FIXED DEPOSITS-Should You Break An Old FD When There Is An Increase In Interest Rates?

Fixed Deposits, commonly called FD's are the safest investment instrument. Savings in the form of Fixed Deposits with a bank are the easiest. You earn interest that is higher than that of a savings account, for a fixed period of time varying between 15 days and 5 years.

Rising interest rates signify an overburdened borrower because of expensive loans. But when rising interest rates are applied to Fixed Deposit rates, investors set to gain. Suddenly, Indian bank fixed deposits see a significant increase in interest rates, in the range of 0.25 -1.5 %. If you are contemplating like me, as to whether you must break your old FD's and make fresh FD's in order to benefit from the increased interest rates, let us take a look at the pros and cons and decide which is better.

As an investor, you should consider each of your FD's and take into account the maturity date and see how much time there yet is for this date. Each bank has a different interest rate applicable, a different penalty for premature withdrawal and so you need to view each bank's FD with the interest rates of that particular bank and the penalty for premature withdrawal as well for you to arrive at a conclusion.

If an FD is nearing maturity, it would be wise not to opt for a premature withdrawal, as you will then lose some interest on that deposit. This is because the interest is calculated on an annualized basis. This loss may be greater than the income you might gain if you make a fresh FD with the new increased interest rates.

Example: If you had invested in an FD about 4 months back for 1 year @ an interest rate of 7.5 %, and decide to break it, so as to reinvest afresh at today's interest rate of say, 8 %, then the rate applicable for 4 months will be applied, which may be 5.5%. This is a loss of 2 % on annualized interest. In addition, a penalty for premature withdrawal is applied, which may be 1-2 % depending on the bank.

Bearing the above in mind, one needs to check if the FD in question will earn you more on breaking it, or keeping it until maturity. Where the interest rates are higher and are able to compensate the penalties or lower rate for the tenure invested for, you could opt for the switch. But, if your interest rates have seen an increase of 0.5 %, and the penalty for premature withdrawal is also 0.5 %, it would be wiser to retain your old FD. And you can make some fresh Bank FD's to avail of the new attractive interest rates.

What My Bank Advised Me - How To Still Benefit With My FD's

My Bank no. 1: In order to take advantage of the new increased interest rates on FD's, and not lose on my old FD's by breaking them, they advised me to opt for an extension of my old FD"s. This means that until the present date, my FD will earn the old interest rate, and this will be added on to the original sum making the total amount the principal for the new FD. This new FD will bear a new maturity date (between 1-5 years as opted by me) with the new increased rate of interest. Since there is no withdrawal, no penalty is levied and I still gain from this FD. This method is called an Extension of the FD.

My Bank no. 2: I was advised to wait until Jan 25,2010, for another increase of at least 0.5 % in interest rates was expected. This bank does not charge any penalty for premature closure if the amount is being reinvested with them.

All banks may not offer such schemes, and it would be wise to cross check with your bank manager, before you take a decision.