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Should you break your bank deposit or borrow against it?
By Shiv N. Majumdar

Avinash Naik and Deepak Joshi are two persons with a similar decision to make. They have to choose between breaking their bank deposit and availing a loan against it.

The following are the relevant facts:

	Avinash Naik	Deepak Joshi
Bank deposit	Rs 1,50,000	Rs 1,00,000
Period of deposit	3 years	3 years
Maturity date	23/12/04	6/6/05
Rate of interest	9%	8%
Amount required	Rs 25,000	Rs 40,000
Interest on loan	11% p.a.	8% p.a.
Current deposit interest rate	7%	7%
Monthly income	Rs 15,000	Rs 20,000
Loan EMI

Loans against deposits are the cheapest loans available.

Breaking deposits have two elements of cost-

• Loss in interest, if any (applicable rate of interest for shorter actual period of deposit will be applied)
• Penalty for premature withdrawal, if any.

There is one additional element, which needs to be considered- the lower earning on the balance amount if kept in a fresh deposit.

Avinash would earn 7% (vs. 9% now) on Rs 1,25,000 while Deepak would earn 7% (vs. 8% now) on Rs 60,000.

Our natural psychological factors would dictate us not to break a deposit, but to go for a loan, because we value round amounts more than odd amounts. For example, we would attach more value to Rs 1,00,000 or Rs 25,000 than Rs 99,100 or Rs 24,500.

This is all right, if we the funds requirement is relatively small. But where the amount required is large, if we get completely driven by psychological factors, we would incur substantial cost.