Breaking a Fixed Deposit

Breaking a FD means pre-mature withdrawal of your money locked in a FD i.e. taking out the money before the term of the FD is over.When you break a FD, banks don’t give you the rate of interest at which you booked the FD ; instead you get the rate applicable for the duration for which you actually kept the money with the bank.For example if you made a FD for 4 years, at an interest rate of 8% and now you wish to break it after 2 years ,you would get the rate applicable to a 2 year FD prevailing at the time when you had booked your FD, and not the 8% which is noted in your FD certificate.So, if the rate for a 2 years FD was 7.25% when you had booked your 4 year FD, you would only get an interest of 7.25% per annum for the 2 years you would have actually kept the money with the bank.In addition there is often a penalty to be paid,comm0nly a further 1% deduction.Some banks do waive off this penalty if the liquidation or premature withdrawal of the FD is due to some emergency. But the word “emergency” is not well defined and this waiver is given on a case-to-case basis.Some banks also waive off the penalty if you reinvest the withdrawn amount with the bank. Some banks provide this waive off only if the new FD is kept for a period higher than the remaining period of the original FD.So there is some leeway to negotiate to avoid paying a penalty while attempting to break a fixed deposit.

However breaking a fixed deposit and chasing higher rates is not always such a smart thing to do.Consider the following case:   

Consider you have a FD of Rs 1 Lakh, for 4 years, earning an 8% interest that you withdraw annually.So the total interest you will receive will be Rs 32,000 over 4 years.In case the FD is broken and reinvesting after 2 years at a higher rate of 9%,the rate applicable for 2 years will be  7.25%.Considering a penalty of 1%,the actual rate applicable will be 6.25% and the total interest received for 2 years will be Rs 12,500.The new FD durationwill be 4-2= 2 years and the new interest rate= 9%.So the interest received for these 2 years will be 18,000.So the total interest received by you will be Rs12,500 +Rs18,000 =Rs30,500 ie a loss of Rs1,500—A case of hyperactivity causing a needless loss.

But such is not always the case.Breaking the FD and reinvesting the sum in a higher-interest FD is a good idea when the original FD is relatively new.For example, consider that 6 months into the deposit in the first case you are considering withdrawing the money and reinvesting it.In this case the actual period of holding would be 6 months and say the rate applicable for 6 months is 6.5% and penaltyis 1%.Then the actual rate applicable will be 5.5%and the interest received for 6 months would work out to Rs 2,750.The new FD duration would be  3.5 years and if the new FD rate of interest is 9%.The interest received for these 3.5 years would be 31,500 and the total interest received in 4 years will be Rs2,750 +Rs31,500 =Rs34,250.In this case you will gain a further Rs 2,250 when you break a relatively new FD and reinvest it at a higher rate!

So the moral of the story is:if the original FD is old or nearing maturity, it is best to continue with it and reinvest the money only when it matures.Consider, breaking a FD only if it is relatively new. And before you do anything at all do the math!