scorecardresearchWhat borrowers must prioritise between loans and bank FDs? 6 analysts answer

What borrowers must prioritise between loans and bank FDs? 6 analysts answer

Updated: 04 Apr 2023, 05:20 PM IST

RBI is slated to raise interest rates on April 06 this year. How should borrowers respond to this continued repo rate hike is a question that bugs the most.

RBI slated to raise interest rates on April 06 this year

RBI slated to raise interest rates on April 06 this year

The Reuters poll of economists shared how the Reserve Bank of India (RBI) would raise its main interest rate by 25 basis points on April 6 this year, thus, taking its repo rate to a new high of 6.75 per cent in April this year.

This means that the cost of borrowing is likely to increase, which could lead to higher interest payments on any outstanding loans. This could hurt your financial situation, particularly if you have taken out a loan that has a variable interest rate.

Though one may argue that bank fixed deposit rates are also going up with the highest being seven per cent offered by many private and public sector banks, one cannot ignore the taxation effect that brings down the effective yield.

The rising rates have frustrated many borrowers to the extent that many are contemplating redeeming their fixed deposits to repay their loans. While this may help many people repay their loans in time or rather prepay their loans, this practice may not bode well for risk-averse investors relying on traditional investment schemes alone.

A tête-à-tête with some personal financial analysts underlined if borrowers must prioritize repaying their loans over conventional savings schemes.

Basavaraj Tonagatti, a Certified Financial Planner (CFP), SEBI Registered Investment Adviser and a Finance Blogger at BasuNivesh says, “Before making any hurried decisions, consider when you had sought the loan. If it is in the beginning stages (say less than five years), you can choose to liquidate your bank fixed deposits to prepay the loan. Prepayment is not worthwhile if the loan is older. Don’t liquidate the deposits to prepay the loan if it is tied to one of your major short-term goals or an emergency fund.”

Viral Bhatt, Founder, Money Mantra says, “It’s important to consider the terms and conditions of your fixed deposits, such as the penalties for early redemption or the minimum lock-in period. If you do decide to redeem your fixed deposits early, you may also lose out on any interest that would have been earned if you had held onto them until maturity. Also, when deciding whether or not to redeem your FDs to pay off a loan, you should also consider the potential tax implications. Interest earned on fixed deposits is taxable as per the income tax slab of the individual, and this could impact the overall return on your investment."

"Additionally, if you have other financial goals or obligations, such as saving for retirement or paying for your children’s education, you may need to consider the opportunity cost of using your savings to pay off a loan,” added Bhatt.

Dev Ashish, SEBI-Registered Investment Advisor and Founder (Stable Investor), says, “During the initial years of the home loan, the interest component is larger in the equated monthly instalments (EMIs). But this gradually decreases as time goes on. So ideally, the best time to prepay a loan is the earlier you can. That way, there is a bigger impact on the total interest cost as the money you prepay goes straight towards reducing the home loan principal. Now loan rates have risen to almost 9-9.5 per cent for many and possibly will go up further, it is hurting the borrowers due to the increased interest costs."

Ashish added, "And these loan rates are now higher than what many safe debt instruments offer. So once you have set aside money for an emergency fund, and if you have debt instruments (like surplus unallocated cash in a savings account, surplus fixed deposits, etc.) that are earning much lower than your home loan rates, you can use a part of it to make prepayments. This will reduce your outstanding principal and help negate the rate hike to an extent.”

Suresh Sadagopan, MD & Principal Officer, Ladder7 Wealth Planners says, “It could be a good idea to pay off the loans in cases where the post-tax returns are much less than the interest being paid on loans.”

Aditya Shah, Founder, JST Investments, said, “Home loans are now at eight to nine per cent whereas the FD interest rate is still pegged at somewhere seven per cent. Therefore, keeping money in fixed deposits will yield a negative return, thus, justifying the idea to pay off the loans with the money accrued in the fixed deposits.”

Your financial decisions depend on your financial goals. No thumb rule can help dictate one’s financial path. Ultimately, ‘To each, his own’ is the guiding formula that underscores all money-making decisions.


These are the RBI's monetary policy instruments.
First Published: 04 Apr 2023, 05:20 PM IST