyzing Both The Cases
Continuation of the Fixed Deposit is the best option when the Fixed Deposit is old and near the maturity period whereas breaking off a new Fixed Deposit is considered best to earn a significant amount of profit but it is still advised to do the math for analysis before breaking off Fixed Deposit.
Alternative to Premature Withdrawal of Fixed Deposit
There is an alternative to premature withdrawal of Fixed Deposit which is taking a loan against the Fixed Deposit. An individual after taking a loan against his/her Fixed Deposit goes through the following;
- He/She will earn the interest on his Fixed Deposit. This implies that the effective rate of interest is around 1-2% on the loan.
- Many banks offer around 70-90% of his/her Deposit as a loan but there are some banks that may offer a higher amount. It depends on the bank and the amount of Fixed Deposit on how much loan he/she will get.
- There is a fee involved which is charged on loan against the Fixed Deposit but only collected by private sector banks and not government banks.
- The Fixed Deposit amount is the maximum limit of a loan tenor to get and can never exceed the Fixed Deposit amount. The individual is not allowed by most of the banks to close his/her Fixed Deposit when he/she is availing the loan. To settle the loan dues, few banks use other Fixed deposits of the individual.
- The individual can select his/her repayment method himself/herself. He/She can payout a fixed amount monthly or as decided with the bank. Few banks even allow the individual to settle his/her loan after the maturity period of the Fixed Deposit.
- There are almost no documents involved and the individual can visit the bank and make a request.
The individual has to pay around 1-2% rate of interest over the interest rate of the Fixed Deposit. Taking a loan against Fixed Deposit is better than the premature withdrawal of a Fixed Deposit. Premature closure penalty is imposed on premature withdrawal of Fixed Deposit which is around 0.5-1% and it is applicable for the period in which the Fixed Deposit was kept with the Bank.
Let us understand this process with the help of an example;
An individual opened a Fixed Deposit of Rs.1,50,000 at an 8% rate of interest for 2 years. He opted for premature withdrawal for some reasons within 6 months duration. The interest rate during that period was 6% and the premature penalty rate was/is 0.5%. So, he earned an interest amount on the interest rate of 5.5% which comes to Rs.4,125. The total amount earned including the invested amount comes to Rs.1,54,125.
If he had invested the Fixed Deposit for 2 years which was the maturity period he would’ve earned Rs.1,75,749 (Rs.75,749 being the amount of interest earned). Now, the individual took out a loan against his Fixed Deposit of Rs,1,00,000 at the end of 6 months on a 9.5% rate of interest and he repaid the principal amount at the end of 1.5 years, he would’ve paid Rs.15,250 as loan interest and net interest income at the end of maturity period i.e. 2 years would be Rs.5,501. So, while the principal amount remains intact, there is a profit even after paying the loan.