When in need of credit, leveraging existing financial assets can be a smart alternative to high-interest unsecured loans. Fixed deposits (FDs) and life insurance policies are two of the most commonly used financial instruments that can serve as collateral for secured borrowing.

Secured credit products such as FD-backed secured credit cards, loans against fixed deposits (LAFDs), and loans against life insurance policies (LAIPs) provide liquidity while ensuring the original asset remains intact. However, the decision on which option to use depends on factors such as loan-to-value (LTV) ratios, interest rates, repayment flexibility, and financial goals.

In this article, we break down how these options work, their key differences, and which one might be the best choice based on your needs.

Understanding Loan Against Fixed Deposits

A Loan Against Fixed Deposit (LAFD) allows depositors to borrow against their FD instead of breaking it. Banks typically offer loans up to 90% of the FD amount, and since the deposit remains intact and continues to earn interest, this is a cost-effective way to access funds.

• Penalty for Breaking FD: If a depositor chooses to prematurely withdraw their FD instead of leveraging it, they usually face a 0.5% to 1% penalty on interest and potential loss of compounded earnings.
• Limited Lender Options: Since the issuer of the FD is also the lender, customers must take the loan from the same bank, limiting choice in terms of loan collateral pricing and structure.

It's important to note that only a small fraction of the total fixed deposits in the banking system have been leveraged. While specific data is limited, it's estimated that less than 1.2% of FDs are leveraged for loans or cards, indicating that while LAFDs are available, they are not widely utilized by depositors.

Understanding Secured Credit Card

Secured credit cards function as a revolving credit line, issued against a fixed deposit. These are ideal for those with low or no credit history, as they provide access to credit while also helping build a credit profile.

• Credit Limit: Typically 90% of the FD value
• Benefits: Similar to regular credit cards, including cashback, rewards, and EMI options
• No Credit Score Requirement: A great way for new borrowers or those with low scores to improve their financial standing
• FD Interest Rate: You continue to earn up to 7% per annum on the fixed deposit.
• Card Interest Rate: Typically ranges from 24% to 36% per annum (2% to 3% per month) on outstanding balances.

Understanding Loan Against Life Insurance

A Loan Against Life Insurance Policy (LAIP) allows policyholders to borrow against their insurance’s surrender value. Unlike FD-backed loans, these are available from multiple banks and NBFCs, not just the provider of the life insurance policy. Taking a loan against a life insurance policy enables the policyholder to access liquidity when in need, whilst continuing to enjoy life cover and keeping long term financial plans intact as his/her endowment or investment portfolio continues to grow towards maturity.

• Collateral: Policies such as endowment, money-back, ULIPs and retirement.
• LTV Ratio: Typically 80%-90% of the surrender value; ULIPs may have lower LTV (~50-60%) based on fund value.
• Higher Opportunity Cost: Surrendering a life insurance policy to access funds can result in a 30%-70% loss of accumulated savings and benefits.

In contrast to other financial assets, the penalty to liquidate or exit an insurance contract early is very high, as life insurance is designed to offer long-term protection and savings. It is often an underutilized source of liquidity. Whilst most life insurance plans in the market accrue a value that can be used as collateral, exceptions to this include term insurance policies (both individual and group), which do not accumulate surrender value, and thus cannot be used for such loans.

To understand these better, below is a comparison of the key considerations across important credit features. For ease, we have combined secured card and LAFD.

Comparison Summary

Making the Right Choice for You

If you have both assets and can’t decide whether to leverage, and if so, which one to leverage, do the math considering factors such as liquidity, repayment flexibility, and long-term financial impact.

For example, if you have INR 1 Lakh in a 3 year FD that matures in 24 months, that is earning 7% per annum, taking a loan against it for the remaining 24 months would work out to:

Principal: INR 1 Lakh
FD current value: INR 1.07 Lakh
Loan Amount at 90% LTV: INR 96,300
Interest Payable: 8.5% (net 1.5% more than what the FD earns)
Loan Cost: INR 16,372 in interest over the 24 months, assuming no principal is repaid until the very end.
FD Value at Maturity: INR 122,504
Net FD Value at Maturity (less Interest and Principal): INR 9,832
Loan amount + Net Present Value of Future Return: INR 105,050

Alternative: Had you exited the FD prematurely, you would instead have paid 1 % or INR 1,070 in penalty fees, and lost some of the compounded interest, say half. You would have received INR 102,430 net of all costs and had to pay no further interest.

In this instance, taking a loan offers a small gain of ~INR 2,500 over premature exit. Considering your current need and repayment ability, you could decide whether to take a loan or just break the FD. Always check if the gain in keeping an FD until maturity and taking a loan significantly outweighs an early exit.

Now in the case of life insurance, for example if you have an endowment policy with a current value of INR 1 Lakh and you are in year 6 of a 20 year policy term. Your Surrender Value will typically be ~INR 40,000. Note the gap between your policy’s current value and surrender value will vary significantly depending on where in the policy term you are, and what the specific conditions of your policy are.

In this example, surrendering the policy or exiting prematurely would mean losing ~60% of the value of the asset. Taking a loan for 1-2 years instead would be a much more prudent solution.

Loans against life insurance are better suited for short to medium-term borrowing, with lower interest rates and a potential impact on policy benefits if not repaid. The financial benefits of not surrendering a policy is often very high, making leverage a smart solution.

Conclusion

If your goal is to build your credit score rather than taking a loan, FD-backed secured credit (such as secured credit cards or overdrafts) can be a good option. Prompt repayments on loans against FDs or life insurance policies also help you build your credit profile if you don’t have one, or need to improve your credit profile. These products allow you to access funds while demonstrating responsible credit usage, which can help improve your credit profile and unlock better loan opportunities in the future.

Both Loans Against Life Insurance and Loans Against Fixed Deposits offer secured financing options that allow borrowers to leverage their existing assets without liquidating them. Ultimately, the right choice depends on financial goals, liquidity needs, and repayment preferences. To explore the best-secured loan options for your needs, use our Sahi Secured Loan Tool.
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