Home Loan Demystified

The age of desiring to own a house is rapidly coming down now a days. For our previous generation making a house of their dream was their life time compilation.They bough their house when they were close to retirement.The young generation would like to own a house before they cross their thirties. This mentality is the results of high earning capability and bank loan availability. Even though most of us know, bank loan for house is the one way to dream a dream house and save large amount of tax, many are still in confusion with certain things. I have tried my best to clear it. I owe thanks to Times Property.

To make this mystery a little clear, let me divide this into two sections.
i) Home loan fundamentals
ii) Tax Benefits over it.

Home Loan Fundamentals

The first basic we need to know is we own a home, while still repaying the loan. This is the kind of the loan, which is as good as investment, which lets you own an asset that has multiplied manifolds in its value. You end up paying manifolds return in the form of interest for the amount you bough the loan. But at least it's works out as savings at the end, which wouldn’t have been possible if you were tried to accumulate it.

Now coming to the point banks gives the loan for constructing a new home or buying already constructed home/flat or residential plots. Even banks re-finance the existing home loans. The amount that one can avail depends upon their salary, age, educational qualifications, history of any loan availed before from the same bank or other banks. One can club his earning with any of the family member (spouse, father, mother, brother) to avail more loan. Typically bank lends the money for which EMI outflow is 30 to 50 percent of your salary. I feel personally to make EMI's which works out to be 40% of the take home salary to avoid the burden at any point of time.

Now question arises is what this EMI at all ?? Well, EMI stands for Equated Monthly Installment. EMI is sum of the principal and interest amount that borrower pays towards the bank on monthly basis for the amount he has barrowed from the bank. EMI repayments commence when u take a full disbursement of the loan amount. Pending final amount disbursement, barrowers only pay interest on the amount disbursed. This is called pre-EMI. During initial years of the repayment barrower ends up paying huge interest amount and less principal. As the years goes by the case will get reversed.

Now coming to types of interest rates, banks offer three flavors of interest rates floating, fixed and hybrid. In case of floating rates interest rates fluctuates with the pre-vailing market rates. Barrowers who offer the floating rate should make their mind ready to pay more if market goes up and enjoy the low interest rate if its goes down. On the other hand fixed rate remains same for the entire tenure of the loan, But very less banks offers this. Most of the banks offers you the fixed rate only for short tenure. Meaning, let us say bank offers fixed interest rate for 5 years. They reset the interest rate after 5 years. Along with these two the third flavor is more flexible even though less popular. In case of hybrid rates, bank gives you options to lock certain amount for fixed rate and lock the remaining for floating rate. Usually good to opt for this, locking 50% for floating and remaining 50% for fixed. :)

Even though there are many EMI calculators available on the net. I am just letting u know, using what formula it is calculated.

EMI = (L*I) * {(1+I)^N/((1+I)^N-1)}

Where, L = Loan Amount
I = Interest rate (rate per anum divided by 12)
^ = to the power of
N = Loan period in months

You can also use online calculator from here. http://www.hdfc.com/calculator/emical.asp

Tax Benefits over it

This is the most interesting and confusing part of the home loan. To state in a simple sentence barrower can avail tax benefits on both principal and interest components. The repayment made on the principal amount from the barrower can be claimed under section 80C. The maximum amount that can be claimed under this section is Rs 1 lakh. Apart from the principal amount repaid this limit includes provident fund from the employee side, public PF, LIC premium, equity linked saving schemes of MFs investments, infrastructure bonds, pension plans etc. The repayment made on the interest component can avail the tax benefits under section 24. The maximum limit here is 1.5 lacks. There are no other components under this section as there were few for 80C. However this limit of 1.5 lacks is only for self occupied property.

So let us take an example to understand this better. Assume Gundapi total taxable income is 5 lacks. he can claim 1.5 lacks under section 24, which is the interest component of the laon for a year. Thus leaving 3.5 lacks as taxable income now. Assuming his contribution for PF from his salary is 50K, and his LIC premium per year is 25K, concluding both he can claim for 75K under section 80C. Now he can claim only 25K under section 80C as the repayment made for principal amount, even though he has made more than 25K as repayment towards principal.

The first house with tax benefits from under section 80C and under section 24 is viewed as the self occupied property. One can avail tax benefits on both the principal amount as well as interest amount on this. However if you invest in second house, it is not treated as the first one for tax benefits. The second property is treated as it is rented out. So homeowners can not claim the principal amount for tax benefits under section 80C. However there is no upper limit for claiming for the tax benefits under 24C. Meaning for second property one can claim the full amount which is repaid to the bank as the interest component.

For example, If one already owns a home(self occupied) for which he has home loan and availing tax benefits of 25K under section 80C and 1.5lakh under section 24.
If he wish to go for second property with home loan, he can still avail tax benefits over it too. Assuming he pays 2 lacks as principal amount, and 2.5 lacks interest in a year. For that year he can not claim any amount under section 80C. However he can avail tax benefits on complete 2.5laks under section 24.

Probably this information did not increase the confusion :) .. Still there are things to be written about the tax implications over the property, and POA.

Tax implications meaning What if I sell out my property after 2 years or after 5 years ?? etc. I will discuss about it in my next blog.

Anyway Bangalore is growing like anything in all the directions. Currently not many developments are seen on Bangalore west. However Master plan 2015 is been designed to develop IT sector along mysore road. So even though many says real estate prices are going down, this applies to the areas where there are excess. Even though rates have gone down, they are still not yet reachable to common man. However I feel this is the correct time to buy a property in Bangalore.

Happy Tax savings :)