With lending rates rising steadily, you would think twice before taking any kind of loan. In fact, in case you really need the money, you would think of liquidating your assets first instead of paying high rates on, say, a personal loan.
But there is one asset that you wouldn’t want to liquidate—fixed deposits (FDs). FDs are giving as much as 10.75% per annum as of now and it’s unlikely they will continue to pay so much six-eight months down the line. Says Suresh Sadagopan, a Mumbai-based certified financial planner, “Instead of breaking a high-interest FD, it’s better to take a loan against FD. The interest rates are expected to start correcting in six-eight months and you may not get such good rates after that.”
But the good news is you can find a solution within the product without liquidating it. FDs give you the option of taking a loan against the secured amount and even provide the overdraft facility, wherein you can withdraw more than your deposit.
Why does it work for you?
Advantage over personal loan: To start with, it definitely scores over a personal loan that you would normally look at for immediate cash needs in terms of rate of interest.
While currently a personal loan can cost you around 20% per annum (some banks are charging as much as 28%), loans against FD charge an interest rate that is a little higher than the rate you are earning on your deposit.
Says Salil Datar, branch banking head and NRI business head, Dhanlaxmi Bank Ltd, “The rate of interest you pay for such a loan with us is 1.75-2% over the interest rate of the FD. Which is much cheaper than what you would have paid for a personal loan.”
Usually government-owned banks charge 100-150 basis points (bps) above the deposit rate, while private banks charge around 200 bps higher than the deposit rate.
One basis point is one-hundredth of a percentage point.
Says Satkam Divya, CEO, Rupeetalk.com, a loan portal, “Your FD continues earning interest, while the loan comes at a rate that costs 100-200 bps plus your FD rate. That means the effective rate of interest is just 1-2% on the loan. It’s cheaper than any personal loan or a credit card loan.”
Advantage over liquidating FD: Even at the cost of 1-2%, it makes more sense than liquidating the asset. To liquidate an FD, most lenders will charge you a premature withdrawal penalty; the charges vary from bank to bank. Usually, the penalty for breaking an FD is 0.5-1% and it is applicable for the period the deposit has remained with the bank.
Suppose you have an FD of Rs1 lakh for two years that earns 9.25% per annum and decide to break it after six months. If the 180-day (six months) FD has an interest rate of 7% and premature withdrawal penalty 0.5%, you will get an interest rate of 7% minus 0.5%, or 6.5%, on your deposit. So at the end of six months, your interest would come toRs3,229 at 6.5%.
If you had remained invested for two years, your Rs1 lakh would have grown to around Rs1.20 lakh at the end of the tenor. But if you had taken a loan of, say, Rs90,000 at the end of six months at 10.50% and repaid the principal at the end of 1.5 years, you would have paid around Rs15,280 as loan interest and the net interest income (total interest income minus cost of loan) at the end of two years would be around Rs5,555. So despite paying for the loan, there is a profit, while the principal remains intact.
Says Sadagopan, “Also, if you have a built-up corpus, breaking it and spending does not make sense. It is a psychological issue. If you take a loan, you will also work towards paying back the loan and have a disciplined approach.”
Quick access to funds: More importantly, this facility gives you quick access to funds. The documentation involved is almost nil and you just need to visit the bank branch and make a request.
What does it offer?
Loan amount: While most banks will give you about 70-90% of your deposit as a loan or an overdraft facility, a few banks may offer a higher amount. Says Uday Sareen, head (retail banking), ING Vysya Bank Ltd, “We offer up to 95% of the deposit value and flexible repayment options.” The amount of loan you get will vary from bank to bank and will also depend on the amount of FD.
Datar says, “For FDs up to Rs50 lakh you can get up to 90% while for FDs of at least Rs50 lakh, you can get up to 70% as overdraft.”
Tenor and repayment: The loan tenor can’t exceed the term of the deposit.
You can schedule your repayment mode on your own: pay a fixed amount every month or as pre-decided with the bank. Some banks insist that the interest be paid every month; you can even settle the loan at the time of the maturity of the FD. Says Divya, “You can repay in equated monthly instalments, or service only the interest amount, or even choose to pay back the entire amount borrowed when the deposit matures.”
But remember that as soon as the borrowed amount plus interest exceeds your deposit, you may be asked to repay a part of the amount. Datar says, “We keep the margins in such a way that it takes care of the loan even if the customers fails to repay. In fact, we have seen many customers, write to us to set it (loan) against the FD on maturity.”
Most banks do not have pre-closure charges.
Fees: Most government-owned banks do not levy a charge on loans against FD, but a few private sector banks may charge a few hundred rupees. If you’ve have a good relationship with the bank, don’t hesitate to ask for a fee waiver in case there is a fee.
Watch out for
Right to lien: Most banks will not let you close the deposit when you are availing the loan. Moreover, some banks specify that they can use any other deposit that you may have in the bank to settle loan dues in case of a default.
For instance, according to the terms and conditions of ICICI Bank Ltd for loan/overdraft facility against 100% of the deposit: “The depositors shall not close the term deposits/withdraw the amounts of the term deposits during the subsistence of the facilities. The bank shall have a lien on the amounts of the term deposits as also any further deposits placed by the depositors with the bank irrespective of any other lien or charge, present or future.”
Short term: Since the tenor of the loan needs to match with that of the FD, you may have a short term. The maximum term that FDs offer is 10 years, but usually people make these deposits for two-three years.
Says Sareen, “Typically, individuals who need funding for a short period of time avail this product. The key benefit is instant availability of funds and ease of maintaining the overdraft line.”
Not all banks offer both the loan and overdraft facility, so it’s worth a check. For instance, while ICICI Bank lets you take a loan as well as an overdraft on an FD, ING Vysya Bank offers only the overdraft facility.