Fixed Deposits (FDs) have long been a popular investment choice for those seeking guaranteed returns with minimal risk. One of the benefits of an FD is that, if necessary, you can break it before the maturity date through premature withdrawal. However, this comes with a few drawbacks. Not only do you receive less interest than initially expected, but banks also impose penalties for early withdrawal. Penalty rates differ across banks, typically ranging from 0.5% to 1%. It’s important to note that these penalties are applied to the interest earned, not the principal amount deposited.
When you break an FD before its maturity, the interest you receive is calculated at the ” card rate ” instead of the originally agreed “booked rate.” The booked rate refers to the interest rate applied when the FD account was opened, while the card rate is the interest rate applicable for the actual term the FD remained active. For example, if you break an FD after one year, the interest will be calculated at the bank’s current one-year FD rate.
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Example: Breaking a 5-Year FD After 1 Year
Let’s say you deposited Rs 1 lakh in an FD for 5 years, with a 7% interest rate. However, after one year, you decide to break the FD. The bank’s interest rate for a one-year FD might be 6%. Therefore, you will receive interest at the card rate of 6% for that year, not the original 7% booked rate. Additionally, the bank will impose a 1% penalty on the interest, reducing your effective interest rate to 5%.
Here’s the math:
- Original FD interest rate for 5 years: 7%
- Interest rate for one year (card rate): 6%
- Penalty: 1%
- Effective interest rate: 5%
If you had kept the FD for the full five years, you would have earned Rs 7,000 in interest (7% of Rs 1 lakh). However, because of the premature withdrawal, you will only earn Rs 5,000, leading to a loss of Rs 2,000.
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How to Minimize Loss from Premature Withdrawal
To minimize potential losses from breaking an FD, a good strategy is to split your investment into multiple smaller FDs instead of putting all your money into one large deposit. For example, instead of making one FD for Rs 1 lakh, you can create five FDs of Rs 20,000 each. This way, if you need funds, you can break only the required number of FDs, keeping the rest intact and earning interest at the original rate.
Breaking an FD before maturity can significantly impact the interest you earn due to lower card rates and penalties. By carefully considering your financial needs and using strategies like splitting FDs into smaller amounts, you can minimize losses and still benefit from the security that Fixed Deposits offer. Always plan ahead to avoid breaking your FD prematurely, and if you do, be prepared for reduced returns.
