Almost every fixed deposit can be broken early, and almost nobody knows what it costs until the bank tells them. The price is not a fee pulled from a drawer — it is a recalculation, with a formula you can run yourself before you decide. This guide states the mechanism, prices one deposit three different ways, and then prices the alternative most people miss: borrowing against the FD instead of breaking it.

How the penalty actually works

When you close an FD before maturity, the bank discards the rate you booked and starts again. You are paid interest at the rate on its card for the tenure you actually completed — a deposit booked for five years and broken after two is repriced as a two-year deposit — and then a penalty is deducted from that rate, commonly around half to one percentage point, under the terms you accepted at booking. Interest for any part-period is worked out on the bank’s day-count basis. Three consequences follow, and only the first is widely understood:

• The penalty percentage is the smallest part of the cost. The bigger part is the rate reset itself: the two-year rate was always lower than the five-year rate you booked.
• Everything you lose is interest. Your principal comes back whole (subject to the rare case, below) — what shrinks is the growth.
• The cost grows with the gap between the booked tenure and the completed one. Breaking a five-year FD in year four is a shrug; breaking it in year one is expensive, because almost all of an FD’s interest arrives late, through compounding.

One boundary case deserves naming: if a deposit is broken very early, before it has earned much interest, a penalty calculated on interest can in principle exceed the interest earned and touch the principal at some banks. Read the premature-closure clause of your own FD before you rely on any of this — the mechanism here is the standard one, and individual banks vary it.

One deposit, three endings

Take a single deposit and price its futures with the same formula the FD Calculator uses: $40,000 booked for 5 years at 7%, compounded quarterly.

Every value computed with A = P(1 + r/n)^(n×t), quarterly compounding. The 5.75% completed-tenure rate is an illustrative card rate for the two-year tenure; your bank’s card decides the real figure.

Read the rows carefully, because they overturn the usual story. The penalty itself — the difference between the second and third rows — costs $876.47. The real cost of breaking is the $12,629.39 of interest that separates the third row from the first: three years of compounding on a growing balance, cancelled. When people say “the bank took my interest”, it is mostly that second, silent item they are describing. This is also why the decision gets easier the longer you have held the deposit: by year four of five, most of the interest has already been earned and the remaining give-up is small.

The alternative: a loan against the FD

If the need is temporary, the deposit itself can fund it. Most banks offer a loan or overdraft secured on a running FD, typically up to about 90% of its value. The loan against FD interest rate is not a market rate discovered anywhere — it is set as a margin over your own deposit’s rate, commonly 1 to 2 percentage points above it, because the bank’s risk is close to zero: the deposit is the collateral, and it is already holding the money.

On the example deposit: 90% of $40,000 is $36,000 of borrowing room. Held for one year at 8% (the 7% FD rate + 1), that loan costs $2,880 of simple interest; at 9% (+ 2) it costs $3,240. Meanwhile the FD is untouched and still compounding toward its full $56,591.13. Compare the shapes, not just the numbers: breaking is a one-off, permanent give-up of $12,629.39 of interest; the loan is a running cost of roughly $3,000 a year that stops the day you repay. For a need measured in months, the loan wins easily. For a need that will still be there in four years, the loan’s cumulative cost overtakes the break — and that crossover, around the third to fourth year at these rates, is the real decision point.

The same deposit, broken at other moments

Timing changes everything, so here is the $40,000 deposit broken at year four and at year one, priced by the same mechanism (completed-tenure rate minus the 1-point penalty; completed-tenure rates illustrative). Broken after four years — repriced at a 6.50% four-year rate, penalised to 5.50% — it pays $49,768.42: $9,768.42 of interest kept out of the $16,591.13 the full term offered. Broken after just one year — repriced at a 5.50% one-year rate, penalised to 4.50% — it pays $41,830.60, keeping $1,830.60. Set the three break points side by side and the pattern is unmistakable: the give-up is $14,760.53 in year one, $12,629.39 in year two, $6,822.71 in year four. Early breaks are the expensive ones, because compounding had barely started; a late break hands back a much smaller fraction of the prize.

The one case where breaking wins: rates have moved, a lot

There is an honourable exception. If market rates have risen sharply since you booked, breaking and rebooking at the new rate can recover the penalty and more. But “sharply” does real work in that sentence, and the example deposit shows how much. Break it at year two (payout $43,961.74) and rebook the whole payout for the remaining three years at 8.50% — a full point and a half above the rate you broke — and it grows to $56,579.58, against $56,591.13 for simply staying put. Still $11.55 behind. The break-even rebooking rate for this deposit is about 8.51%: below it, breaking to chase a rate loses money however exciting the new card looks; above it, it wins. The method generalises — price your own payout, rebook it on paper for the remaining term, compare with the booked maturity — and it is a five-minute calculation in the FD Calculator, not a leap of faith.

What happens to the tax when you break

Breaking changes the interest; it does not rewrite tax history. Interest credited to the deposit in earlier years was income in those years — in the US it was reportable as credited, and in India it entered your slab income with any TDS already deducted showing as a credit. When the bank recalculates the deposit downward at closure, the final year’s interest figure absorbs the adjustment in most cases; if the recalculation claws back interest that was taxed in an earlier year, the correction runs through your next return rather than through the bank. Keep the closure statement — it is the document your return is reconciled against.

Softer landings worth asking about first

• Partial withdrawal. Some banks let you break only the portion you need, in round units, leaving the rest of the FD compounding at its booked rate. If it is offered, it beats both breaking the whole deposit and borrowing the whole amount.
• Sweep-in accounts. A linked savings account that auto-breaks FD units, smallest first, only when a payment would otherwise fail. The breaking still happens, but in the smallest possible slices and only when truly needed.
• No-penalty variants. Some banks and many US issuers sell CDs/FDs that waive the early-withdrawal penalty after a short initial period, at a slightly lower booked rate. If your tenure is uncertain at booking, the lower rate can be the cheaper product.
• The ladder. The structural fix: money split across staggered maturities frees up on a schedule, so “breaking” mostly stops being a question. The final guide in this series builds one, priced rung by rung.

Exceptions and waivers that genuinely exist

The mechanism is standard, but it is not quite universal, and three exceptions are worth knowing before you accept a closure figure. In India, the Reserve Bank has directed banks not to levy a premature-withdrawal penalty when a deposit is closed early following the depositor’s death — the nominee or legal heir receives the interest for the period held without the penalty deduction. Some banks waive or reduce the penalty when the proceeds are immediately redeposited with them for a tenure at least as long as the broken one’s remaining term — a retention concession, offered rather than owed, and worth asking for by name. And a minority of deposits are sold from the start as no-penalty or flexible-withdrawal products, typically at a slightly lower rate: if your closure quote shows no penalty line, it may be the contract you bought rather than an error in your favour. Everything else — hardship, loyalty, a bigger deposit waiting — is negotiation, not entitlement, and the checklist below assumes the standard mechanism applies.

Before you break: a five-minute checklist

1. Get the bank’s premature-closure figure in writing — the repriced rate, the penalty, and the payout. Compare it with the mechanism above; it should reconcile.
2. Price the loan-against-FD for the amount and the months you actually need, and find your crossover point.
3. Check whether a partial break covers the need.
4. Remember the tax: interest already credited stays taxable in the year it was credited, penalty or not.
5. Decide with the numbers, not the guilt. An FD is a tool, and sometimes the right answer really is to break it — the mistake is breaking it unpriced.