Can you take a loan against a Fixed Deposit?

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As per a SEBI survey in August 2019, ‘More than 95 per cent Indian households prefer to park their money in bank deposits, while less than 10 per cent opt for investing in mutual funds or stocks’.

It is no surprise that fixed deposits are the preferred investment vehicle for many Indian families. Due to the lack of financial literacy, Indians as a habit have been inclined to invest in safer assets. Hence, it is no surprise that the most popular asset classes following FD are insurance, gold, post-office savings and real estate.

Fixed deposits are also preferred by investors because its one of the easiest products to understand. Another added advantage is the possibility of getting a loan against fixed deposit. In order to avail this loan, one does not need a credit score nor is there an income eligibility criterion.

What is the process to apply for a loan against an FD
 

In order to apply for a loan against fixed deposit one needs to get the form from their respective bank branch. One may submit this form with the required documents in order to apply for the loan.

1. Eligibility

  • Applicant should be at least 21 years old
  • Applicant must be an Indian resident
  • Must have an active fixed deposit with the lending bank

2. Documents Required

Generally, the following documents are required along with the bank application form. However, one may check with their bank.

  • Application form
  • Fixed Deposit Receipt
  • Passport size photographs
  • Valid photo identity proof
  • Address proof

Interest Rate on loan against fixed deposit
 

The bank lends to an applicant against the FD that he holds with the bank. Therefore, the FD works as a collateral for the lending. So, logically the interest on such a loan should be lower than an unsecured loan. This rate is generally 1 or 2 percentage points more than the rate of the deposit.

For instance, in the case of loan against fixed deposit from the State Bank of India, the interest on the loan is 1% above the term deposit rate. Whereas, for HDFC and Axis Bank it is 2% above the deposit rates. This is very attractive when compared to personal loan rates, which are in the range of 10-12%.

What is also worth noting is that with some banks one can avail up to 90% of the fixed deposit value in loan.

Pre-payment of the loan

One is permitted to prepay his loan against fixed deposit at any point during the period of the loan. Unlike other form of loan where the bank may charge a pre-payment penalty for early closure of loans, loans against FD do not levy any such charges. One may close their loan at any point in time without incurring any penalties.

Tenure of loan against FD

The tenure of the loan is dependent on the remaining time for the fixed deposit to mature. The tenure of the loan cannot exceed the maturity date of the FD since the FD acts as a collateral for the lending bank.

Option of Breaking the Fixed Deposit

When one has an active FD with a bank and is need of funds, he has 2 options. The first option is to break the FD and use the funds. The second option is to avail a loan against the Fixed deposit. As we have already discussed, a loan against fd will entail a cost which is higher than the returns you receive from the FD. So, wouldn’t it be better for you to break the FD and save the additional interest cost? In order to answer this question, let’s understand the differences between both the options. 

Convenience – In order to receive a loan against an existing FD, one would need to go through an application process and submit necessary documents etc. The loan would be disbursed only on verification and approval of the documents. On the other hand, when one breaks an FD, the funds are almost instantly disbursed to the clients account.

Maximum Amount – The amount of loan that the banks usually allow against fixed deposits is restricted to 85-90%. However, in the case of breaking an FD, the entire amount is credited to the bank account.

Costs – There are no costs involved when taking a loan against fixed deposit. Pre-maturing a Fixed Deposit might however entail a small penalty.

Interest Rate – The loan against fd comes at a higher rate compared to the rate of return on the FD. 

 

Loan Against FD vs Breaking of FD
 Loan Against FDBreaking FD
Convenience×
Amount×
Cost×
Interest×

As one can tell from the table above, most of the differences are in favour of breaking of FD. However, there are certain human biases that we must take into account prior to coming to a decision. It is always very difficult to put money together and make a lumpsum investment like an FD. Therefore, to break the FD may not be the best option. In case one takes a loan against fixed deposit, he needs to repay with EMIs which may be more convenient.

Also, one must take into consideration the need for the loan and the estimated tenure of the loan. If the money is needed for almost the same tenure as the maturity of the FD, one may consider breaking the FD. However, if it is for a short period, then taking a loan may be a smarter option.

 

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