Introduction: The Common Financial Dilemma
Imagine you have ₹10 lakh parked in a Fixed Deposit (FD) earning 6% annually. Suddenly, you need ₹10 lakh for an urgent purchase or investment. You have two options: break your FD and use the money, or take a loan at 15% interest and keep your FD intact. Most people panic at the high loan interest and rush to break their FD, thinking it’s cheaper to pay off the loan upfront.
But what if that instinct is wrong? What if, despite the seemingly high loan interest, it actually makes more financial sense to keep your FD growing and take the loan? This article explains why, using real-world financial principles, data-backed math, and practical examples.
The Magic Threshold: Why 15.26% Interest Rate Matters
The key insight is that the loan interest rate threshold at which breaking your FD becomes beneficial depends on the FD’s interest rate and tenure. For an FD earning 6% annually over 20 years, that threshold is approximately 15.26%. What does this mean? If your loan interest rate is below 15.26%, you are better off keeping your FD and taking the loan. If it’s above, breaking the FD might be justified.
This threshold comes from comparing the effective cost of the loan (which reduces monthly due to the reducing balance method) against the compound interest earned on the FD. Because loans are repaid monthly and interest is charged on the outstanding principal, the effective interest paid over time is less than the nominal rate. Meanwhile, the FD compounds annually, growing exponentially.
How is the Threshold Calculated?
Let’s break down the math behind this magic number:
- Fixed Deposit Growth: The FD compounds annually at 6%. Over 20 years, ₹1 grows to ₹1 × (1.06)20 ≈ ₹3.21.
- Loan Repayment: A loan at 15.26% interest with equal monthly installments (EMIs) reduces the principal every month, lowering the interest charged on the outstanding amount.
- Comparing Costs: When you calculate the total interest paid on the loan and compare it with the interest earned on the FD, the breakeven point is near 15.26%.
This means the compounding effect on your FD can outpace the reducing interest cost of the loan until the loan interest crosses this threshold.
Understanding Compound Interest: The Power of Time
Compound interest is often called the “eighth wonder of the world” for a reason. It means you earn interest not only on your principal but also on the accumulated interest. Over long periods, this leads to exponential growth.
For example, ₹10 lakh in an FD at 6% compounded annually for 20 years grows to about ₹32.1 lakh. That’s more than triple your initial investment without any additional deposits.
Contrast this with a loan, where interest is calculated monthly on the outstanding principal. As you pay EMIs, the principal reduces, so the interest portion of each EMI decreases over time. This means your effective interest cost is less than the nominal rate suggests.
Visualizing Compound Growth vs Reducing Loan Interest
Below is a simple HTML/CSS graph illustrating the growth of ₹1 invested in an FD at 6% annually versus the declining interest paid on a loan at 15% over 20 years.
Why Loan Interest Rates Appear High But Cost Less Over Time
Loan interest rates are often quoted as annual percentages, which can look intimidating. But loans are repaid monthly, and each EMI reduces the principal, so the interest you pay each month declines. This is called the reducing balance method.
For example, on a ₹10 lakh loan at 15% annual interest for 20 years, your monthly EMI might be around ₹13,200. But in the first month, a large chunk of this EMI is interest; by the last month, almost all of it goes toward principal repayment. The total interest paid over the loan tenure is significantly less than what a simple annual rate might suggest.
This contrasts with your FD, where interest is compounded annually and credited yearly. The FD balance grows steadily, earning interest on interest.
Real-World Example: Raj’s ₹10 Lakh Dilemma
Raj has ₹10 lakh in an FD earning 6% annually. He needs ₹10 lakh for a home renovation. He considers two options:
- Break his FD and use the ₹10 lakh directly.
- Take a loan at 14% interest and keep his FD intact.
Using the LoanVsFD app, Raj calculates:
- Over 20 years, his FD would grow to ₹32.1 lakh if untouched.
- His loan EMI at 14% for 20 years is approximately ₹12,900.
- The total interest paid on the loan is less than the growth on his FD.
Raj realizes that by taking the loan, he can keep his FD compounding and pay off the loan comfortably, resulting in better net financial position than breaking the FD.
When Should You Break Your Fixed Deposit?
While the magic threshold gives a useful guideline, there are scenarios where breaking your FD makes sense:
- Loan Interest Rate Above Threshold: If your loan interest rate is significantly higher than the threshold (e.g., >16% when FD is 6%), the cost of borrowing outweighs FD growth.
- Short Loan Tenure: For very short loans, the compounding advantage is limited, so breaking FD might be better.
- Emergency Needs: If the loan is not easily available or the FD penalty for breaking is minimal, breaking FD can be justified.
- FD Interest Rate Drops: If your FD interest rate is very low (e.g., 3-4%), the threshold lowers, making loans less attractive.
Comparative Table: Loan Interest Threshold vs FD Rate for 20 Years
| FD Interest Rate (Annual) | Loan Interest Threshold (Approx.) | Interpretation |
|---|---|---|
| 4% | ~10.2% | Loans below 10.2% better to keep FD |
| 5% | ~12.3% | Loans below 12.3% better to keep FD |
| 6% | ~15.26% | Loans below 15.26% better to keep FD |
| 7% | ~18.5% | Loans below 18.5% better to keep FD |
| 8% | ~22.1% | Loans below 22.1% better to keep FD |
Inflation and Its Impact on Your Decision
Inflation erodes the purchasing power of money over time. While your FD grows at a nominal rate (e.g., 6%), the real return after adjusting for inflation (say 5%) might be just 1%. Similarly, your loan EMIs remain fixed in nominal terms but become easier to pay over time as your income and inflation rise.
This means the real burden of your loan decreases over time, making loans more affordable than they appear. Meanwhile, your FD’s real value grows slowly but steadily.
Therefore, factoring inflation reinforces the argument to keep your FD intact if your loan interest rate is below the threshold.
Practical Tips for Making the Right Choice
- Use a Loan vs FD Calculator: Don’t rely on intuition. Use tools like the LoanVsFD app to input your exact loan and FD rates and tenure to get precise recommendations.
- Consider Loan Tenure: Longer tenure loans favor keeping the FD, as compounding benefits accumulate over time.
- Check FD Penalty Charges: Breaking FD early usually incurs penalties. Factor this cost into your decision.
- Assess Your Cash Flow: If EMIs strain your monthly budget, breaking FD might be necessary despite the math.
- Think About Asset Creation: If the loan is for an appreciating asset (like property), taking the loan is generally better than breaking FD.
Summary: Why Smart Money Chooses Loans Over Breaking FD
The surprising truth is that loans at interest rates below a certain threshold (around 15.26% for 6% FD over 20 years) cost less than the growth you lose by breaking your FD. This is because:
- Loan interest is charged on a reducing balance, lowering your effective interest cost.
- FD interest compounds annually, growing your money exponentially over time.
- Inflation reduces the real cost of EMIs over the loan tenure.
- Breaking FD early usually incurs penalties and stops compounding benefits.
So next time you face the choice, don’t panic. Run the numbers, understand the threshold, and make a decision based on data — not emotions.
Call to Action: Use the LoanVsFD App to Find Your Exact Threshold
Every financial situation is unique. Loan interest rates, FD returns, tenure, and inflation vary. That’s why we built the LoanVsFD app — to help you calculate the precise breakeven point for your loan and FD.
Download the app today, input your details, and get a clear recommendation on whether to break your FD or take the loan. Smarter financial decisions start with smarter tools.