Lets say you take a 25 year loan to buy a house.
The bank charges you a 7.25% annual interest on the amount outstanding. At the end of 25 years you have paid up all the installments (popularly called EMI - Equated Monthly Installment).
But have you ACTUALLY repaid the loan along with the interest. Or for that matter have you ACTUALLY even repaid the loan amount?
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If you factor in the fact that the value of money diminishes each year, you will realize that a long term loan is not such a bad thing after all.
Rs 100 today is equivalent to Rs 110 next year (assuming a 10% fall in value of money each year). This means that what Rs 100 can buy today, would need Rs 110 to buy after one year.
When you take a 25 year loan, you commit to pay say Rs 10,000 per month for the next 25 years. Today the Rs 10,000 may seem to be a lot of money, but 10, 15 and 20 years later it will seem like a small amount.
This implies that you use the money at today’s value (for buying a house) while you repay it at future values.
When you factor in the tax benefits and the appreciation in the value of the house, you realize that a home loan is probably the best liability in the world.
For the math on this please visit:
http://teachmefinance.com/timevalueofmoney.html
Example: Rs 100,000 has been borrowed and has to be repaid @ Rs 802 per month i.e. Rs 9624 per year for 25 years.
On the face of it, it seems that you have repaid Rs 240,600 (i.e. 25 multiplied by 9624).
The table at http://www.asianlaws.org/students/current/sec/articles/money_value.htm is a simple calculation of the money actually repaid presuming that the value of money falls by 10% per year.
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