loans – Stable Investor

Home Loan Tax Benefits – How much do You Really get?

by Dev AshishDecember 14, 2018February 4, 2019 6 Comments

In India, home loans come with tax benefits. You already know that.

And there is no denying that these tax benefits make it all the more attractive to buy property using home loans.

But time and again I have seen people overestimating these tax benefits. Why?

Because the tax benefits available on home loans are capped. So depending on the home loan they take, the actual benefit may not be as large as what many borrowers think.

Now there are 2 components of a home loan – principal and interest. And the home loan EMI also has the same two components – (i) principal repayment, and (ii) interest payment.

So what tax benefits are available for Home Loan borrowers that can reduce their tax outgo?

Deduction of up to Rs 1.5 lac for principal repayment under Section 80C of the Income Tax Act.
Deduction of up to Rs 2 lac for interest payment for self-occupied property under Section 24 of the Income Tax Act. The interest payment of up to Rs 2 lac is available as loss under income from a let out property
Additional deduction of Rs 50,000 on interest payment, over and above the deduction claimed in Section 24 is available for the first time home buyers under Section 80EE.

Tax Benefits on Home Loan Principal Repayment

A deduction of up to Rs 1.5 lac is available for principal repayment of home loans under Section 80C of the Income Tax Act.

There are few things to note here.

First, Section 80C’s tax savings are also applicable on your investments in EPF, PPF, ELSS (Equity Linked Savings Scheme) and expenses like insurance premiums, school fee, etc.

So all these investments and expenses compete with home loan principal repayment for the Section 80C benefits. Chances are high that the sum of EPF + PPF + ELSS + insurance premiums + Home Loan Principal repaid will be higher than Rs 1.5 lac. If that’s the case, the cap of Rs 1.5 lac in Section 80C limits the benefit to just Rs 1.5 lac irrespective of what you claim from within EPF, PPF, ELSS, premiums or home loan principal repayments.

Even if you have a big loan and are repaying more than Rs 1.5 lac of home loan principal, the tax benefit is limited to just Rs 1.5 lac.

Tax Benefits on Home Loan Interest Payment

Deduction of up to Rs 2 lac is available for interest payment for self-occupied property under Section 24 of the Income Tax Act. And the interest payment of up to Rs 2 lac is available as a loss under income from a let out property.

This is where things get interesting and people get confused.

Due to the above-mentioned capping of benefit, even if you are paying more than Rs 2 lac interest in a given financial year, the excess interest above Rs 2 lac will not fetch you any tax benefits.

Here is a small example:

Suppose you take a Rs 35 lac home loan for 20 years at 9.5%. You EMI will be Rs 32,625 per month (read more about how home loan tenure impacts interest paid).

As you can see, in total Rs 3.91 lac is paid in EMIs in 1^st year. Out of this, principal forms only Rs 61,633 whereas interest is Rs 3.29 lac. Out of this Rs 3.29 lac, only Rs 2 lac is eligible for tax benefits under Section 24. The remaining amount (can be seen in red-colored text) cannot get tax benefits.

The home loans are structured like this that during initial years, a major part of your EMI goes towards interest payment. So it’s possible that the interest you pay in the initial years will be much higher than Rs 2 lac (the limit for tax benefit).

Let’s take another example to find out another interesting aspect.

We compare two loans. First of Rs 25 lac and the second of Rs 50 lac. The loan tenure and interest rate on both are 20 years and 9.5% respectively. The EMIs are Rs 23,303 (for Rs 25 lac home loan) and Rs 46,607 (for Rs 50 lac home loan).

Now have a look at the table below:

For the Rs 25 lac loan, the interest part that misses out on tax benefit is very small (Rs 35,616 in the first year and goes on reducing). But for the Rs 50 lac loan, you initially pay Rs 4.71 lac as interest in the first year. This is much more than the Rs 2 lac per year limit. So you only get the tax benefit on Rs 2 lac of interest (under Section 24). The remaining Rs 2.71 lac doesn’t get any tax benefit.

And if you focus on the table (on right) of Rs 50 lac loan, you will see that you keep having an interest component that misses out on tax benefits till the 15th year. And more interestingly, during the first 7 years of loan repayment, the tax benefit on interest payment of Rs 25 lac loan is the same as tax benefit on Rs 50 lac loan!

So much so and hue and cry for home loan tax benefits. 🙂

This is all the more reason why one needs to look at the tax angle when planning to prepay home loans. And if that wasn’t enough, there is also the dilemma of whether to invest vs prepay home loan – to benefit from higher returns elsewhere as compared to low post-tax home loan interest rates that are prevalent in India.

But I suggest that before you decide to prepay your home loan, you run your own numbers or get in touch with an investment advisor to help you out.

And if you are one among those who are still deciding whether to take a home loan or not, then I suggest that even before you begin your search for home loans online, some time should be spent to understand how home loans actually work and how best you can manage home loans once you take them.

The idea of doing this post was to highlight that at times, people get over excited when it comes to tax benefits from their home loans.

It is quite possible that you may not even get as much tax benefit as you thought you would be getting from your home loan.

Personal Loans – How to borrow if you Can’t Avoid?

by Dev AshishApril 14, 2018 Leave a comment

A friend recently needed some money to spend (or maybe splurge) on his wedding. 🙂

I helped him a bit. But since his need was greater than what I could pitch in with, he went ahead and took a small personal loan too.

I know what you are thinking.

Taking a personal loan to spend on discretionary expenses like a wedding, holiday, etc. is financially incorrect.

I agree. It doesn’t make sense.

But let’s be a little realistic here.

It’s easy for us to write here that one shouldn’t take a personal loan and this and that. But given the fact that our society ‘still’ gives importance to a lot of things and since we need to move around in the same society, many people end up taking loans to fund such discretionary expenses.

Please don’t think that I am in favor of such behavior. I am not judging anybody here. I am just telling what I observe. It’s not uncommon to see parents dipping into their retirement savings to fund their children’s big fat wedding and as a result, screw up their retirements. Look around and you will find such people. 🙂

I respect them for the sacrifices that they make, knowingly or unknowingly.

I have nothing more to add here on the justification of people taking loans for discretionary expenses. There are solid views on both sides of the table. Most people are borrowing out of compulsion (real or perceived).

We will only waste time by judging them or by being idealistic. 🙂

The fact of the matter is that people have been doing it and will continue to do it.

And by the way, the friend I helped – I can never judge him too 😉 It is difficult to say no to your close ones. Atleast I find it very difficult.

But let’s come back to the point.

Now my friend took a loan for his discretionary expenses. But there are genuine cases where people need to take personal loans for real emergencies.

In such cases, and in absence of a decent enough contingency (emergency) fund kept aside for such purpose, a person is really left with three options:

Ask friends or family for help
Dip into the savings & investments
Take a (personal) loan

One thing about emergencies is that if it eventually boils down to the 3rd option of taking a loan, then the cost of money becomes irrelevant. Oh come on… it is an emergency and you cannot bother about the cost at such moments! You need money no matter what at such times!

If you are unable to arrange funds from elsewhere, the personal loan is a go to option most of the times (credit cards can also come in handy for immediate liquidity needs). The best part is that such loans can be quite quickly, in less than a couple of days depending on the lender-borrower dynamics. And since these are mostly unsecured loans, there is no need for any collaterals or guarantors.

Obviously, these conveniences come at the cost of comparatively higher loan rates. But that is an acceptable tradeoff I guess for the cash you are getting access to on an urgent basis.

But before I move forward, let me say that that you should go for personal loans only if you really need the money and you cannot arrange it from elsewhere.

And I really mean… that you borrow when you ‘really need it!’

As for the definition of ‘real need’, its best left to each and everyone to figure it out.

Most people are smart enough to know it.

Important Things to note when taking a Personal Loan

1) Aim for Lower Personal Loan Interest Rates

This is a no brainer. Lower the rate better it is for you. But you may have to accept higher rates at times if the loan amount you need is available from a lender who is charging slightly higher. Isn’t it?

Generally, the interest rate offered to you will depend on factors like your age, income stability, whether salaried or self-employed, years of work experience, credit score, existing EMIs, your repayment capacity, loan tenure, etc.

Just be careful about the loan rates and try to bring it down to as low as possible. Don’t just stick to your existing bank to check for personal loans. There are several online tools to help you compare personal loan rates across banks and NBFC. Make use of such tools.

2) EMI you can Afford + Tenure as short as Possible

The mathematics of loans is such that the loan tenor you select along with the loan amount and the interest rate determines your final EMI.

EMI should be affordable and comfortable for you to manage during the full tenor and not just initially. So find out what is that you can comfortably manage first. And then manipulate the loan tenure and/or the loan amount to arrive at an EMI that is affordable for you. Go ahead and use personal loan EMI calculators that are easily available online. These personal loan calculators not only show the loan EMI but also tell you the total loan interest payable throughout the loan tenure.

Spend some time on the calculators and play with options. It will give you a clear picture about the loan you can afford and how to go about it.

But here I must highlight one thing. Being comfortable with EMI is one thing. But ideally, you should also try to keep the repayment period as short as possible.

The reason is that it will reduce your total interest burden during the loan tenor. Although your EMIs for a short-tenor loan would be higher than a longer-tenure loan, it makes mathematical sense to reduce your total interest outgo. Here is a small example to help you understand this:

Suppose you avail a personal loan of Rs 5 lakh at an interest rate of 16%. Then your total interest paid over the loan tenor would be as following:

5-year Tenor – Rs 2.29 lakh
4-year Tenor – Rs 1.80 lakh
3-year Tenor – Rs 1.32 lakh

Ofcourse, you need to consider EMI affordability too, which changes with loan tenor:

5-year Tenor – EMI of Rs 12,159
4-year Tenor – EMI of Rs 14,170
3-year Tenor – EMI of Rs 17,579

But I hope you understand what I am saying. If you can increase your EMI a bit, you can easily save a lot of money on interest. I did a similar analysis for home loans. You can read how shorter loan tenor reduces total interest outgo for home loans.

3) Loan Amount

What about loan amount? You already know how much you need. Isn’t it?

In many cases, lenders attract potential borrowers to borrow more than what they actually need but playing around with tenor and EMI. Please don’t do that. Just because you can avail a loan, don’t go overboard. Take a loan amount of as small an amount as possible.

This is the reason why you should be very cautious about going for pre-approved personal loans that are bombarded on you via emails, calls and other means!

If you already have a Personal Loan?

Taking loans is one thing and managing them smartly is another.

Some people are really smart about how they manage their debts. Their proper loan management helps them add real value to their financial portfolio.

Using the previous example of a borrower taking a Rs 5 lakh personal loan, you have seen that how just a few thousand more every month can be a smart money move to reduce the total interest burden over the loan tenor. An additional benefit is that with a shorter loan tenor, you become debt free much quickly.

Then if you are savvy enough, you can try for transfer of your existing loan to reduce your interest rate. It’s possible to get a personal loan balance transfer from existing lender to a new one. It benefits as the new lender may be willing to reduce your interest rate or provide more loan (if you need) or increase the tenor. This can work well for some people in many ways.

At times, you may get additional funds. Now you may think whether it makes sense to repay a part of the loan or not. Another possibility can be to utilize that amount to invest elsewhere. I have addressed this dilemma in detail already. You can read Payoff Loans Vs Start Investing.

Can better planning help?

I understand that we cannot plan or predict everything. And unexpected and unplanned emergencies will come.

But some level of planning can help you be in better control of your financial life.

Having a reasonably sized emergency fund can help at such times. You will not need to take a loan or dip into your savings for other critical financial goals.

Remember, that if you are repaying a loan then that also means that the money available to invest for other future financial goals is reduced. So some bit of planning can go a long way in sorting out your financial life.

Finally…

There is not much to add.

Generally, it is advisable not to take a personal loan for discretionary expenses. It’s best to save for such expenses first and then spend. This requires some planning that can be done in a goal or expense based financial plan.

However, if you really need to take a personal loan due to an emergency, make sure that you do consider interest rates, charges and convenience. It’s easier said than done because it would be difficult to find time for these things during an emergency. But this is what is important. Atleast you should know what to look for when going for personal loans.

Home Loans – How Shorter Tenor can save you Lacs?

by Dev AshishAugust 17, 2017 10 Comments

Home Loans have been a game changer for home buyers.

Had it not been for the easy availability of these loans, it would not have been possible for most people to purchase a home in first place. It’s another matter that easy availability of loans is one of the reasons why property prices have become unreasonably high.

But let’s focus on the issue at hand.

Home loan tenors.

Can a shorter home loan tenor save you money? On what factors should you base your decision to chose the home loan tenor?

For the sake of discussion, let’s take a small example: Suppose you wish to take a home loan of Rs 50 lac. The loan is available at 9.5%. Now theoretically, you have the option to chose a tenor between 10 and 30 years.

Let’s see what happens to the EMI and the total interest paid over various tenors:

I am sure there are few things that have already caught your eye. 🙂

As you can see, shorter the tenor, higher is the EMI. That’s easy. Obviously, the loan gets repaid faster too.

But more important is that shorter the tenor, lesser is the absolute interest cost. And by substantial numbers!

Just compare the rows of 20- and 30-year tenors.

For just a few thousand more (in EMI), you end up saving about Rs 35-40 lac in total interest payment and 10 years in tenor.

Not bad. Right?

And have a look at the last column. It reinforces the idea of having a loan with the shorter tenor.

Let’s take another scenario: You plan to take a property loan of Rs 30 lac. The loan is available at 9.0%. Once again, you have the option to chose a tenor between 10 and 30 years.

Here is the table with answers:

Similar story.

If you are planning for a 30-year loan with EMI of about 24K, just remember that by paying just a few thousand more (around 30K), you will half your tenor to 15 years and also save tons of money on interest (down from Rs 57 lacs to Rs 25 lacs).

This is no magic. And banks are not fooling you.

This is plain maths at play. Don’t be under the impression that a shorter loan is cheaper than a longer one. Both cost the same (9-10% or whatever is your home loan rate). It is just that you are paying the x% interest for a longer duration in the longer-tenor loan.

So the gist of this analysis is that as the loan tenor increases, you need to pay a lot more towards interest cost.

Lenders (banks and NBFCs) won’t tell you this angle because of various reasons – mainly being that they earn more from borrowers if the tenor is longer. 🙂

But to be fair, there are other factors at play too when it comes to deciding home loan tenor.

The biggest factor is EMI Affordability. That too at two levels:

EMI Affordability: As seen by the borrower
EMI Affordability: As seen by the lender

Let’s deliberate on each of these in a bit detail.

EMI Affordability: As seen by the lender

Lenders are in the business of lending. More often than not, they know whom to lend, how much to lend, etc. (ignore big corporate NPAs for this discussion please).

In order to safeguard their interests when lending money to home loan borrowers, the lenders adhere to certain guidelines. And according to these guidelines, the lenders ensure that sum of EMIs of all the loans (home, auto, personal, etc.) does not exceed more than 40-45% of the borrower’s monthly income. So if your monthly income is Rs 1 lac, you will only get loans until the time your total EMIs are around Rs 40,000.

So that is one limit that is put by the lender on home loan borrowers too. If your income is Rs 80,000, then at most you can expect a loan that has an EMI of Rs 32,000. That too if you don’t have any other loans and have a good credit score.

Now different loan-tenor combinations are possible with an EMI of Rs 32,000:

Rs 25 lac loan for 10 year tenure = EMI of 31,669
Rs 30 lac loan for 14 year tenure = EMI of 31,468
Rs 35 lac loan for 19 year tenure = EMI of 32,091
Rs 40 lac loan for 30 year tenure = EMI of 32,185

So for the same EMI eligibility (as per lender’s 40% rule), you can have various loan amounts and tenors.

It depends on how much money you need. So if you need Rs 40 lac as loan and earn Rs 80K a month, then you will have to take a loan of 30-year tenor so that EMI remains within the scope of 40%-lender’s limit.

That’s even if you know that going for a long-term loan means losing out on lacs of rupees on interest paid. This is another reason why you shouldn’t over borrow. Only borrow what is necessary.

Lenders might not even give you the option to chose. But you can always prepay and get over with the loan when you want. Isn’t it?

EMI Affordability: As seen by the borrower

You are earning Rs 80,000 a month and lenders are willing to give you a loan of Rs 35 lac with 20-year tenor. As the EMI would be about ~ Rs 31,500 and within the limit of 40%. But you know (and lenders don’t) that in a few years time, you have to contribute towards your sister’s wedding. So you cannot just be paying loan EMIs. You need to save for her wedding too.

So even though the bank is ready to give you a loan with EMI of Rs 31,500, the fact of the matter is that it’s not affordable for you due to other personal requirements.

Now you have two options:

Reduce your loan requirement (not easy)
Increase your tenor (possible if lender agrees)

This is what EMI affordability from borrower’s perspective means.

But on the other hand, if you recently got married with your+spouse’s income almost doubling, then you can easily pay more every month to close the loan as quickly as possible. You don’t need to keep paying ‘only’ the bank specified EMI just because you have been told to do so. You should pay more if it’s comfortably possible for you!

Three more points before I end.

In an effort to close the loan as early as possible, do not neglect saving for other financial goals. You need to have balance between paying EMIs, saving for short term goals and investing for long term goals.
I have not discussed the tax angle here. A lot of people want to continue the loans because of the tax benefits. I feel it’s a bit overrated given the fact that you can save a lot more by closing the loan early. I will discuss this angle in detail in another post.
If you are confused and have doubt about your future repayment ability (even after considering your salary hikes), it’s better to go for longer tenor. It will give you flexibility and peace of mind. You can always prepay (when you want) even when you have a long tenor.

That’s it.

I hope I was able to highlight the importance of having a shorter home loan tenor. The choice of home loan tenor does have a big impact on total interest paid to the banks/lenders.

So when you are planning to take a home loan, first of all make sure that the EMI is affordable, not just today but also tomorrow. Also remember that you need to save & invest for other financial goals. You cannot postpone everything till you clear your home loan. It might not work. And most importantly, try to reduce your loan tenor to the minimum you can comfortably manage. It means paying higher EMIs but that is fine. It will help you save a lot of money on the interest costs.

Loans & Why we Borrow?

by Dev AshishMay 3, 2017 11 Comments

Loan – one word that has helped millions prepone their dreams.

Be it owning a house, buying a car, getting higher education or even gifting a diamond ring to your wife! Loans have been helpful no doubt.

Unsurprisingly, this help comes at a cost – interest.

But that is how this financial product is designed to be and there is nothing wrong about it. You want to buy something you can’t afford to pay for today? Sure… you can have it. Just pay some extra interest. Fair and square.

But if people can’t afford something today, why can’t they just wait to have more money? In a twist to original words by Thomas Jefferson,

“Why do these people want to spend the money before even they have it?”

So the question is…

Why do People Borrow Money?

Its easy for me to say that you should never borrow.

But for most people, that’s not possible. Nobody borrows out of their desire to help banks / lenders earn interest. 🙂 Isn’t it?

In most cases, people borrow when they need to.

Primarily, its to…

Buy some asset (house – if you consider it one; land, even car, etc.)
Increase one’s earning potential (higher education)
Pay for emergencies (like death or medical ones)
Live beyond their means (…you know what I mean)

Lets take up all four of these points in reverse order:

Number#4

This should be avoided at all costs.

Its true that you get one life and you need to live it up ‘today’. But don’t use this logic to screw yourself financially.

If you can’t afford to buy a Rs 75,000 mobile phone from your own pocket, then taking a loan to buy it won’t help you. Such showoff (when you can’t even afford it) will only push you deeper into financial misery.

There can be many other examples. Think about it (hint: credit cards).

And this quote by James Basford truly summarizes everything:

The man who never has money enough to pay his debts has too much of something else.

And avoid living beyond your means as much as possible.

Number#3

This one is about being in a situation where you don’t have enough money to pay for the unexpected and unplanned events (like repairs, medical emergencies or even death). Some of these risks can be covered by proper insurance (like life, health, critical illness, accident, vehicles, etc.).

But if those insurance covers aren’t in place, you will be forced to borrow.

You can’t avoid it. Though you could have if you had bought insurance earlier. I seriously recommend you read why buying a health insurance can protect your wealth.

Many emergencies cannot be insured. If you need to borrow for such ones, you once again can’t do anything about it. One example is when you can’t say no to your close relatives.

Number#2

This one is about funding higher education costs.

The rising fees have led to the growing need for loans for higher education.

Infact, education loans are slowly turning into the new ‘housing loans’. Most middle class children can’t get a decent higher education without loans. Sad but true…

From parent’s perspective, views might differ from one person to other. Some people want to fully fund their children’s higher education, even if it means sacrificing their future financial security. Others want their children to share the burden. And many have a view similar to those in developed nations, where there are no societal expectations that parents will support children financially.

An education loan can help bridge the gap between required amount and money contributed by parents (or self if earned earlier).

It won’t be wrong to consider education loans as sort of good loans. In a way, its an investment you make to potentially increase your future earning power – which is a fair deal I would say.

But people need to be careful about taking education loans. Taking a loan to study in good colleges is fine. But given the kind of shitty colleges there are these days, there are high chances that the degree you get might not be much useful. Getting a loan-funded degree from such colleges may put you in a terrible situation – a big loan to repay and a worthless degree that can’t even get you a decent job.

Even countries like the U.S. are facing a big student loans crisis. In fact, if statistics are to be believed then the Americans owe over $1.2 trillion in student loan debt. To understand the enormity of that figure, compare it with India’s GDP that stands a little over $2 trillion. Unable to repay their education loans, a lot of Americans are resorting to student loan refinancing at lower rates. I don’t know whether India’s education loan portfolio will achieve such gargantuan proportions in near future or not, but authorities must ensure that we don’t walk the path of US student loan crisis.

Number#1

Finally, this one is about taking loans to buy assets. Can be for both appreciating as well as depreciating assets.

Buying a house on loan is more of a necessity. Most people don’t have spare Rs 30-50 lacs to just go out one evening and buy a house. Even managing a downpayment of 20% is a tough task for most people.

Buying a house for personal use is fine. I know many people will share mathematical logics about staying on rent and stuff. But if you want peace of mind, having one ‘self-owned’ primary residence is the way to go. If not today, then maybe later. But it helps.

As for investing in real estate is concerned, it turns out that its not a very great investment as many people believe it to be – there is a popular post on Stable Investor about this topic. Please refer to it here.

Buying property on loan is fine. But what about taking loans for depreciating assets like car? You might take it. For many people, buying a car is a need that can’t be postponed. So go ahead and take a loan for it. But try to keep the loan amount to minimum. Also try to pay it off quickly. No point paying more interest on something that is losing value every single day.

Managing Loans Smartly

Taking loans is one thing and managing them smartly is another.

Some people are really smart about how they manage their debts. Their proper loan management helps them add real value to their financial portfolio.

For example (and I am using approximate numbers here), if you take a home loan of Rs 50 lac @ 9% for 20 years, your total interest outgo will be about Rs 58 lac. So in total, you pay Rs 1.08 Cr (= Rs 50 lac + Rs 58 lac). EMI is about Rs 44-45K.

But if you are ready to shell out slightly higher EMI of Rs 50-52K, then you loan tenure can come down to 15 years and total interest to about Rs 41 lac. So in total, you pay Rs 91 lac (Rs 50 lac + Rs 41 lac). That’s a saving of about Rs 15-17 lacs on total interest paid. In terms of loan principle, it translates into 30-35%.

These are broad numbers. But clearly show how just a few thousand more every month can be a smart money move when dealing with loans of long tenure.

Those who are not familiar with how loans really work, sadly end up messing their personal financial situations. I will write about this topic in detail some other time.

Now if you have multiple loans, then you need to understand the real nature of each one of them, prioritize them and allocate resources to repay them from your income accordingly. Here, I am not saying that you shouldn’t pay the legally required EMI for each of the loans.

But if you have additional funds that can be used to clear off some of loans, find the most suitable ones (generally high interest loans) to clear off first. Talking of surplus, if you are thinking of investing elsewhere before repaying the loan, please read this – Payoff Loans or Start Investing.

To conclude, I think no one would take loans if they had all the money they genuinely needed.

But since most people don’t have that kind of money, people will continue to borrow. Its just suffice to say that you need to be sensible about your borrowings. More so in case of large loans. I leave you with a hilarious quote by Earl Wilson: