The Mathematics of Closing Out a Home Loan

In order to compare closing out a loan vs keeping it we would need to compare two cash-flows.

1. Where the EMI amount is going towards the loan & the principle amount is being invested and

2. Where the EMI amount is going towards the?creation of another asset & the loan is paid out (or closed out).

Note: We need to assume that two assets are being simultaneously created. For our purposes we are assuming a property being purchased (with or without a loan in the first and second case respectively) and a mutual fund portfolio being created (as an initial lump-sum investment or the EMIs would become SIPs in the second case). In order to assess which mode is preferred we would need to

a. Compare the balance sheets in time ( we have considered 20 years) &

b. Assume rate of returns on 1. the property, 2. the investment (mutual fund) portfolio & use the current home loan rates (and change it as and when it changes).

The concept is called?Time-Value of Money???

First set of Assumptions-

Case 1: Investments return the same value as the interest rate of the loan.

Note: If we are earning the absolute same rate on the loan vs the investments then neither strategy is different. We have assumed a 5% rate for real estate. But, that will make no difference to taking a loan or not as illustrated below where we will assume a 15% rate of growth for real estate.?

Note: The way of funding the property (or asset purchase) has no relation to the comparison of cash-flows for keeping a loan or not.

Case 2: Investments return a higher value than the cost of the loan. We are assuming market returns to be 10%. Average Nifty market returns are around 11% (you can refer to the article?here).?

Note: There is a clear case for keeping the loan and investing the corpus (at rates higher than loan rates) in order to maximise?value.