Benefit of fixed deposits: Need cash? Go for overdraft against fixed deposit

The advantage of taking an OD against an FD is that you are charged interest only on the amount utilised from the OD, and the interest is calculated daily.

The Covid-19 pandemic has seriously complicated the finances of countless people who are facing multiple challenges due to lockdowns, job losses and reduced income. Many would be looking for short-term funding facilities to overcome immediate financial distress. Your fixed deposits (FDs) could prove to be extremely helpful in arranging quick liquidity.

You can use your FDs in multiple ways to meet financial requirements during a difficult time. Here are a few options.
Overdraft against FD

A loan or an overdraft (OD) against an FD is one of the quickest ways to borrow from the bank. Your FD is used as collateral under the OD facility according to the bank’s terms and conditions. Typically, banks allow overdrafts up to 90% of the existing FD value, and interest on the OD facility is 1-2% above the interest you earn on the underlying FD. For example, if your FD returns 6% p.a., the OD will attract interest at 7-8% p.a.

The advantage of taking an OD against an FD is that you are charged interest only on the amount utilised from the OD, and the interest is calculated daily.

For example, suppose you are availing an OD of Rs 1 lakh in a bank at a rate of 8% p.a. You withdraw Rs 10,000 from the OD account, use it for 20 days, and then deposit the money back into the OD account. The bank will calculate interest on Rs 10,000 only for the period of 20 days that could work out to be Rs 43.

So, an OD against FD can be used as a regular liquidity instrument to meet a short-term requirement. Another advantage of the overdraft is that you don’t need to worry about monthly EMI obligations. You get the flexibility to deposit the outstanding amount at your convenience.

However, it’s advisable to service your OD interest every month. The tenure of an OD would depend on your loan maturity period. Banks usually allow the renewal of the OD facility when you renew the FD, and the interest rate on the OD gets readjusted as per the interest rate on the renewed FD.

If your liquidity requirement is temporary, such as due to delay in salary, delay in payment, etc., then an OD against FD can prove to be one of the best borrowing tools. The OD facility against FDs can be availed easily through your online banking account, or you can apply through a written form by visiting your bank branch.

Pre-closing an FD
If your fund requirement is bigger and you don’t know when you’ll be able to overcome the liquidity crunch, you may explore the option of pre-closing your existing FD. But before closing your FD, know about the penalty charges levied by your bank. Penalty charges vary from 0.5% to 1% which is subtracted from the effective interest rate applicable on the fixed deposit at the time of the premature withdrawal.

Before pre-closing an FD, do the calculations carefully based on the terms and conditions of your bank. Some banks also offer partial withdrawal of FD amount without liquidating the entire investment. Pre-closing an FD could be used as a last resort to overcome a liquidity crunch during an emergency and might work out to be a better idea than taking a loan which may cost you a higher interest rate and processing charges, and may also involve a longer processing time.

More importantly, if your income takes a long time to normalise, such a loan could further complicate your finances. However, you must also understand that pre-closing an FD could also impact the financial goals attached to it; thus, you’ll be well-advised to take necessary steps as soon as your finances stabilise.

In conclusion, FDs could be much more than being an investment instrument– they can also double up as excellent liquidity tools during an emergency. But the terms and conditions associated with different FD products and facilities could differ from bank to bank, in addition to the fact that most banks have reduced their FD rates in the recent past due to the economic fallout of the pandemic.

The author is CEO, BankBazaar.com