When will breaking your FD to reinvest be profitable for you? Find out here For existing depositors it could be quite a tempting proposition to withdraw an FD and deposit the money with a bank offering a higher interest rate. Should you break all the old fixed deposits and rebook a new one at higher interest rates?
Keeping pace with the back-to-back repo rate hikes by the Reserve Bank of India (RBI), banks have started raising interest rates on fixed deposits in the last few months. A two-year fixed deposit (FD) now will fetch as much as 6.75 per cent to 7 per cent return in any well-known public sector or private bank. If you are a senior citizen, you can even earn more than 9 per cent by picking the right fixed deposit in a small finance bank. Only eight months back depositors had no option but to book their FDs at the lowest interest rates seen in the last two decades. For existing depositors it could be quite a tempting proposition to withdraw an FD and deposit the money with a bank offering a higher interest rate.Should you break all the old fixed deposits and rebook a new one at higher interest rates?
Key things to keep in mind while breaking your old FDs
While breaking a fixed deposit, you need to keep three things in mind a) When your fixed deposit is maturing, b) the cost of breaking FD — the interest rate that the bank will offer on reduced tenure and the premature penalty that you have to pay c) Additional interest that you are getting on the new FD.
If the fixed deposit is nearing maturity, it may not be a wise decision to opt for a premature withdrawal. You will get a lower interest rate for reducing the tenure. Moreover, you have to pay a premature withdrawal penalty. "So, any fixed deposit which is maturing in the next six months to one year should not be touched," said Ankit Jain, Partner, Ved Jain & Associates, a chartered accountancy firm.
Cost of closing your old fixed deposit
Do remember that banks usually levy a penalty if you break your FD before it matures. The penalty is in the form of a reduced interest rate than what was originally promised on the fixed deposit. It varies from bank to bank and typically ranges from 0.5 per cent to 1 per cent. "If you decide to break the existing FD to renew it at a higher rate, you should be mindful of the penalty that will be levied. The incremental gain – additional return less penalty - from this exercise should be positive," said Rahul Jain, President, and Head, of Personal Wealth, Edelweiss Wealth Management.
For example, you have booked Rs 1 lakh in a five-year FD at 5.75 per cent interest rate in June 2022. Suppose after more than six months, you break it now at a reduced interest rate of 4.5 per cent applicable for actual tenure for which the FD actually ran. Moreover, some of the banks will charge another 0.5 per cent reduction in interest rate as a penalty for prematurely withdrawing your fixed deposit. So, you will get an interest rate of 4 per cent on Rs 1 lakh. From this investment, you will get a Rs 2,010 return.
Now you reinvest the entire amount of Rs 1,02,010 in a five-year FD at an interest rate of 7 per cent for the remaining tenure. So, after five years, you will get a total return of Rs 39,400 (Rs 2,010 from old FD+ Rs 37,390 from new FD in 4.5 years). If you had invested the amount at the old rate, you would have received a total interest of Rs 33,036 in five years. So, by breaking your FD prematurely and reinvesting it now, you could make Rs 6,364 in the given scenario.
Scenario 1: Old fixed deposit continues for the full tenurePrincipal Amount Rs 1,00,000Rs 1,00,000Rs 1,00,000Rs 1,00,000Tenure 5 years3 years 10 years2 yearsInterest rate5.75%5.10%6%5.50%Return after maturity Rs 33,036Rs 16,420Rs 81,402Rs 5,860Interest calculated quarterly
Scenario 2: If you break your FD and reinvestNet income from premature withdrawalPrincipal Amount Rs 1,00,000Rs 1,00,000 Rs 1,00,000Rs 1,00,000Tenure for which FD actually ran 6 months1 year 7 years1 yearInterest on FD while booking5.75%5.10%6%5.40%Completed tenure of the FD while breaking 6 months1 year7 years1 yearApplicable interest rate for the tenure which FD actually ran4.50%4.40%6%4.80%Penalty for premature closure of FD levied by the bank0.50%0.50%0.50%0.50%Final rate of interest payable at the time of withdrawal4.00%3.90%5.50%4.30%Return on prematurely liquidated FDRs 2,010 Rs 3,957Rs 46,576 Rs 4370Reinvesting the principal and accumulated interest at higher interest rateIncome from reinvestmentNew principal AmountRs 1,02,010Rs 103,957Rs 146,576Rs 104,370Remaining tenure 4.5 years2 years3 years1 yearInterest Rate7.00%6.75%7.25%7%Return for remaining tenureRs 37,390 Rs 14892Rs 35,258Rs 7,500Total return in scenario 2Rs 39,400Rs 18,849Rs 81,834Rs 11,870Additional benefit compared to scenario 1Rs 6,364Rs 2,429Rs 432Rs 6,010Interest calculated quarterly
Do remember to factor in the income tax part while calculating the net yield from the fixed deposits. The interest earned on a fixed deposit is subject to income tax, i.e., you have to pay the applicable tax on it. If your tax slab is 30 per cent, your FD returns will be taxed to that extent. For the general public, a 6-per-cent FD will return 4.2 per cent after income tax and that is your effective post-tax return.
Where should you reinvest?
So, is there a thumb rule you can follow while deciding whether you should break your FD or not? Remaining tenure could be the key. "Any fixed deposit with a remaining maturity period of three years or more at this stage can be broken to reinvest at the current rates. However, the investor should compare the interest rates available before taking such a step," said Jain.
While the option for reinvesting for the remaining period is always there, you can even think about revising the tenure to maximise your return. At the time of re-investing in a fixed deposit at a higher interest rate, a short-to-mid-term period (one year to three years) is ideal, said experts. "A higher overall yield could also be achieved by splitting it up into two 6-month FDs with a rollover option, considering we are in a rising interest rate environment," said - Aditya Chopra, Managing Partner, Victoriam Legalis - Advocates & Solicitors.
To fight inflation, the RBI has increased the repo rate by 225 basis points since May 2022. With every rate hike, banks have increased the interest rates of FDs deposits but at a slower rate. So, banks are yet to fully transmit the entire repo rate hike into the FD interest rate hikes. The era of low FD interest rates is certainly behind us.
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This story originally appeared on: India Times - Author:Faqs of Insurances
