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Should you break your FD and create a new one at new higher rates?

This article lets you calculate if you should break your old FD and create a new one at higher interest rates after adjusting for premature breakage penalty.

Should you break your FD and create a new one at new higher rates?


20 Nov 2022 - Contact Sayan Sircar
8 mins read

This article lets you calculate if you should break your old FD and create a new one at higher interest rates after adjusting for premature breakage penalty.

Should you break your FD and create a new one at new higher rates?

Table of Contents

FD rates going up following Repo rates

RBI, in line with other central banks, has hiked the Repo rate from 4.00% to 5.90% in quick succession:

  • 30-Sep-2022: RBI hiked the repo rate to 5.9% from 5.4%.
  • 05-Aug-2022: RBI hiked the repo rate to 5.4% from 4.9%.
  • 08-Jun-2022: RBI hiked the repo rate to 4.9% from 4.4%.
  • 04-May-2022: RBI hiked the repo rate to 4.4% from 4.0%.

The hike is a part of inflation-taming measures put in place by global central banks. For RBI, the Repo rate is now rising towards the pre-COVID-19 pandemic days when the rate was 5.15%. It was lowered twice in March 2020 (to 4.40%) and then again in May 2020 (to 4.00%) to negate the impact of the economic slowdown caused by the pandemic.

As inflation has been rising as the economy recovered, the repo rate rise was inevitable, and further rate increases are unavoidable. The RBI is planning more rate hikes.

Since repo rates are going up, Fixed Deposit (FD) rates are following the same trend currently.

SBI 10-year FD rate

Given that rates are now up, and some banks are offering even higher rates above 7-7.5%, does it make sense to break the FD and make a new one? This question should have an obvious answer except for the hitch of FD premature breakage penalties. You see the bank really does not want you to break FDs and move to the higher rate since they will now have to pay more interest. Hence they levy a penalty when you break an FD.

We will, in the sections below, calculate the penalty to see if it makes sense to break the FD or leave it alone.

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How is the FD penalty calculated?

The penalty has two parts:

  • Penalty on the principal: If you have invested less than ₹5 lakhs in FD, then the penalty is 0.5%. If the principal is more, the penalty is 1%. All banks do not have this and you need to check with your bank.
  • Penalty on the interest: Interest Rate on the period you have held the FD is reduced by 0.5% or 1% (based on the same ₹5L principal rule) and the rate used to calculate the interest is the rate for the lower period for which you have held the FD, at the time of FD creation, minus the penalty of 0.5% or 1%.
  • The total penalty is the sum of these two. The maturity value you get, assuming the principal is more than ₹5 lakhs is

FD Maturity Value = Principal * (1+LowerRate-1%) ^ (Time passed) - Principal * 1% (with principal penalty)

or

FD Maturity Value = Principal * (1+LowerRate-1%) ^ (Time passed) [without principal penalty]

This maturity amount will be subject to tax at slab rates.

FD Duration Rate when you created old FD (A) Rate applied at 0.5% penalty (A-0.5%) Rate applied at 1% penalty (A-1%) Rate when you want new FD (B)
1 year 4.0% 3.5% 3.0% 5.5%
2 years 4.5% 4.0% 3.5% 6.0%
5 years 5.0% 4.5% 4.0% 6.5%
10 years 5.5% 5.0% 4.5% 7.0%

Here LowerRate = the prevailing rate of FD for the duration that has passed at the time of creating the FD. This part is important since the bank will not give you interest at the higher rate since you have held the FD for a shorter period.

Worked out example with an FD smaller than 5 lakhs

For example, the penalty for a ₹3 lakh FD, created at 5.5%, to be broken after 2 years are:

  • 0.5% of ₹3 lakh or ₹1,500 (principal penalty may not be there in your bank)
  • 0.5% less rate than the 2-year FD rate, say 4.5%, at the time of creating the FD
  • Maturity value with only penalty on interest = 3 * (1+4.5%-0.5%)^2 = ₹3.25 lakhs
  • Maturity value = 3 * (1+4.5%-0.5%)^2 - 3 * 0.5% = ₹3.23 lakhs with principal penalty
  • The current value of the FD, in case not broken, is 3 * (1+5.5%)^2 = ₹3.34 lakhs. The difference vs. the previous number is the penalty

Worked out example with an FD larger than 5 lakhs

For example, the penalty for a ₹6 lakh FD, created at 5.5%, to be broken after 2 years are:

  • 1% of ₹3 lakh or ₹3,000 (principal penalty may not be there in your bank)
  • 1% less rate than the 2-year FD rate, say 4.5%, at the time of creating the FD
  • Maturity value with only penalty on interest = 6 * (1+4.5%-1%)^2 = ₹6.43 lakhs
  • Maturity value = 6 * (1+4.5%-1%)^2 - 6 * 1% = ₹6.40 lakhs with principal penalty
  • The current value of the FD, in case not broken, is 6 * (1+5.5%)^2 = ₹6.68 lakhs. The difference vs. the previous number is the penalty

Goal-based-investing plan

Using the calculator

We have put together an easy-to-use calculator to calculate whether you should break your FD given that the penalty exists. We use the decision-making test as the value of the new FD on the date of maturity of the old FD. You should break the old FD only if the new FD has a higher value on the date the old FD would have matured.

The calculator assumes that the FD is of the cumulative type. If interest gets paid out regularly, the higher interest paid out will be deducted from the principal and the result will be the same.

(click to open in a new tab)
FD breakage penalty calculator

Important: You should enter data only in the yellow cells.

Step 1: Enter details of the old FD

  • Box 1: Enter your name.
  • Box 2: The date of creating the new FD. By default, the calculator assumes today’s date
  • Box 3: The amount you invested in the old FD
  • Box 4: The date on which you opened the old FD
  • Box 5: The date on which the old FD will mature
  • Box 6: The interest rate of the old FD

Step 2: Enter the rate of the old FD

Box 7: This is an important input. You need to enter the prevailing FD rate, at the time you created the old FD, for the period that you have held the FD. You can get the period from the “Time since old FD was opened” field above. The rate will be available from the bank’s website or you have to assume it to be 1-2% lower than the old FD rate.

Optional: If your bank does have the penalty on the principal, then set the cells in the “Penalty Calculation inputs” for the principal to the right numbers. If your bank does not have the interest penalty or at different rates in your case, then you can change the interest penalty rates here.

Step 3: Enter the new FD details

Box 8: This is the rate of the new FD. This FD is expected to mature at the same time or later compared to the old FD.

Once you enter the details, you will see the calculator show you the “Benefit of Breaking”. If the number is positive, then you should break it otherwise you should not. Also, you need to decide if the benefits post breaking and reinvesting are worth the effort or not.

Get the calculator

Since the calculator uses Google Sheets, you need to be logged into your Google Account on a browser before clicking the link.

Link to the calculator: here. You will get the calculator, which is free for use, in the “fd-break-or-keep” sheet.

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Next steps:

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2. Use our goal-based investing template to prepare a financial plan for yourself
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This post titled Should you break your FD and create a new one at new higher rates? first appeared on 20 Nov 2022 at https://arthgyaan.com


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