Introduction: The Temptation to Break Your FD
Imagine you have ₹50 lakhs parked safely in a fixed deposit account earning around 7% per annum. You want to buy a flat worth ₹50 lakhs. Your first instinct might be to break the FD and pay for the flat outright, avoiding the hassle and interest cost of a home loan. After all, the home loan interest rate is 10%, which is higher than your FD return. Intuitively, it feels smarter to liquidate your FD and save on loan interest.
But what if this seemingly logical step is actually a costly mistake? What if keeping your FD intact and taking a home loan is the smarter move in the long run? Let’s explore why.
The Power of Compound Interest: Why Your FD Can Outgrow Your Loan Cost
Fixed deposits earn interest on the principal plus accumulated interest — this is called compound interest. Over long periods, compounding can lead to exponential growth of your investment.
Consider your ₹50 lakh FD earning 7% compounded annually. Over 30 years, this grows substantially due to compounding. Meanwhile, your home loan interest, though at 10%, is charged on a reducing balance — meaning the principal reduces with every EMI payment, so the interest cost decreases over time.
Let’s look at the numbers:
| Parameter | Value |
|---|---|
| Initial FD Amount | ₹50,00,000 |
| FD Interest Rate | 7% p.a. (compounded annually) |
| Loan Amount | ₹50,00,000 |
| Home Loan Interest Rate | 10% p.a. (reducing balance) |
| Loan Tenure | 30 years |
| Monthly EMI | ₹43,000 approx. |
| Total Loan Cost (Principal + Interest) | ₹1.58 crores approx. |
| FD Value after 30 years | ₹3.8 crores approx. |
The FD grows more than double the total loan cost over 30 years. This is the magic of compound interest working in your favor.
Understanding Loan Interest: The Reducing Balance Effect
Unlike FDs, loans do not accrue compound interest. Instead, home loans use a reducing balance method where the interest is calculated on the outstanding principal, which reduces every month as you pay EMIs. This means your interest burden decreases over time.
For example, in the initial years, a large portion of your EMI goes toward paying interest, but as the principal reduces, the interest component shrinks, and more of your EMI goes toward principal repayment.
This reducing balance effect effectively lowers your total interest cost compared to a simple interest calculation on the full principal throughout.
Inflation: The Silent Ally in Your Loan Repayment
Inflation is often seen as a villain that erodes purchasing power, but when it comes to loans, inflation can be your silent ally. How?
Your EMI is fixed in nominal terms. But as inflation increases, the real value (or purchasing power) of your EMI decreases. Put simply, ₹43,000 today will feel like about ₹9,000 in 30 years if inflation averages around 7% per annum.
This means your loan repayments become easier over time in real terms, especially if your income grows with inflation, which is usually the case.
Here’s a simple inflation-adjusted EMI table for ₹43,000 monthly EMI over 30 years at 7% inflation:
| Year | Nominal EMI (₹) | Inflation-Adjusted EMI (₹) |
|---|---|---|
| 1 | 43,000 | 43,000 |
| 10 | 43,000 | 22,500 |
| 20 | 43,000 | 11,800 |
| 30 | 43,000 | 9,000 |
This shows that while your EMI remains constant in rupee terms, its real burden reduces drastically over time.
Why Letting Your FD Grow is Financially Smart
By not breaking your FD, you allow your money to compound uninterrupted. This is crucial for wealth creation. The FD acts as a financial asset growing at a steady rate, while your loan is a liability that becomes cheaper in real terms due to inflation.
If you break your FD to pay upfront, you lose the benefit of compounding and the potential to earn more in the future. Instead, by taking a loan, you leverage your money — using borrowed funds while your own capital continues to grow.
Real-World Example: How Our Ancestors Built Wealth
Historically, many Indian families built wealth by taking loans to buy property while keeping their savings invested. They understood that inflation and compounding work together to increase asset value and reduce loan burden in real terms.
For example, a house bought 30 years ago for ₹10 lakhs could be worth over ₹3 crores today. Meanwhile, the loan EMIs paid back then would be a fraction of today’s value when adjusted for inflation.
This principle still holds true today. The key is to use loans to acquire appreciating assets while letting your investments grow.
Comparing Scenarios: Breaking FD vs Taking Loan
Let’s compare two scenarios over 30 years for a ₹50 lakh flat purchase:
| Scenario | Break FD and Pay Upfront | Take Home Loan & Keep FD |
|---|---|---|
| Initial Investment | ₹50,00,000 (FD broken) | ₹0 (FD intact) |
| Loan Amount | ₹0 | ₹50,00,000 |
| Total Loan Cost | ₹0 | ₹1.58 crores |
| FD Value after 30 years | ₹0 (broken) | ₹3.8 crores |
| Net Worth After 30 Years | ₹50,00,000 (property value assumed constant for simplicity) | ₹3.8 crores (FD) + Property |
Even if we conservatively assume the property value remains ₹50 lakhs (which is unlikely), the scenario of taking a loan and keeping your FD intact results in a much higher net worth due to compounding.
Salary Growth and EMI Affordability
Another important factor is your salary growth. Typically, salaries increase annually, often in line with or above inflation. This means that while your EMI remains fixed, it becomes a smaller portion of your monthly income over time, making repayments more affordable.
This dynamic further supports the idea that taking a home loan and letting your FD grow is a financially sound strategy.
When Does Breaking Your FD Make Sense?
While the above logic holds true for most cases, there are exceptions:
- Emergency Needs: If you urgently need funds and cannot afford EMI payments.
- High-Interest Loans: If your loan interest rate is significantly higher than your FD returns (e.g., >14-15%), the cost of borrowing might outweigh FD benefits.
- Short-Term Goals: If you plan to sell the property quickly or the loan tenure is very short, the math might differ.
- FD Penalty Charges: If breaking the FD incurs heavy penalties that reduce your returns drastically.
In these cases, carefully analyze your situation or consult a financial advisor.
Summary: The Financial Wisdom of Taking a Loan and Letting FD Grow
- Fixed deposits compound your money steadily, creating wealth over time.
- Home loans have reducing balance interest, lowering your interest burden monthly.
- Inflation reduces the real value of your EMIs, making repayments easier over time.
- Keeping your FD intact while taking a loan leverages your capital and maximizes wealth creation.
- Breaking your FD to avoid loans can cost you potential wealth gains in the long run.
Final Thoughts: Let Inflation and Compounding Work for You
The decision to break your FD or take a home loan is more than just comparing interest rates. It’s about understanding time value of money, inflation, compounding, and your personal financial goals.
Our ancestors built property wealth by leveraging loans and letting their savings grow. Today, you can do the same — take a home loan, keep your FD intact, and let inflation and compounding work in your favor.
Use tools like the Loan versus FD App to simulate your scenarios and make smarter financial decisions.
Download the Loan versus FD App for Smarter Financial Decisions
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