Personal Finance Concepts

Being debt-free feels virtuous. Being financially prudent, however, requires resisting some very comfortable instincts.

A home loan that effectively costs just 2.25% sounds implausible—almost misleading. And yet, for borrowers who combine discipline with patience and a marginally higher appetite for risk, this outcome is not only possible but mathematically sound. The key lies not in negotiating harder with banks, but in understanding how differential returns from various asset classes can be combined to generate arbitrage income over time.

India’s Love Affair with Early Repayment

Indian households have long equated financial success with an early elimination of debt. As retirement approaches, leverage feels dangerous and debt feels burdensome. This mindset became even more entrenched after May 2014, when the Reserve Bank of India barred banks and NBFCs from charging foreclosure penalties on home loan prepayments. Since then, prepaying home loans using bonuses, increments, or windfalls has felt not just sensible, but virtuous.

It is common to hear people proudly say they took a 20-year home loan and closed it within a decade. There is genuine discipline behind such achievements, and they deserve admiration. But admiration should not prevent scrutiny. The more relevant question is whether this widely celebrated approach is also the most financially efficient one.

The Nature of Cheap Capital

A home loan is unlike any other form of borrowing available to individuals. At current rates of around 7.25 percent—RBI repo rate plus a margin—home loans represent the cheapest long-term capital most households will ever access. No personal loan, education loan, or business loan comes remotely close.

When capital is this inexpensive, repaying it aggressively may not always be the wisest decision. Sometimes, allowing cheap liability to exist while deploying surplus funds elsewhere can quietly reshape long-term outcomes.

One Borrower, Two Paths

Consider the case of Kiran, who takes a ₹2 crore home loan for 15 years at an interest rate of 7.25 percent. The monthly EMI works out to approximately ₹1.83 lakh. Like many disciplined earners, Kiran keeps expenses under control and channels any surplus funds toward prepaying the loan.

In the first scenario, this approach works exactly as intended. Through consistent prepayments, the entire loan is closed in just eight years. Kiran is debt-free, unburdened, and psychologically secure.

Yet there is a structural detail hidden beneath this success. Home loan EMIs are heavily skewed toward paying interest in the early years. By the midpoint of the loan tenure, only about one-third of the principal is typically repaid. To eliminate a ₹2 crore loan in eight years, Kiran must therefore contribute nearly ₹1.35 crore in surplus prepayments. The remaining ₹65 lakh is covered through the contribution of regular EMIs.

The sense of freedom is real—but it comes at a cost that is rarely examined.

Letting Time Do the Heavy Lifting

Now imagine that Kiran chooses a different path. Instead of prepaying the loan, the same surplus funds are invested gradually into large-cap mutual funds. Over eight years, these investments accumulate to roughly ₹1.35 crore, with contributions spread across market cycles. This staggered approach results in a portfolio whose average age is around two to three years—old enough to have absorbed volatility and begun compounding meaningfully.

As the home loan enters its final seven years, the contrast becomes striking. Large-cap mutual funds have historically delivered long-term annualised returns in the range of 12 to 12.5 percent. The cost of borrowing, meanwhile, remains anchored around 7.25 percent.

The gap between the two—approximately five percent annually—represents a clean arbitrage. For seven years, Kiran earns this spread on ₹1.35 crore while continuing to service the original loan. When viewed across the full 15-year horizon, this quiet compounding dramatically alters the economics of the loan. As a result, the effective cost of borrowing on the original ₹2 crore falls to roughly 2.25 percent per year for the entire 15 years duration.

What appears counterintuitive at first is simply the result of time, discipline, and inexpensive capital working together.

Uncertainty Acknowledged

Finance, of course, does not operate in straight lines. Interest rates will rise and fall. Equity markets will go through periods of exuberance and despair. Returns will not arrive evenly or predictably.

Yet this framework is, if anything, conservative. It does not factor in the returns generated during the first eight years of investing. Nor does it account for the flexibility a seven-year horizon provides to introduce flexi-cap or multi-cap strategies that may enhance returns over time.

While markets can disappoint in the short term, extended periods of negative real returns over seven-year horizons have historically been extremely rare in high-growth economies such as India. The risk here is not absent but it is measured, visible, and historically rewarded.

Suitability of This Strategy 

This approach is not designed for everyone. It favours borrowers with stable incomes, long investment horizons, and the temperament to remain invested during market downturns. It demands the ability to distinguish volatility from loss and prudence from comfort.

For those nearing retirement, or for whom market fluctuations induce anxiety rather than opportunity, early repayment may still be the right choice. Financial decisions do not exist in isolation from psychology. But the distinct advantage of deploying this strategy is that it can be unwound at a very short notice. Any time during the loan servicing phase, if returns from the invested surplus remains disappointing for reasonably long period or if there is any other turn of events, these investments can be liquidated effortlessly to foreclose the outstanding loan.

A Different Definition of Prudence

Prepaying a home loan using surplus funds offers emotional certainty. But investing these surplus funds offers mathematical advantage. True financial prudence lies not in eliminating debt as quickly as possible, but in understanding when debt is cheap enough to coexist with compounding assets. Sometimes, the smartest move is not to fight leverage—but to make it work quietly in your favour.

Being debt-free feels good.

Being financially prudent feels better.