Introduction: The Common Dilemma
Imagine you have an FD earning 7% interest annually. Suddenly, you need ₹10 lakh but don’t want to take a loan charging 18% interest. The immediate reaction for many is to break the FD and avoid the expensive loan. At face value, this seems like a no-brainer — why pay 18% interest when you can simply use your own money?
But here’s the twist: despite the high loan interest, keeping your FD intact and taking the loan can actually make you richer in the long run. How is this possible? The answer lies in understanding how loans and investments grow or shrink over time, and how inflation changes the real value of money.
Understanding the Mechanics: Compound Interest vs. Reducing Balance Loans
To understand why keeping your FD might be better, we need to explore two key financial concepts: compound interest and reducing balance loans.
Compound Interest — Your FD’s Powerhouse
Fixed deposits earn compound interest, meaning you earn interest not only on your principal but also on the accumulated interest from previous periods. This leads to exponential growth over time.
For example, an FD of ₹10 lakh at 7% compounded annually will grow as follows:
| Year | FD Value (₹) |
|---|---|
| 0 | 10,00,000 |
| 5 | 14,03,000 |
| 10 | 19,67,000 |
| 20 | 38,70,000 |
| 30 | 76,12,000 |
Notice how the FD nearly doubles every 10 years due to compounding.
Reducing Balance Loans — How Interest Actually Works
Loans, especially personal or car loans, typically use a reducing balance method for interest calculation. This means interest is charged only on the outstanding principal, which decreases as you pay EMIs (Equated Monthly Installments).
For example, an 18% annual interest loan of ₹10 lakh over 30 years will have a high initial EMI, but as you pay down the principal, the interest component reduces, lowering your EMI’s effective interest cost.
The key takeaway: while the nominal interest rate on the loan is high, the actual interest paid over time decreases due to the reducing balance effect.
Inflation — The Silent Game-Changer
Inflation erodes the purchasing power of money over time. What ₹90,000 can buy today will cost much less in “real” terms 30 years from now. This means your monthly EMI payments, though fixed nominally, become easier to bear as inflation rises.
Let’s say inflation averages 6% annually. ₹90,000 today will be equivalent to roughly ₹15,000 in today’s money after 30 years.
Real Value after 30 years = Nominal Value / (1 + Inflation Rate)Years
= ₹90,000 / (1 + 0.06)30 ≈ ₹15,000
This means your EMI burden reduces significantly in real terms, making high-interest loans more manageable than they appear.
Putting It All Together: A 30-Year Scenario
Let’s analyze a real-world scenario to see how these factors interact.
| Parameter | Loan | FD Investment |
|---|---|---|
| Principal / Initial Amount | ₹10,00,000 | ₹10,00,000 |
| Interest Rate | 18% p.a. | 7% p.a. |
| Tenure | 30 years | 30 years |
| Monthly EMI (Nominal) | ₹90,000 approx. | N/A |
| Total Amount Paid (Nominal) | ₹2.7 crores | N/A |
| FD Value at 7% (Maturity) | N/A | ₹3.8 crores |
| Total EMI Paid (Inflation Adjusted) | ₹1.24 crores (real value) | N/A |
As you can see, although you pay ₹2.7 crores in nominal terms on the loan, inflation reduces the real burden to approximately ₹1.24 crores. Meanwhile, your FD grows to ₹3.8 crores, which is significantly higher than your real loan cost.
Why Does This Happen? The Financial Logic Explained
The key reasons behind this counterintuitive outcome are:
- Reducing Balance Interest: Your loan interest is calculated on the outstanding principal, which keeps decreasing. This means your interest burden reduces every month.
- Inflation Erodes EMI Value: Your fixed EMI amount becomes easier to pay over time because inflation reduces the real value of money.
- Compounding Grows Your FD: Your FD earns interest on interest, leading to exponential growth over decades.
Real-World Example: The Story of Rajesh
Rajesh, a software engineer from Bangalore, faced this exact dilemma five years ago. He had ₹10 lakh in an FD earning 7%, but needed ₹10 lakh urgently to start a side business. The loan he qualified for had an 18% interest rate.
His first instinct was to break the FD and avoid the expensive loan. But after using a LoanVsFD calculator, he realized that taking the loan and keeping his FD intact would be better financially.
Today, after five years, his FD has grown to approximately ₹14 lakh, while he has paid down a significant portion of his loan principal. The inflation-adjusted burden of his EMIs feels lighter, and his side business is generating additional income — a win-win.
When Does Breaking Your FD Make Sense?
While the math favors keeping your FD in many cases, there are situations where breaking it is justified:
- Emergency Needs: Medical emergencies or urgent cash needs where loan approval is not feasible.
- Loan Interest Much Higher Than FD Returns: If your loan interest is exorbitantly high (e.g., 25%+), the cost of borrowing may outweigh FD growth.
- Short Tenure Loans: For very short-term loans, the compounding advantage may not materialize.
- FD Penalty Charges: Some banks levy heavy penalties for premature FD withdrawal, reducing the effective returns.
Comparing Loan Interest Rates and FD Returns
The gap between loan interest rates and FD returns is crucial. Here’s a comparative table of typical interest rates in India (as of 2024):
| Loan Type | Typical Interest Rate (p.a.) | Notes |
|---|---|---|
| Personal Loan | 12% - 24% | Unsecured, high rates |
| Car Loan | 8% - 12% | Secured, lower rates |
| Home Loan | 7% - 9% | Secured, long tenure |
| Fixed Deposit | 6.5% - 7.5% | Safe, guaranteed returns |
If your loan interest rate is close to or less than twice your FD rate, keeping the FD and taking the loan often makes sense.
Visualizing the Impact: Loan vs FD Growth Over Time
Below is a simple graph illustrating the growth of ₹10 lakh in an FD at 7% and the nominal loan payments for an 18% loan over 30 years.
Blue line: FD value grows exponentially.
Red line: Loan payments increase nominally but reduce in real terms due to inflation and reducing balance interest.
How to Use the LoanVsFD App to Make Smarter Decisions
Making these calculations manually can be complex and error-prone. That’s why we built the LoanVsFD App — a powerful tool that lets you input your loan amount, interest rates, FD returns, tenure, and inflation assumptions to see the real financial impact.
The app helps you:
- Compare the total cost of loan repayments vs. FD maturity value.
- Adjust for inflation to see the real value of money over time.
- Visualize how reducing balance interest and compounding affect your finances.
- Make informed decisions based on data, not emotions.
Download the LoanVsFD App today and put your money to work smarter — not harder.
Key Takeaways
- Breaking your FD to avoid a high-interest loan might seem logical but can reduce your long-term wealth.
- Loans use reducing balance interest, which lowers your interest burden over time.
- Inflation reduces the real value of your EMIs, making loan repayments easier in the future.
- FDs earn compound interest, growing your money exponentially over decades.
- Use financial calculators or apps to analyze your specific situation before making decisions.
Final Thoughts
Financial decisions are rarely black and white. What seems like an obvious choice today may cost you dearly tomorrow. By understanding the interplay of loans, investments, and inflation, you can avoid costly mistakes and build lasting wealth.
Remember Rajesh’s story — a little patience and smart calculation can turn a high-interest loan into a wealth-building opportunity. So next time you face the FD vs. loan dilemma, take a step back, run the numbers, and let logic guide your choice.
Keep your FD intact, take the loan if needed, and watch your money grow over time.
