Loan Products Masterclass · Part 8 · Loans · 9 min read · October 2026
Breaking your FD costs more than the 1% penalty. A loan against it often costs less.
Two years into a five-year deposit of ₹5 lakh at 7.25%, you need ₹2 lakh for about six months. The bank's page says premature withdrawal carries a penalty of 1%, which sounds like ₹2,000 on the money you need. Breaking the deposit on these numbers costs ₹14,024 on the day you do it, before the remaining ₹3.6 lakh is re-booked at whatever the rate is today. Borrowing the same ₹2 lakh against the same deposit for six months costs ₹8,250.
- The penalty is the smallest part of breaking. RBI's rules pay interest for the period the deposit actually ran, not at the rate you booked. Most banks pay the lower of your rate and their rate for that shorter period, and only then take the penalty off.
- It hits the whole deposit, not the part you need. Break a ₹5 lakh FD to use ₹2 lakh, and all ₹5 lakh is repaid at the lower rate for the whole two years.
- A loan or overdraft against the FD charges only for what you borrow, for as long as you borrow it, while the deposit keeps its rate. The catch is tax: deposit interest is taxed, loan interest is not deductible, so the loan's edge shrinks every month you keep it.
- On the worked example, borrowing wins for anything up to about two and a half years. If the money is never coming back, break the deposit and do not pay interest to postpone it.
What breaking actually costs
RBI's Interest Rate on Deposits Directions, 2025 set the base rule. When a term deposit is withdrawn before maturity, interest is paid at the rate for the amount and the period the deposit actually stayed with the bank, not at the contracted rate. The penalty on top is each bank's own, under a policy approved by its board, and the directions add one protection that is worth knowing: the components of the penalty have to be brought to the depositor's notice when the deposit is accepted. If they were not, the bank cannot levy a penalty.
In practice the calculation runs in three steps. The bank looks up the rate it was offering, on the day you opened the deposit, for a deposit of the length yours actually ran. It applies the lower of that and your booked rate. Then it takes the penalty off, commonly between half a percent and one percent.
The 1% sounded like ₹2,000 because people apply it to the money they need, for a year. The bank applies it, and the fall from 7.25% to 7.00% before it, to the whole ₹5 lakh, for the whole two years. That is the part of breaking that the penalty line never shows.
Then there is the money you did not need. In the example, ₹3,63,246 is left after taking out ₹2 lakh, and it has to go somewhere for the three years the old deposit had left. If today's rate for three years is lower than 7.25%, that is a second cost; if it is higher, it softens the first.
How a loan against an FD works
The bank marks a lien on your deposit and lends against it, either as a term loan or as an overdraft limit on an account. The deposit itself is not touched: it keeps running to maturity at the rate you booked, interest and all.
- How much. A share of the deposit set by the bank's policy, commonly up to about 90%.
- At what rate. RBI's Interest Rates on Advances Directions, 2025 exempt advances to depositors against their own deposits from the benchmark-linked pricing that governs most loans, so the rate is the bank's own call. Most price it as a margin over the deposit's own rate.
- Overdraft or loan. An overdraft charges interest only on the amount actually drawn, for the days it is drawn, so a need that shrinks as you repay costs less than a term loan for the full amount.
- Only at your own bank. The directions bar banks from lending against deposits held with another bank.
- Only until maturity. The loan cannot outlive the deposit. Whatever is still owed when the deposit matures is recovered from it.
- On your credit report. It is a loan like any other and is reported as one. Kept within its limit and serviced, it is a secured account in good standing. Left to run past its limit with interest unpaid, it shows as overdue on the same report a home loan desk will read later.
On the example, ₹2 lakh for six months at 8.25%, a point above the deposit's rate, costs ₹8,250 if the full amount stays drawn until you repay it all at once.
Same deposit, two routes, one date
The fair comparison follows both routes to the same day, the date the deposit would have matured. On the loan route, the deposit earns its full interest and you pay the loan's interest. On the break route, you get the lower interest on breaking, re-book the rest at today's rate, and when you would have repaid the loan, put the ₹2 lakh into a fresh deposit instead. Assume today's three-year rate is 7.00% and you pay tax at 30% plus cess, 31.2%.
| Line | Borrow against it | Break it |
|---|---|---|
| Deposit interest to the original maturity date | ₹2,16,130 | ₹1,85,204 |
| Tax on that interest at 31.2% | ₹67,433 | ₹57,784 |
| Loan interest, not deductible | ₹8,250 | ₹0 |
| Left with, after tax | ₹1,40,447 | ₹1,27,420 |
The break route's ₹1,85,204 is made of ₹63,246 paid on breaking, ₹84,069 earned on the re-booked ₹3.63 lakh over three years, and ₹37,889 on the ₹2 lakh put back after six months. Borrowing leaves you ₹13,027 better off after tax. Before tax the gap is ₹22,676.
Why the loan's edge shrinks with time
Breaking costs you once, on the day. Borrowing costs you every month, and the tax system leans against it. The deposit's 7.25% is taxed at your slab, which at 31.2% leaves about 4.99% in your hands. The loan's 8.25% gets no deduction when the money is spent on personal needs, so every month you carry it costs the full 8.25%.
On the worked example the two routes cost the same at about 33 months of borrowing. Up to 32 months, the loan is cheaper; beyond that, breaking would have been. If you are not confident the money will be back in that time, a loan is not avoiding the break, only delaying it and adding interest.
The tool for this
Enter your deposit, the bank's rate for the period it ran, the penalty, today's rate, what you need and for how long. It follows both routes to your maturity date after tax, shows the cost of breaking on the day, recovers payouts where your deposit paid interest out, and finds the borrowing period at which the two routes meet.
When breaking is the better call
- The money is not coming back. A down payment, a medical bill paid for good, a debt cleared for good. Borrowing against a deposit you will never rebuild only postpones the break and adds interest to it.
- The deposit is close to maturity. With a few months left, the loss from breaking is small, and often the simplest route is to wait or to borrow only until the maturity date.
- You need almost all of it, for a long time. The loan then costs interest on nearly the whole deposit for most of its remaining life.
- Rates have risen far enough. After RBI raised the repo rate to 5.50% on 7 October 2026, depositors are asking whether to break old deposits and re-book. The same arithmetic applies with nothing borrowed. On the example, breaking to re-book only pays if today's three-year rate is above about 8.1%, almost a full point above the old 7.25%, because the penalty and the lower rate for the two years run have to be earned back first.
Questions to ask before you choose
- What rate will you pay for the period my deposit has actually run, and is it lower than my booked rate?
- What is the premature withdrawal penalty on this deposit, and where was it disclosed to me?
- Can I withdraw part of the deposit instead of closing all of it? The directions expect each bank's penalty policy to cover partial withdrawal, so ask what yours allows.
- For a loan or overdraft against the deposit: what share of it can I draw, at what rate, with what processing charge if any, and how is interest debited?
- What happens at maturity if the loan is still running: is it adjusted from the deposit automatically, and does the deposit renew?
Deposits you cannot break or borrow against
- Five-year tax-saving deposits can be neither withdrawn early nor pledged for a loan before the five years are up. The one exception is the depositor's death, when the nominee or legal heir can claim early.
- Deposits above ₹1 crore may have been taken without a premature withdrawal option, usually at a slightly higher rate. RBI requires the option on individuals' deposits of ₹1 crore and below, not above it.
- Joint deposits usually need every holder to sign before the deposit can be pledged for a loan.
One more habit saves the whole question next time. A single large deposit has to be broken whole. The same money split into a few smaller deposits lets you break only the one you need, and the rest keeps its rate.
The one-line summary
Breaking costs you once and costs the whole deposit; borrowing costs you monthly and costs only what you take. For a need that will be repaid within a year or two, the loan usually wins. For money that is gone for good, break the deposit and do not pay interest for the privilege of waiting. Either way, ask the bank for the rate it will actually pay on breaking before you decide, because that number, not the penalty, is the one that moves the answer.
Written at the MoneyClarityTech desk — by a working retail-credit professional in Indian banking who reads loan files, credit reports and bank statements every working day. Patterns from hundreds of real cases; every identifying detail removed. More about MoneyClarityTech →