How much do you lose by breaking a Fixed Deposit (FD)? Understand the complete calculation of interest and penalties..

FD Premature Closure: Fixed Deposits (FDs) are considered one of the safest investment options. You deposit money in the bank and earn interest over a fixed period. However, there are times when you might suddenly need funds, requiring you to close the FD before its maturity date.

The question arises: how much do you lose by breaking an FD early? The straightforward answer is that the interest you earn may decrease. Additionally, the bank may impose a penalty for premature closure.

What happens when you break an FD early?

Suppose you opened an FD for two years with an annual interest rate of 7%. However, you needed the money after just 10 months. In this scenario, the bank is not obliged to pay the 7% rate applicable to the full two-year term; instead, it may apply the interest rate corresponding to the actual duration the FD was active.

Let’s assume the bank's interest rate for a 10-month FD was 6% at that time. If the bank also charges a 1% penalty for premature closure, your effective interest rate would drop to approximately 5%.

Understanding this with a ₹5 lakh FD

For instance, suppose you opened an FD of ₹5 lakh for two years at an interest rate of 7%. If the FD ran for the full term, the amount would grow to approximately ₹5.72 lakh after two years.

However, if you needed the money after 10 months and closed the FD, the bank would apply the 6% rate relevant to those 10 months and deduct a 1% penalty. This results in an effective interest rate of around 5%. At a rate of 5%, the interest earned on ₹5 lakh over 10 months would be approximately ₹20,833, meaning you would receive a total of about ₹5.21 lakh. Now, let’s look at both scenarios side-by-side:

**Scenario** | **Interest Rate** | **Tenure** | **Estimated Amount**
FD runs for the full term | 7% | 2 years | Approx. ₹5.72 lakh
Broken after 10 months | 5% | 10 months | Approx. ₹5.21 lakh
Difference | — | — | Approx. ₹51,000

This shows a difference of approximately ₹51,000. The reason is that the FD was broken prematurely. Taxes have not been factored into this example; the final amount could be even lower after accounting for taxes.

**Rules vary by bank**

It is important to note that not all banks have the same rules for premature FD withdrawal. Some banks lower the interest rate, while others impose a penalty. In some cases, both may apply. Therefore, it is essential to get a clear breakdown of the figures from the bank before breaking the FD.

Ask the bank directly how much money you would receive if you broke the FD today. Also, inquire about the applicable interest rate and the penalty amount.

**Consider an alternative before breaking the FD**

If you need funds for a short period, you do not necessarily have to break the entire FD. You can ask the bank if a loan or overdraft facility is available against the FD.

The advantage here is that the FD continues to run, and you still get the money you need. However, do consider the interest cost associated with this option.

**It is better to wait if the FD is nearing maturity**

If your FD is due to mature in a few months, weigh the pros and cons before breaking it. Waiting a few months could allow you to earn the full interest. Conversely, breaking the FD now could result in both lower interest earnings and a penalty.

However, if the need for funds is urgent, taking out an expensive loan just to avoid the penalty may not be the right move. In such a scenario, make your decision by comparing the loss from breaking the FD against the cost of the alternative option. Ask these 3 questions before breaking your FD

Ask the bank three things before closing your FD. First, find out the exact amount that will be credited to your account if you break the FD today. Second, determine which interest rate will apply. Third, ask about the penalty for premature closure.

Next, check the amount you would receive if you held the FD until maturity. The difference between the two figures will clearly show you how costly it would be to break the FD now.

Disclaimer: This content has been sourced and edited from Money Control. While we have made modifications for clarity and presentation, the original content belongs to its respective authors and website. We do not claim ownership of the content.