Introduction: The Surprising Power of Compounding
When it comes to personal finance, many of us instinctively think that taking a loan with a high interest rate is always a bad idea — and breaking a fixed deposit (FD) to avoid the loan is the smart move. But what if I told you that, under certain conditions, even a loan with a sky-high interest rate of 19% per annum can be financially better than breaking your FD earning 6% annually?
This sounds counterintuitive at first, but it’s all about how money grows and shrinks over time. The secret lies in understanding compound interest, loan amortization, and inflation — and how they interact over long periods.
In this article, we’ll unpack these concepts, show you the math behind this surprising fact, and help you make smarter decisions with your money.
Section 1: Understanding Fixed Deposits and Compound Interest
Fixed Deposits (FDs) are one of the most popular investment instruments in many countries, especially in India. They offer a fixed rate of interest, usually compounded quarterly or annually, and promise capital protection.
The key feature of FDs is compound interest — you earn interest not only on your initial principal but also on the interest accumulated in previous periods. Over long periods, this compounding effect can lead to exponential growth.
For example, if you invest ₹1,00,000 in an FD at 6% annual interest compounded yearly, after 30 years, your investment will grow to:
FV = P × (1 + r)^n FV = 100,000 × (1 + 0.06)^30 ≈ ₹574,349
That’s almost 5.7 times your original investment! This power of compounding is why FDs are considered safe and reliable for long-term wealth creation.
Section 2: How Loans Work — The Reducing Balance Method
Loans, especially personal loans, home loans, or car loans, usually have an interest rate that applies to the outstanding principal amount. As you repay the loan through Equated Monthly Installments (EMIs), the principal reduces, and so does the interest charged.
This is called the reducing balance method. Unlike FDs where interest compounds on accumulated interest, loan interest is charged only on the remaining principal.
Let’s consider a ₹1,00,000 loan at 19.08% annual interest for 30 years (360 months). The monthly interest rate is approximately 1.59%. Using the EMI formula:
EMI = P × r × (1 + r)^n / ((1 + r)^n - 1) where, P = Principal = 100,000 r = monthly interest rate = 19.08% / 12 ≈ 1.59% = 0.0159 n = number of months = 360 EMI ≈ ₹1,586.98
Over 30 years, you pay:
Total Payment = EMI × n = 1,586.98 × 360 = ₹5,71,313
Notice this is close to the FD maturity amount of ₹5,74,349. This is the magic breakeven point where the loan cost equals the FD growth.
Section 3: The Magic Number — 19.08% Explained
The number 19.08% is not random. It emerges from the interplay between the FD interest rate (6%) and the loan tenure (30 years). When you take a loan at an interest rate below this breakeven point, the cost of the loan (EMI payments) is effectively less than or equal to the growth your FD will achieve over the same period.
This means you can keep your FD intact, continue earning compound interest, and pay off the loan gradually — all without losing money in the long run.
If your loan interest rate is higher than 19.08%, then breaking the FD to pay off the loan might make more financial sense.
Section 4: Why Does This Happen? The Role of Time and Compounding
The key driver behind this surprising result is time. Over long durations, compound interest grows your money exponentially. In contrast, loan interest is charged on a declining balance, so your interest payments decrease over time.
Let’s visualize this with a graph comparing the FD growth and the outstanding loan principal over 30 years:
| Year | FD Value (₹) | Outstanding Loan Principal (₹) |
|---|---|---|
| 0 | 100,000 | 100,000 |
| 5 | 134,391 | 81,234 |
| 10 | 180,094 | 59,789 |
| 15 | 241,916 | 34,568 |
| 20 | 324,340 | 4,312 |
| 25 | 434,392 | 0 |
| 30 | 574,349 | 0 |
Table 1: FD value grows exponentially, while loan principal reduces steadily over time.
Notice how the FD value grows steadily due to compounding, while the loan principal reduces each year as you pay EMIs. The total interest paid on the loan is front-loaded, but the principal shrinks, reducing interest burden over time.
Section 5: Inflation — The Silent Ally
Inflation reduces the real value of money over time. While your loan EMI remains fixed in nominal terms, its real cost decreases every year because inflation erodes the purchasing power of money.
For example, if inflation averages 6% annually, an EMI of ₹1,586 today will feel like only about ₹838 in 10 years in today’s money.
This means the burden of repaying the loan becomes lighter over time in real terms, making loans more affordable in the long run.
On the flip side, your FD returns are also impacted by inflation. A 6% nominal return with 6% inflation means your real return is effectively zero. However, the nominal compounding still helps to offset the loan payments.
Section 6: Real-World Scenario — Should You Break Your FD?
Let’s put this into a practical example:
- You have ₹5,00,000 in an FD earning 6% annually.
- You need ₹5,00,000 for a personal expense and are considering taking a loan or breaking the FD.
- Your loan interest rate options are between 12% and 20%.
Using the breakeven logic, if your loan interest rate is below 19.08%, it’s better to take the loan and keep your FD intact. Your FD will continue to compound and grow, offsetting the loan cost.
If the loan interest rate is above 19.08%, breaking the FD to pay off the loan might save you money in the long run.
This is why guessing or following gut feelings can be dangerous. Use a calculator like the LoanVsFD App to input your exact numbers and get a personalized breakeven interest rate.
Section 7: When Breaking the FD Makes Sense
While the math favors keeping your FD intact for loans below the breakeven rate, there are situations where breaking your FD is the right choice:
- Emergency needs: If you need immediate cash for health or urgent family matters, breaking the FD is justified regardless of interest rates.
- Loan interest is exorbitantly high: Some personal loans or credit card loans can have interest rates well above 25%. In such cases, breaking the FD to avoid these loans is prudent.
- Short loan tenure: If your loan tenure is very short (e.g., 1-2 years), the compounding advantage of the FD is limited, so breaking it might be better.
- FD penalty is low: Sometimes, breaking an FD incurs minimal penalty, making it financially viable.
Section 8: The Psychological Factor — Debt Aversion and Peace of Mind
Many people prefer to avoid debt altogether, even if it means breaking an FD and losing out on potential gains. This is understandable — debt can cause stress and anxiety.
However, understanding the numbers can help you make more rational decisions. Sometimes, carrying a loan at a reasonable interest rate while your money compounds elsewhere is the smarter path to wealth.
Balancing emotional comfort with financial logic is key. Use tools and calculators to quantify your options and reduce guesswork.
Section 9: Comparative Table — Loan Interest vs FD Returns Over 30 Years
| Loan Interest Rate | FD Interest Rate | Loan EMI (₹ per ₹1L) | FD Maturity Value (₹ per ₹1L) | Loan Total Payment (₹) | Breakeven? |
|---|---|---|---|---|---|
| 12% | 6% | 1,028 | 5,74,349 | 3,70,080 | Yes |
| 15% | 6% | 1,288 | 5,74,349 | 4,63,680 | Yes |
| 19.08% | 6% | 1,587 | 5,74,349 | 5,71,320 | Breakeven |
| 22% | 6% | 1,788 | 5,74,349 | 6,43,680 | No |
| 25% | 6% | 2,022 | 5,74,349 | 7,28,000 | No |
Table 2: Loan interest rates below 19.08% are financially better to keep FD intact.
Section 10: How to Use the LoanVsFD App to Make Smarter Decisions
The LoanVsFD App is designed to take the guesswork out of this complex decision. By entering your FD interest rate, loan amount, loan interest rate, and tenure, the app calculates your breakeven points and shows you the financial outcome of both options.
This personalized insight helps you:
- Identify if breaking your FD is financially justified.
- Understand the long-term impact of loan interest and compounding.
- Make decisions based on data, not emotions or hearsay.
Don’t guess — calculate! Download the LoanVsFD App today and take control of your financial future.
Conclusion: The Long-Term View Wins
The financial world is full of myths and misconceptions. One of the biggest is that any loan with high interest is automatically worse than breaking an FD. But as we’ve seen, thanks to the magic of compound interest, loan amortization, and inflation, even a 19.08% loan can be better than breaking a 6% FD over 30 years.
Remember these key takeaways:
- Compound interest grows your money exponentially over time.
- Loan interest is charged on a reducing balance, making the effective cost lower over time.
- Inflation reduces the real burden of loan EMIs over time.
- Breaking an FD prematurely can cost you in lost compounding gains.
- Use calculators and apps to find your exact breakeven point and make informed decisions.
Financial wisdom is about patience, understanding, and using the right tools. Keep your FDs intact if your loan interest is below the breakeven rate, and let your money work for you.
For more insights and calculators, keep visiting LoanVsFD.com — your trusted partner in smart financial decisions.