A home loan helps you achieve peace of mind by providing you with one of the basic necessities of life-a roof over your head. But if you don’t borrow right and are not aware of the financial and tax implications, a home loan can rob you of that very peace of mind. Ask Yati Salin. The Bangalore-based software professional learnt a hard lesson five years ago when he and his sister jointly applied for a home loan. “No one was willing to give me a loan because the co-borrower was my sister. A big foreign bank initially agreed to lend 31 lakh but later backed out,” he says.
The cancellation left the Salin siblings in the lurch because they had already booked the house as joint owners. With the payment deadline fast approaching, they were forced to settle for a lender who charged a very high rate of interest. This could have been avoided had they tied up the financing before applying for the property.
ET Wealth tells you about certain home loan truths so that you don’t face such a situation. Whether you are planning to take a loan, are servicing one or intend to foreclose it, these insights will help you avoid nasty surprises and get the most out of borrowing.
1 BEFORE YOU APPLY
What decides your borrowing capacity:
The green signal for the loan is given once a bank is confident of your ability to repay the sum. “The criteria for deciding the home loan are primarily the cash flow and expenses of the borrower,” says R K , executive director and chief financial officer of Bank. However, it’s difficult for lenders to figure out the expenses of each loan applicant because every individual has a different spending pattern. So, banks typically assume that up to 40% of your monthly income can go into paying the EMI. If an individual has a monthly income of 1 lakh, the maximum EMI he would be able to pay is 40,000. The loan amount is then calculated on the basis of the tenure and interest rate. For instance, if the interest rate is 9.5% and the tenure is 20 years, the individual can take a loan of 43 lakh. If the interest rate was higher at 10%, the eligibility would have come down to 41.5 lakh. Similarly, if he had gone for a shorter term of 15 years, the loan eligibility would have dropped to 38.5 lakh.
Banks also take into account other liabilities of the borrower while determining his loan eligibility. “We try and assess the expenditure and liabilities of the borrower. The total expenses (including EMIs of other loans taken) should not be more than 55-60% of the total monthly income,” says K R, executive vice-president and business head of personal finance at Bank.
Age is also an important criterion for deciding the tenure of the loan. Most banks want that you should not be more than 58 years when you pay your last EMI. If you are 45 and due to retire in 15 years, a lender will not give a loan for more than 10-12 years. But if you are 25 years old and have more than 30 years of working life left, then the home loan tenure can easily extend to 20 years.
Your salary structure is also a factor. Lenders don’t take into account the allowances you get as part of the salary even though the amount is a part of your cost to company package. If the salary is packed with perks and allowances, your loan eligibility might come down. Other incomes like bonus and performance-linked pay may also not be considered by the banks if there is no confirmation of regularity.
While there is very little you can do to increase your income level or change your salary structure, you can increase your borrowing capacity by roping in a co-borrower. Here too, lenders are not comfortable if the co-borrower is not your spouse. They feel that there could be disputes between siblings over the property ownership and the repayment liability. It’s much safer if the co-borrower is a life partner. In fact, some lenders go to the extent of sanctioning a loan to would-be couples, though disbursement takes place only after the marriage is solemnised. “The lender will ask for a copy of the marriage certificate for disbursing the loan,” says H R, CEO,
2 TAX BENEFITS FOR BORROWERS
The tax benefits available on home loans bring down the effective cost of borrowing. The repayment of principal for a home loan, for instance, is eligible for a deduction of up to 1 lakh a year under Section 80C. This is especially useful for borrowers who are paying a huge EMI and, therefore, don’t have too much to invest in other tax-saving options. But the icing on the cake is the deduction of the interest paid on the loan. Up to 1.5 lakh a year is deductible from the taxable income of the borrower under Section 24(b).
Living in another city
The home loan benefits are available if the house is for self-occupation or if it’s given out on rent. However, a borrower can avail of the deduction even if he has bought a house in another city without losing out on the exemption for house rent allowance. So, if you work in Mumbai but have purchased a home in Nagpur, you can claim a deduction under Section 24(b) as well as an exemption for the house rent allowance received.
Partial disbursement
In some cases, the disbursement of the loan is linked to the stages of construction of the property. The tax treatment is different here. This portion of the interest paid prior to the completion of construction cannot be claimed as a deduction in the year in which it is paid. However, the borrower can claim deduction for the interest under Section 24(b) in five equal instalments after the construction is completed. Do note that the limit on deduction in a year remains 1.5 lakh.
More than one loan
Benefits under Section 80C and Section 24(b) can be taken for more than one home if all the properties meet the requirements. Irrespective of the number of homes, the limit of 1 lakh under Section80C and 1.5 lakh under Section 24(b) still apply. However, if the house has been given out on rent, there is no limit on the deduction of the interest paid.
Joint home loan
Co-borrowers can separately claim tax deduction if the house is jointly owned. The tax benefit can be availed of in the same proportion as the ownership in the property. If the husband has paid 60% of the total amount, the tax deduction will be available in the same proportion. So if principal repaid during a year is 1 lakh, the husband can claim deduction of 60,000, and his wife, for 40,000.
Loan from relatives also eligible for tax breaks
The tax incentives on home loans are available even if you have borrowed from your relatives or informal sources. “With respect to claiming deduction for interest on a housing loan, there are no conditions regarding the entity from whom the amount is borrowed,” says P Sir, executive director, Adds BJ, chief financial officer, : “The requirement is that the loan should have been taken for the purpose of construction, purchase, renovation and repair of the property.” However, you cannot claim deduction under Section 80C for the principal repaid if the loan has not been taken from a financial institution.
No tax benefits for buying plots
Home loan tax benefits are offered only in case of built property. There is no tax deduction if the loan is taken to buy a plot of land. “A plot of land would not qualify as a ‘house property’ and, hence, any income derived from it will not be taxable under the head income from house property. Accordingly, the deductions available for interest on loan for purchase of the plot will also not be allowed under the said head,” says Sir.
3 ENDING THE LOAN
Should you prepay?
This is a perennial dilemma for home loan customers. And the short answer is, new file (copy)yes. The long answer is that if the interest you are paying on the home loan is higher than that being earned by your investments, you are better off foreclosing the loan.Five years ago,Ni Bads,a Mumbai-based software professional, took a home loan of 10 lakh at an interest rate of 7.25%. At the time he hadn’t imagined that he would have to pay an interest rate of 11-12%. Badkas has prepaid about 1 lakh and plans to refinance his loan at a cheaper rate.
Mumbai-based financial planner Ah Wake advises that if you are paying 8-9% on the loan, it may be a good idea to continue with it and invest your surplus elsewhere. After all, even bank fixed deposits are offering 9-10% returns per annum. “But if the rate of interest is very high, then it is better to prepay the amount,” says Wakhare.
Banks charge a prepayment penalty of 2-2.5% if the loan is being refinanced by another lender. However, if you are paying from your own funds, some banks don’t charge any penalty. Vaid says that in most cases the prepayment charges can be negotiated and brought down.
You lose tax benefits if you sell soon
If you sell a property within three years of buying it, any gain will be treated as short-term capital gains and taxed as your income for that year. In the highest tax bracket, you could lose a big chunk of your profit to taxes. But this is not your only loss. Any tax benefit availed of by you on a home loan for the property will also be reversed. The Income Tax Act states that if the property is sold within five years from the end of the financial year during which it was bought, the tax deductions claimed will be added to the income for that particular year and taxed at the marginal rate of tax. So, keep this in mind when you strike a deal to sell your house.
WHICH IS THE BEST LOAN FOR YOU? Lenders have customised their loans to suit different types of borrowers. Pick the one that suits you best
Step-up repayment
The EMIs are smaller in the initial years and increase over fixed intervals, as the borrower’s career progresses. This can help a younger person take a bigger loan based on the increase in his income. The lender takes a call on his future earnings
Flexible loan instalment
This is the reverse of the step-up scheme. In the initial years (up to the retirement of the elder applicant), banks keep EMIs high. They reduce towards the end of the tenure. This is suitable for joint purchase of property by parents and children
Tranche-based EMIs
If you buy a property that is under construction, you have to pay interest on the partial disbursals. In tranche-based plans, a borrower can fix the amount he wishes to pay till the property is ready. The minimum amount is the simple interest on the loan
Accelerated repayment
This allows a borrower to increase the EMI to repay the loan faster. Whenever there is an increment or increase in the disposable income or a lump-sum gain, the borrower.
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