Can I Take a Loan Against My FD to Start Another? (7.5% Interest)

Ans: Your question raises a valid point about the simplicity and perceived safety of Fixed Deposits (FDs). While FDs offer a guaranteed return, there are some aspects to consider when opting for them as a primary source of income:

Inflation: The 7% FD rate might seem attractive now, but inflation erodes the purchasing power of money over time. A higher FD return might be necessary to combat inflation and maintain the real value of the invested amount.
Taxation: Interest income from FDs is taxable as per the investor's income tax slab. For someone in the higher tax bracket, the post-tax return might be significantly lower than the pre-tax return, reducing the effective yield.
Liquidity: FDs typically come with a lock-in period, and breaking them prematurely might attract a penalty. This could impact liquidity, especially in emergencies.
Interest Rate Risk: In a falling interest rate scenario, locking into an FD at a lower rate might result in missed opportunities for higher returns from other investment avenues.
Diversification: Putting all the corpus in FDs exposes the investor to concentration risk. Diversifying across different asset classes can help in spreading the risk and potentially enhancing returns.
While FDs offer safety and guaranteed returns, it's essential to consider the impact of inflation, taxation, and liquidity needs. A Certified Financial Planner can provide personalized advice considering the investor's financial goals, risk tolerance, and income needs. They can help in designing a well-balanced portfolio that meets the income requirements while ensuring capital preservation and growth over the long term.

Remember, while FDs can be a part of the investment strategy, relying solely on them might not be the most efficient way to generate a monthly income of 1 lakh from a 3.5 cr corpus, especially when considering factors like inflation, taxation, and investment opportunities in other asset classes.

Ans: Here's a breakdown of your friend's situation with Unity Small Finance Bank FDs and some insights:

Unity Small Finance Bank FDs:

Positive aspects:

High Interest Rates: Unity Small Finance Bank offers competitive FD rates, potentially giving your friend higher returns than traditional savings accounts. [1]
DICGC Insurance: Up to ?5 lakh per depositor per bank is insured by Deposit Insurance and Credit Guarantee Corporation (DICGC), providing some security for his investment. [1]
Flexible Tenures: He can choose a tenure that aligns with his financial goals, offering flexibility. [1]
Limitations to consider:

Limited DICGC Coverage: If the total deposit exceeds ?5 lakh per person, the exceeding amount is not insured by DICGC. Spreading the FD across different banks can potentially mitigate this risk.
Premature Withdrawal Penalty: Penalties apply if your friend needs to withdraw the money before maturity, potentially impacting his returns. [1]
Not Risk-Free: Although FD rates are generally stable, there is always a chance of interest rates dropping in the future, impacting returns.
Alternative Strategies for Larger Amounts:

Multiple FDs Across Banks: Distribute the ?50 lakh across several banks, ensuring each individual holds less than ?5 lakh per bank to maximize DICGC coverage.
Consider Public Sector Banks: Public sector banks might offer slightly lower interest rates but may be perceived as a safer option due to government backing.
Explore Debt Funds: Debt funds, especially fixed-income funds, can offer potentially higher returns than FDs with similar liquidity profiles. However, they come with slightly higher market risks.
Educating Your Friend:

Risk Tolerance: Discuss your friend's risk tolerance. FDs are generally low-risk, but other options might offer higher potential returns with slightly more risk.
Investment Goals: Understanding his financial goals (short-term vs. long-term) is crucial. FDs can be suitable for short-term needs, while debt funds might be better for long-term goals.
Diversification: Encourage diversification across asset classes to potentially improve returns and mitigate risk.
Conclusion:

Investing in Unity Small Finance Bank FDs can be a reasonable option for your friend, especially for a portion of his savings. However, due to the limited DICGC coverage for larger sums, explore spreading the investment or consider alternative options for the remaining amount. Ultimately, the best approach depends on his risk tolerance, investment goals, and overall financial situation.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in

Ans: You have an FD of Rs. 1 lakh at 7.5% interest for 24 months.

Your bank allows a loan of up to 90% against this FD at 8.5% interest.

You are considering taking Rs. 90,000 as a loan and placing it in another FD at 7.5%.

This cycle can continue, creating a chain of FDs and loans.

At first glance, this seems like a way to earn interest while leveraging loans.

The Hidden Costs of This Strategy
The loan interest is higher than the FD interest by 1%.

Over time, the gap in interest rates eats into returns.

Every FD created with loaned money earns less than the cost of the loan.

This results in a compounding loss, not gain.

Instead of profits, you accumulate more liabilities.

Loan Interest vs. FD Returns
The effective return from an FD is reduced when using borrowed funds.

The 1% extra interest on the loan cancels out the FD gains.

Your net return turns negative after tax and compounding effects.

Borrowing to reinvest in FDs is not wealth creation.

It increases your financial burden over time.

Impact of Taxes on Returns
FD interest is fully taxable as per your tax slab.

If you are in the 30% tax bracket, your post-tax FD return is much lower.

The loan interest is an expense, but you cannot claim a tax benefit.

The real return from the FD loan cycle becomes negative after tax.

Banks Benefit, Not You
Banks always earn more from this structure.

They collect loan interest at 8.5% while paying you only 7.5% on FDs.

Banks also charge processing fees and renewal charges.

You end up paying more in interest than you earn.

Instead of growing wealth, you help banks make profits.

Liquidity Issues and Loan Repayment
Loan against FD must be repaid, usually within the FD tenure.

If not repaid, the bank can close your FD to recover the amount.

Rolling the loan into new FDs creates a cycle of dependency.

If you face an emergency, you may struggle with cash flow.

This approach reduces financial flexibility.

Better Alternatives for Investment
Instead of creating a loan-FD loop, consider investing in better options.

Actively managed mutual funds offer better long-term returns than FDs.

Debt mutual funds give stable returns with lower tax liability.

If you want safe investments, consider PPF or tax-free bonds.

Wealth creation happens by investing smartly, not by taking unnecessary loans.

Final Insights
Taking a loan to reinvest in FDs does not work.

Loan interest exceeds FD returns, leading to a financial loss.

Tax reduces the effective FD return even further.

Banks benefit from this structure, not investors.

Avoid financial strategies that create unnecessary liabilities.

Focus on investments that grow wealth efficiently.

A well-planned portfolio gives better results than an FD-loan cycle.

Best Regards,

K. Ramalingam, MBA, CFP

Chief Financial Planner

www.holisticinvestment.in
https://www.youtube.com/@HolisticInvestment