If you have a Fixed Deposit (FD) of 500,000 rupees for two years, you expect the amount to reach approximately 572,000 rupees after two years. However, if an unforeseen need arises to close the FD after only 10 months, the entire financial picture can change. The bank may apply the interest rate applicable for a shorter term instead of the one initially agreed upon for two years. Furthermore, a penalty may be charged for early termination, which could result in a difference of about 51,000 rupees.
What happens when an FD is closed early?
An FD, or fixed deposit, is considered a reliable investment tool because interest is accrued on the deposited amount at a predetermined rate in the bank. Nevertheless, if funds are withdrawn before the full term of the FD expires, the bank's terms may be altered. Typically, the bank assesses the actual duration of the FD. Interest is paid based on the rate applicable for that period. Thus, the rate agreed upon when opening the FD for two years will not necessarily be applied upon early withdrawal of funds.
Example with a 7% rate
Suppose you place an FD of 500,000 rupees for two years, and the bank sets the annual interest rate at 7%. If the FD runs for the full two-year term, the maturity amount can be around 572,000 rupees due to compound interest, meaning accumulated interest of approximately 72,000 rupees. But if you need the money after only 10 months and terminate the FD, let's say the bank applies an annual rate of 6% for the 10-month period. Additionally, a penalty of 1% is charged for premature closure. In this case, the effective interest rate drops from 7% to approximately 5%. The calculation of simple interest on 500,000 rupees at an annual rate of 5% for 10 months amounts to about 20,833 rupees, and the total amount could be around 521,000 rupees. This is significantly less than 572,000 rupees for the full term. In this example, the difference between the two amounts is about 51,000 rupees. It is important to remember that this is only an illustrative example; the actual amount depends on the bank's policy for early closure, the applicable interest rate, the interest calculation method, and the FD terms.
Be sure to check the bank's penalties
Before terminating an FD, it is not enough to just check the interest rate. You must also review the bank's clause regarding Premature Closure. Rules may vary across different banks and for different FD products. In some cases, a penalty may be applied, while in others, the interest rate may change. Therefore, it is crucial to familiarize yourself with the bank's terms both when opening and when prematurely closing the FD.
Consider other options before terminating the FD
If you only need the money for a short time, and early termination of the FD will lead to significant interest losses, you can approach the bank to request a loan or overdraft facility instead of terminating the FD. In this case, there will be no need to close the FD early, but you will have to pay interest on the loan or overdraft. Therefore, it is better to make a decision after comparing the costs of both options. It should also be noted that taxes are not included in the above example. The taxation of FD interest may vary depending on your personal situation, so the actual amount you receive may be less.
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