Can mutual fund SWPs safely pay your home loan EMI?
Where the strategy starts to unravel Observed outcomes The behavioural dimension Whom does this strategy suit? Windfalls have a way of making us creative. An
Where the strategy starts to unravel Observed outcomes The behavioural dimension Whom does this strategy suit? Windfalls have a way of making us creative. An investor I know came into an unexpected inheritance while still servicing a home loan. A mutual fund distributor known to him put an interesting idea on the table: don’t rush to prepay and close your loan. Instead, park the money in an equity mutual fund, start a systematic withdrawal plan (SWP), and let it cover your equated monthly instalments (EMIs). The fund offers a 15% compound annual growth rate (CAGR), the loan costs you 8%—pocket the difference. On paper, it looked like a no-brainer. The math, though, tells a more complicated story.Before we get into the math, let us look at some bizarre assumptions this strategy makes. These assumptions, as we will see, also challenge how equity markets—and equity mutual funds—behave.Markets are assumed to compound at a steady rate each year. In reality, equity returns are volatile and uneven.Loan interest rates are assumed to remain unchanged over 15 years, which is rarely true in practice.The timing of returns is treated as irrelevant, though it is central to SWP sustainability.Models assume investors continue SWPs regardless of market conditions.The assumptions completely ignore an investor’s life, career, and family situation.
A job loss, a medical emergency, or any disruption to income may force an investor to unwind the strategy at the worst possible time.If the investor dies with insufficient insurance coverage, the family inherits the liability. Prepaying the loan eliminates this risk entirely. Continuing it to chase market returns amplifies it.These assumptions collectively create an overly optimistic outcome that rarely survives real-world volatility. When the strategy is tested against 15-year historical return cycles across multiple mutual fund categories (large cap, mid cap, hybrid, and large & mid cap), the outcome is far less favourable than commonly perceived.Let us assume that the loan amount is Rs.1 crore, the loan tenure is 15 years, the interest rate is 8.75% per annum, and the total interest outgoings are Rs.79 lakh. The Rs.1 crore principal is irrelevant to the comparison; whether prepaid or invested, it’s deployed.Think of it this way. If you prepay the loan, the Rs.1 crore is gone, but so is the loan. You pay zero interest from that point. If you invest instead, the Rs.1 crore stays in the market, but the bank keeps charging you interest for 15 years. That interest—Rs.79.82 lakh—is the price you pay for keeping your money invested. So the only way this strategy makes sense is if your fund corpus, after funding 181 monthly withdrawals, leaves you with more than Rs.79.82 lakh.
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