Introduction: The Conventional Dilemma
When it comes to managing large loans alongside substantial savings, many people face a common dilemma: should they break their fixed deposits (FDs) or mutual fund investments to pay off loans upfront, or should they continue to service the loan while keeping their investments intact? The instinctive reaction is often to liquidate investments to reduce debt immediately, but this may not always be the smartest move.
This article will demonstrate with real-world numbers and financial logic how maintaining your investments and using a systematic withdrawal plan (SWP) can help you manage loan repayments efficiently, sometimes even better than breaking your savings.
Scenario Setup: ₹50 Lakh Savings and ₹50 Lakh Loan
Let’s start with a practical example. Suppose you have ₹50 lakh saved in a fixed deposit or mutual fund. You plan to take a ₹50 lakh loan for 30 years at an interest rate of 7.5% per annum. Your monthly EMI (Equated Monthly Installment) for this loan will be approximately ₹34,960.
The question is: should you break your ₹50 lakh FD or mutual fund investment to pay off the loan upfront? Or can you keep your investment intact and still pay the EMI using systematic withdrawals?
Understanding Systematic Withdrawal Plan (SWP)
A Systematic Withdrawal Plan allows you to withdraw a fixed amount from your mutual fund or investment portfolio at regular intervals, such as monthly or quarterly. This approach lets your principal continue to earn returns while you use a portion of the gains to meet your expenses or liabilities.
In our example, you would set up an SWP to withdraw ₹34,960 every month to pay your loan EMI. The remaining investment continues to grow, compounding over time.
The Magic Number: 7.83% Annual Return
Here’s the surprising part: your investment only needs to earn a modest 7.83% per year to cover the entire loan repayment for 30 years through SWP. This rate is just slightly above your loan interest rate of 7.5%, meaning your investment growth can almost entirely offset your loan cost.
This is a powerful insight. Instead of breaking your FD or mutual fund, you can let your money work for you, paying the loan EMI while still growing your principal.
How Does This Work? The Power of Compound Interest
Compound interest is the cornerstone of wealth creation. It means you earn interest not only on your initial principal but also on the accumulated interest from previous periods. Over long periods, compound interest can lead to exponential growth.
When you keep your ₹50 lakh invested at 7.83%, your money grows every year. By withdrawing the EMI amount monthly, you are effectively using the returns generated to service your loan while preserving most of the principal.
In contrast, if you break your FD to pay the loan upfront, you lose out on this compounding effect, and your money stops working for you.
Loan Interest vs Investment Returns: A Delicate Balance
The key to this strategy is ensuring your investment returns slightly exceed your loan interest rate. Here’s why:
- Loan Interest Rate (7.5%): The cost you pay for borrowing money.
- Investment Return Rate (7.83%): The growth rate of your invested savings.
If your investment return is higher than the loan interest, your money can grow faster than the loan cost accumulates, making the SWP strategy viable.
Comparative Table: Loan Interest vs Investment Return
| Parameter | Loan Interest Rate | Investment Return Rate |
|---|---|---|
| Annual Rate | 7.5% | 7.83% |
| Loan Tenure | 30 years | 30 years |
| Monthly EMI / Withdrawal | ₹34,960 | ₹34,960 (Systematic Withdrawal) |
| Principal Amount | ₹50,00,000 (Loan) | ₹50,00,000 (Investment) |
Real-World Example: The Wealthy Mindset
Wealthy individuals often follow this principle: they don’t touch their principal investments but make their money work smarter. Instead of liquidating assets to pay off loans, they use the income or returns generated from their investments to service debt.
For example, consider a high-net-worth individual who has ₹1 crore invested in a diversified mutual fund portfolio earning 8% annually. They take a home loan for ₹1 crore at 7% interest. Instead of breaking their investments, they set up an SWP to pay the EMIs. Over 20-30 years, their investments continue to grow, and the loan gets repaid — all without dipping into the principal.
This method preserves wealth and leverages the power of compounding, a strategy often overlooked by many.
Why Breaking Your FD Might Be a Costly Mistake
Breaking a fixed deposit prematurely usually comes with penalties and loss of interest income. Moreover, it stops the compounding effect on the principal amount.
Let’s say your FD earns 7% annually, but premature withdrawal reduces the effective return to 5% or less. Meanwhile, your loan interest remains at 7.5%. This mismatch means you lose money in the long run.
Additionally, you lose the opportunity to grow your corpus, which could have been used for future financial needs or emergencies.
Inflation: The Silent Partner in Your Financial Journey
Inflation erodes the purchasing power of money over time. However, it also reduces the real burden of your loan EMIs.
For example, an EMI of ₹34,960 today may feel like just ₹20,000 in real terms 15 years from now due to inflation. This means your effective loan repayment burden decreases over time.
On the flip side, your investments also need to outpace inflation to ensure real wealth growth. A 7.83% return against an average inflation rate of 5-6% means your real return is around 1.8-2.8%, which is modest but positive.
Graph: Impact of Inflation on EMI Burden Over 30 Years
*Graph illustrates the decreasing real value of a fixed EMI over 30 years due to inflation (assumed 5% per annum).
Risks and Considerations
While this strategy is compelling, it’s important to consider the following:
- Investment Returns Are Not Guaranteed: Mutual funds and market-linked investments can be volatile. Ensure your portfolio is diversified and aligned with your risk tolerance.
- Interest Rate Changes: Loan interest rates may fluctuate if you have a floating rate loan, affecting your EMI amount.
- Discipline Required: You must consistently withdraw the exact EMI amount every month to avoid loan defaults.
- Tax Implications: Withdrawals from mutual funds may attract capital gains tax. FDs have tax deducted at source (TDS). Factor these into your calculations.
- Emergency Funds: Maintain a separate emergency corpus to avoid forced liquidation of investments.
Comparing Breaking FD vs Using SWP to Pay Loan
| Aspect | Breaking FD to Pay Loan | Using SWP to Pay Loan |
|---|---|---|
| Investment Growth | Stops; principal withdrawn | Continues; principal largely intact |
| Penalty/Charges | Premature withdrawal penalty, loss of interest | None |
| Loan Burden | Reduced immediately | Serviced monthly via withdrawals |
| Liquidity | Reduced; funds tied up in loan repayment | Maintained; investments remain |
| Inflation Impact | Loan burden reduces over time, but no investment growth | Loan burden reduces and investments grow, beating inflation |
| Tax Efficiency | Interest income lost; no capital gains | Capital gains tax on withdrawals; potential tax benefits on loan interest |
How to Calculate Your Own Numbers
Every individual’s financial situation is unique. To decide whether to break your FD or use an SWP to pay your loan, consider the following steps:
- Calculate your loan EMI: Use an EMI calculator to find your monthly payment based on loan amount, tenure, and interest rate.
- Assess your investment returns: Estimate the expected annual return on your FD or mutual fund.
- Determine the required withdrawal rate: Calculate the monthly amount you need to withdraw to cover your EMI.
- Compare returns and loan cost: If your investment returns exceed the loan interest rate, SWP is a viable option.
- Factor in taxes and inflation: Adjust your calculations for taxes on withdrawals and inflation impact on EMI burden.
Our Loan Vs FD App automates this process, letting you input your numbers and see the results instantly.
Summary: Why This Strategy Works
- Systematic withdrawals allow you to service your loan EMIs without liquidating your principal investment.
- Compound interest on your investments helps offset the cost of the loan.
- Inflation reduces the real burden of your EMIs over time.
- Maintaining investments preserves liquidity and potential for wealth creation.
- Smart financial planning and discipline are key to success.
Final Thoughts
The idea that you must break your fixed deposits or mutual funds to pay off loans is a myth that can cost you dearly in the long run. Instead, by leveraging systematic withdrawal plans and understanding the interplay between loan interest rates, investment returns, and inflation, you can manage your finances more efficiently.
This approach requires patience, discipline, and a clear understanding of your financial goals. Using tools like the Loan Vs FD app can help you make informed decisions tailored to your unique situation.
Remember, wealth is not just about how much you earn but how smartly you manage and grow your money.
Ready to try it yourself? Download the Loan Vs FD App and start making smarter financial decisions today!