Considering the huge amount and the long tenure involved, a home loan is surely a liability. But it also offers you some benefits
Buying a home is a big step. It is a source of anxiety, frustration -- and a huge sense of accomplishment. With the zooming property rates, it is difficult a buy a home through our savings entirely. Almost all of us have a to avail a home loan.
Usually, a home loan is one of the biggest liabilities. Considering the huge amount and the long tenure involved, However your home loan also offers you some benefits. The below write-up highlights the advantages of taking a home loan.
Sense of accomplishment
Buying a home is one of the biggest financial investments you may make in your lifetime; and that's not just because of the sentimental value. The sum that most of us sink into our home does make it the largest component of our investment portfolio!
For each one of us who has seen property prices boom over the last five years, the prospect of mouth-watering capital appreciation is the biggest argument for buying a home. Construction costs alone, which account for more than 70 per cent of the flat's cost, have risen at 15 per cent annually in the past decade. Rents too seem to keep up with inflation; making a home one of the few investments can shield you from inflation for the long term.
Low interest rate
Buying a home is a long-term decision of over a 10-year period; the interest rates may go through several up and down cycles. Therefore, you can be sure that you will benefit from falling rates at some point in the cycle.
There could also be situations in which the interest rates fall, allowing you to prepay your loan and own your home. For instance, those who bought property in 1995, at an interest rate of 18 per cent, not only saw interest rates fall dramatically over the next decade, to bottom out at about 7.5 per cent, property prices too appreciated steeply. This works as a double boost to wealth.
The best way to manage borrowing costs is by actively managing your home loans! That's not as difficult as it is sounds. Banks and home-loan lenders often give new borrowers much better rates than existing borrowers. During the uptick of the interest rate cycle, if your cost of borrowing increases by more than 2 percentage points, pay 0.5 per cent of the loan outstanding as processing fee (conversion charge) to your lender to avail the rates offered to the new borrowers.
Tax Benefit: Interest paid
As per Section 24(b) of the Income Tax Act, 1961 a deduction up to Rs. 1.5 lakh towards the total interest payable on the home loan towards purchase / construction of house property can be claimed while computing the income from house property. (The deduction stands reduced to Rs. 30,000 in case of loans taken prior to March 01, 1999).
The interest payable for the pre-acquisition or pre-construction period would be deductible in five equal annual instalments commencing from the year in which the house has been acquired or constructed.
Tax Benefit: Principal Repayment
As per the newly introduced Sections 80C read with section 80CCE of the Income Tax Act, 1961 the principal repayment up to Rs. 1 lakh on your home loan will be allowed as a deduction from the gross total income subject to fulfilment of prescribed conditions.
Buying a home vs renting a house
Let's compare two individuals. Ram, is willing to buy a flat at current prices, while the other — Shyam — prefers to stay in a rented house. We assume Ram funds the flat cost of Rs. 33 lakh with his own capital of Rs. 8 lakh and the balance through a loan of Rs. 25 lakh for 15 years at an interest rate of 10 per cent per annum. His monthly commitment (equated monthly instalment) towards the loan will be Rs. 26,835.
Assuming that the interest rate remains the same throughout the 15 years, he will pay back a sum of Rs. 48.35 lakh to the bank. Assuming he is in the 30 per cent tax bracket and earns tax benefits on the interest component alone (in deference to the new Direct Taxes Code), he would shell out a net sum of Rs. 42.75 lakh.
Now, assuming property prices increase at a rate of 7 per cent, his Rs 33-lakh home will be worth Rs. 91 lakh after 15 years. His investment in the property fetched him an appreciation of Rs. 40.25 lakh. That is an internal rate of return of 6.9 per cent.
Now, coming to Shyam, he decides to rent a home very similar to that bought by Ram. Assuming rental yields of about 3.5 per cent, he would need to shell out about Rs 10,000 per month in the form of rent. Now, as property prices are rising by 7 per cent every year, the landlord will raise his rent too by a similar amount. Having not invested in a home, he has a surplus every month (the notional value of the EMI minus the rent paid) to invest in safe instruments.
Let us presume that Shyam is able to avail tax benefits at 30 per cent of the rent paid, by way of HRA. In the first year he saves monthly a sum of Rs 19,835 (Rs 26835 - Rs 7,000) and invests Rs 7 lakh (margin money for buying a house) at a post-tax return of 7 per cent. At the end of 15 years his total savings will be worth Rs 68 lakh. He would have paid out Rs 21 lakh by way of rent. His IRR would work out to 2.5 per cent. Though the investor saves quite a bit in initial years, the rise in rents reduces his savings in later years.
In the above instance, obviously, Ram has got a much better deal than Shyam. Therefore, buying a home will pay off most for people who plan to stay in one location for a long horizon (say 15 years) and those who are in the higher tax brackets. Apart from this, property prices have to appreciate at a reasonable rate, preferably higher than inflation.