When closing an FD for a sudden need or for any short-term requirements, there are a few economically viable solutions to consider. The alternatives should be designed to reduce borrowing costs and maximize the use of the FD, allowing you to obtain the lowest loan option if an emergency demands a short-term monetary commitment.
- Using a Loan against the FD – This could be the most affordable alternative. This is because lending against FDs normally has cheaper interest rates than unsecured loans like personal loans or credit card loans (since the loan against FDs are secured by the FD itself). The reasoning for this method is based on capital costs. When the cost of terminating the FD (including interest loss and possible penalties for early withdrawal) is more than the interest you would be paying on a short-term borrowing against the FD, it makes economic sense to take the loan. This is especially true if you intend to repay the loan in the short term. In doing so, you retain the FD’s integrity, enabling it to keep earning interest while avoiding the penalty that comes with premature withdrawal. If the loan can be repaid soon, the cost savings from reduced interest rates on loans against FDs can be enormous.
- Repayment of the loan using the FD balances – If an emergency arises, another option is to settle the existing debt against the FD with the FD’s principal amount. By doing so, though you will effectively reduce your FD investment, you will also be removing any loan-related interest costs. This technique may be favourable, especially if the income you earn on the principal amount of the FD is less than the interest you would pay on the loan. Furthermore, this option is significant if the penalties for partial withdrawal from the FD are more lenient than those for complete withdrawal of FD.
In both the above mentioned cases, the choice should be based on a careful examination of the costs associated with breaking the FD vs the cost of borrowing, as well as a grasp of your cash flow situation.
