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Pros and cons of investing in bank fixed deposits

Most banks offer loans against FD, usually in the form of an overdraft facility, wherein a credit limit is sanctioned to the borrower based on the FD amount submitted as collateral.Premium
Most banks offer loans against FD, usually in the form of an overdraft facility, wherein a credit limit is sanctioned to the borrower based on the FD amount submitted as collateral.

  • The booked interest rates of bank FDs remain fixed till their maturity, irrespective of any change in the banks’ FD card rates in the interim
  • Interest earned from bank FDs, including tax-saving FDs eligible for a tax deduction under section 80C, are taxed according to the depositor's tax slab

NEW DELHI : Bank fixed deposits (FDs) are usually the first port of call for those beginning their investment journey. Income certainty and capital protection features of bank FDs also make them immensely popular among investors with low-risk appetite and those investing to meet their short-term financial goals.

Let us take a look at some of the pros and cons of investing in bank fixed deposits.

Pros

Protection in the form of deposit insurance cover

Fixed deposits opened with scheduled banks are covered under the deposit insurance programme of Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the Reserve Bank of India (RBI). The insurance cover is applicable on cumulative bank deposits, which includes fixed deposits, savings account, recurring deposits and current account, of up to Rs5 lakh per bank, per depositor in the event of bank failures.

“Those seeking to avail higher FD returns while ensuring maximum capital protection can do so by opening FD with multiple scheduled banks offering higher rates in a manner that their cumulative deposits with each bank do not exceed Rs5 lakh," said Sahil Arora, director, Paisabazaar.com.

Assured returns on investments

The booked interest rates of bank FDs remain fixed till their maturity, irrespective of any change in the banks’ FD card rates in the interim. For instance, if an individual opens a bank fixed deposit of 2 years tenure at 6% p.a., the interest rate will stay the same till the end of 2 years tenure. This provides a high degree of income certainty in FDs, even higher than those offered by most small saving schemes.

Availability of secured credit card

Secured credit cards are offered against the collateral of FD. “Secured credit cards can be helpful for those who aren’t able to get regular credit cards due to no or low credit score, inadequate income, unserviceable location, company’s profile or job profile. Note that the secured card users also continue to earn interest on their FDs used as collateral," said Arora.

Availability of loan against FD

Most banks offer loans against FD, usually in the form of an overdraft facility, wherein a credit limit is sanctioned to the borrower based on the FD amount submitted as collateral. The borrower continues to earn interest on the pledged FDs during the loan tenure. Borrowers can withdraw up to the sanctioned amount from their overdraft account and repay it basis their repayment capacity. The interest is levied on the amount drawn till its repayment.

Arora said, “The liberty to borrow from the sanctioned limit, repay drawn amount on the basis of one’s repayment capacity and incur the interest cost just on drawn amount makes the overdraft against FD one of the best tools to mitigate frequent short-term liquidity and cash flow mismatches. It allows borrowers to raise funds without closing his FDs prematurely and incurring any prepayment charges."


Cons

Penalty on premature FD withdrawal

Most banks charge premature withdrawal fees of up to 1% for prematurely closing a fixed deposit. The penal rate is deducted from the effective rate of interest, which is lower than the original booked FD rate or FD card rate prevalent at the time of booking the FD for the period for which the FD remained in effect.

Thus, make sure to consider your liquidity and the time horizon of your crucial financial goals when choosing FD tenures.

Interest from tax savings FD are not tax-free

Interest earned from bank FDs, including tax-saving FDs eligible for a tax deduction under section 80C, are taxed according to the depositor's tax slab. Thus, for the ones falling in higher-income slabs, their post-tax returns generated from most bank FDs may not exceed the average inflation rate during the FD tenure.

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