Though, investors do lock in their FDs for a time period depending on their future financial needs, certain contingency events compel them to opt for early breaking or premature withdrawal of their invested money. Also, as interest rates are revised by banks on fixed deposits from time to time in accordance with the economic outlook, customers tend to get tempted and break their existing investments in order to park their money in a more lucrative investment option offering higher rate of return.
Further, as early breakage of the FD results in mismatch of assets and liabilities for the bank, they pass on their losses to customers in the form of penalty charges and other losses. Such losses that are to be borne by customers on account of early breakage of the fixed deposit differ from bank to bank. However, few common losses or penalty charges charged include:
1. Rate of Interest offered @ applicable for the time frame for which the deposit is held with the bank : In case of early or premature breaking of fixed deposit, interest rate on FD is offered @ applicable at the time of deposit for the term the deposit remains with the bank.
2. Penalty charges or Lower interest rate : Premature withdrawal also results in the bank offering lower rate of interest by 0.5% -1% in both the sweep-in as well as partial withdrawals specific to different banks. Some of the state-run banks do not levy charges if the FD is re-invested with them for a period more than the remaining term of investment for earning higher rate of interest. Unlike, public sector banks, private banking institutions do charge on reinvestment or early breakage of FD.
The actual or real return accruing after early withdrawal or breakage of the FD could be illustrated as below:
Suppose if an individual invests Rs. 10,000 in an FD for a tenure of 1 year offering compounded interest @ 6.5%. But on account of some reason, breaks the FD after 7 months then in this case interest would be offered @ applicable for a tenure of 7 months. Also, banks levy penalty by lowering rate of interest by 0.5%-1%. As, thus the real rate of return is reduced considerably.
Unless necessary, investors should give a prior thought before breaking the existing FD on the whole or reinvesting the amount in another FD for higher return.