Check the lock-in period and penalty on premature withdrawal while investing in a fixed deposit.
With interest rates on a rise, Shiram Upadhayay is flooded with SMSes and calls from distributors who want to sell both bank and company fixed deposits.
For instance, some real estate companies are offering 12 per cent annually for a three-year deposit. But his financial advisor is not enthused. “He feels bank fixed deposits are a better option, as these are more liquid,” says Upadhyay. It is a valid concern when one is unsure when he/she may have to break the deposit.
| ON THE BALANCE | |
| COMPANY FIXED DEPOSITS | BANK FIXED DEPOSITS |
| Higher risk, illiquid | Safer, liquid |
| Lock-in of 3-6 months, premature withdrawal at company’s discretion | No lock-in period |
| Lower interest payout by as much as 2-3 per cent (for premature withdrawals)* | Penalty of around 0.5-1 per cent (for premature withdrawals)* |
| Minimum investment amount: Rs 10,000-25,000 | Minimum investment amount: Rs 1,000-5,000 |
| * This is in addition to the applicable rate for the tenure in which the money is being withdrawn. For example, if a three-year deposit is withdrawn in the second year, the investor will get 2-3 per cent (for company fixed deposits) and 0.5 -1 per cent (for bank fixed deposits) lower than the interest rate applicable for a two-year deposit | |
While a rising interest rate regime is a great opportunity for a fixed deposit investor, there are many things that need to be taken into consideration. Liquidity can be a major issue, at least in the initial period. “In most company fixed deposits, the investor cannot break the deposit for the first six months,” says C Saravanan, president, Bluechip Chip India, a financial product distributor.
And, the penalty is mostly in the form of a low rate of interest — as much as one-two per cent — in many cases. This number becomes smaller as you move closer to the maturity date. Housing Development and Finance Corporation (HDFC) does not allow withdrawal in the first three months. If the deposit is terminated between three-six months, no interest is paid. Thereafter, you get two per cent lower than the applicable rate for that period, or three per cent lower than the minimum rate (if the rate is not specified).
In many cases, there are specific clauses that protect the company from even allowing you to withdraw. Application forms for company deposits make this quite clear. “The company may at its sole discretion permit the depositor to withdraw the deposit amount,” is the clause in many application forms.
According to Surya Bhatia, a Delhi-based financial planner, companies allow premature withdrawal only in case of emergencies such as a family or medical one.
Banks are less harsh. Penalties, therefore, are less stringent. Banks allow the breaking of fixed deposits for a penalty of around one per cent. However, there is no lock-in period like in company deposits. And, all banks allow premature withdrawal unconditionally. However, this is also charged in the form of a lower interest payment, in most cases.
A couple of days back, HDFC Bank announced a one per cent penalty for premature withdrawal from January 24. ICICI Bank charges anywhere between 0.5-1.5 per cent while State Bank of India and Punjab National Bank levy a one per cent charge. Axis Bank and IDBI Bank do not charge for premature withdrawals from fixed deposits.
But the positives are reliability and a lower risk of default by banks. Small depositors (up to Rs 1 lakh) even get their money back if a bank defaults. Also, the minimum investment amount for bank fixed deposits is Rs 1,000, which in the case of corporate deposits is Rs 10,000-25,000.
On the other hand, while companies offer better returns, their deposits are unsecured. As a result, in case of any default, the investors will find it difficult to recover their monies. No wonder, Rajat Prasad, managing director, RR Financial Consultant, feels despite high rates, investors need to be selective about the company.
Ideally, one should invest in the deposits of largecap companies. At present, the rates on offer are 7.5-9.5 per cent on one-two year deposits. Smaller firms or ones with huge debt on their books are offering 10-12 per cent for the same tenure.
If you are looking for liquidity in fixed deposits, split the investible amount in smaller parts. Say, you have Rs 50,000 to deposit, make 10 deposits of Rs 5,000 each. If you need money, you can break these easily and pay a penalty on a smaller amount.
For better returns than bank fixed deposits, financial experts suggest fixed maturity plans over company deposits. These are tax-efficient as well.
