Need quick credit for short tenure? Consider loan against fixed deposit

But if you require additional liquidity for long term, break the FD and borrow against another asset

One form of loan that has caught the eye of retail borrowers in recent times is loan against fixed deposits (FDs). According to data from the Reserve Bank of India’s (RBI’s) April 2023 bulletin, this form of loan witnessed an unprecedented surge of 43 per cent during the 2022-23 financial year, making it one of the fastest-growing retail loan products in the country. The outstanding portfolio of this form of loan had soared to Rs 1.13 trillion by February 2023.

How does it work?

If you have an FD and want a loan, the bank will lien-mark the FD and give you the money. Banks charge an interest rate that is 100-200 basis points higher than the interest paid by the FD.

Low-cost, accessible credit

The interest cost of this loan is low. “If you have an FD that pays an interest rate of 6 or 6.5 per cent, you could get this loan for 7.5-8 per cent,” says Adhil Shetty, chief executive officer (CEO), Bankbazaar.com.

FD rates had hit historic lows post-Covid-19 and remained so till the RBI began to hike the repo rate from May 2022. “By using FDs booked during the low interest rate regime as collateral, the borrower can get this loan at a low cost,” says Gaurav Aggarwal, senior director, Paisabazaar.

This loan is easy to get. Usually, when a customer applies for an unsecured (or even a secured) loan, the bank checks his income, repayment capability, and credit score. “In case of a loan against FD, the lender waives these checks because it gets a highly liquid collateral — the FD,” says Arun Ramamurthy, director, digital transformation, branding & strategy, Andromeda Loans.

Most banks offer loans against FD in the form of an overdraft (OD) facility. A credit limit is sanctioned (which depends on the FD amount). The borrower can withdraw up to the sanctioned amount and repay it at his convenience. Interest is incurred only on the amount drawn, and for the period of utilisation. “This makes it an excellent tool for mitigating frequent liquidity and cash flow mismatches,” says Aggarwal.

This loan allows the borrower to access a large portion of the money in his FD without closing it prematurely. If you break the FD, you are paid a lower interest rate, corresponding to the period for which the FD was held. You also have to incur a premature withdrawal penalty.

The loan to value (LTV) ratio (the value of loan given versus value of the collateral) is high at 85-95 per cent. In case of a gold loan, the LTV ratio doesn’t usually exceed 75 per cent. In the case of a gold loan, the lender also does its own valuation of the gold you hand over. In case of a loan against shares, the LTV ratio doesn’t go beyond 50-70 per cent. And, a loan against property takes considerable time to sanction because the lender evaluates the legal title and then does the valuation of the property.

Suitable for limited period only

This loan can only be availed for the short term. “The loan must be repaid before the FD matures. That puts a limit on its tenure,” says Shetty.

Once an FD is used as collateral, it can’t be closed unless the borrower pays off the loan. “The money lying in the FD can’t be used in an emergency,” says Aggarwal.

The loan can only be taken from the bank where you have the FD, so you can’t shop around.

Who should go for it?

People who have a poor credit score find it difficult to get an unsecured loan and have to turn to a secured loan.

If you need money for the short term, and quickly, a loan against FD is advisable. “But if you require the money for a longer tenure, consider breaking the FD and using your own funds instead of paying interest on this loan,” says Ramamurthy.

Factor in the interest rate at which you booked the FD. “If your FD was booked at a high interest rate, this loan will not be cheap,” says Shetty.