Summary of this article
Do you have an FD and an outstanding loan? Before breaking the deposit, find out whether repaying the loan will actually save you money.
Your FD may be earning less than what you pay on a loan. But withdrawing it before maturity has its own costs.
Thinking of using your FD to clear a loan? Factor in the tax, withdrawal penalty and money you may need for emergencies.
A fixed deposit (FD) offers a sense of security. A loan, on the other hand, means a monthly interest outgo that can eat into household savings. So, when borrowers have an FD running alongside an outstanding loan, the temptation to withdraw the deposit and clear the debt can be strong. But is that always a sensible financial decision?
The answer depends on how much interest you are paying on the loan, what your FD earns after tax and, equally importantly, whether you can afford to part with that money.
Compare The Actual Cost Of Borrowing With The FD Return
The first step is to compare the effective interest rates. Suppose you have a fixed deposit of Rs 5 lakh earning 7 per cent a year and an outstanding personal loan carrying interest of 12 per cent. The FD earns Rs 35,000 annually before tax, while the interest on an equivalent loan balance would be around Rs 60,000.
The gap is already Rs 25,000. But the difference becomes wider once tax is taken into account. FD interest is added to the depositor's income and taxed at the applicable slab rate.
Financial planners say the decision should be based on the post-tax return on the fixed deposit and the loan's effective interest cost. If the borrowing cost is significantly higher, continuing with the loan merely to preserve an FD may not be financially efficient.
The Tax Angle Can Change The Calculation
Interest earned on bank fixed deposits is taxable as per the depositor's income-tax slab. This means the advertised FD rate does not represent the actual return.
For someone in the 30 per cent tax bracket, a 7 per cent FD yield translates into a post-tax return of roughly 4.9 per cent, excluding cess. If the person is paying 12-14 per cent interest on a personal loan, the difference is substantial.
However, the calculation may look different for someone in a lower tax bracket or when the loan carries a relatively low interest rate. The interest saved by closing a loan should also be compared with the return that the money could earn if the FD is allowed to run its full course.
Don't Ignore Premature Withdrawal Penalties
Breaking an FD before its maturity date may mean giving up part of the interest you expected to earn. The bank will work out the interest for the period the money stayed with it, usually at the rate applicable for that tenure. It may also deduct a penalty for closing the deposit early.
So, an FD opened at 7.5 per cent may not fetch anything close to that rate if you break it midway. Find out how much you stand to lose before deciding to withdraw the money.
There is another cost borrowers should check before taking a loan. Does the lender charge for repaying it ahead of schedule? RBI rules bar banks and other lenders from levying prepayment charges on floating-rate loans taken by individuals for non-business purposes. The protection also covers eligible existing loans and those sanctioned or renewed from January 1, 2026. Fixed-rate loans are subject to different terms.
Don't Leave Yourself Short Of Emergency Money
There is another side to this decision that borrowers often overlook. An FD may be earning less than the loan is costing, but it also provides ready access to money when an unexpected expense comes up.
Using the entire deposit to close a loan could leave a household with little financial cushion. A medical emergency, job loss or an urgent family expense may then force the borrower to take another loan, possibly at a much higher interest rate.
This is why financial planners generally advise keeping aside money for at least six months of essential household expenses. Those with irregular incomes or dependants may need a larger cushion.
Consider Partial Repayment
There is no rule that says an FD must either be kept intact or withdrawn in full. If the deposit is larger than the emergency savings a household needs, part of it could be used to bring down the loan.
For instance, someone with an FD of Rs 8 lakh and a loan outstanding of Rs 5 lakh need not necessarily use the entire deposit to close the loan.
But don't rush to use up the entire FD. You may need that money if an unexpected expense comes up or household costs rise. Work out how much you need to keep aside and use only the balance, if any, to pay down the loan.
If you are making a part-payment, ask the bank what it will do to your EMI and loan tenure. If your monthly budget allows you to continue with the same EMI, it may be better to shorten the loan period. You will get out of debt sooner and save on the interest you would otherwise pay over the remaining years.
Ultimately, the point is not to get rid of every loan at the earliest opportunity. It is to avoid paying more interest than necessary without leaving yourself short of money when you need it.
