Category Archives: Home Loans
FOR many, Section 80C of the Income Tax Act forms the cornerstone of their tax saving strategy. The section incorporates tax breaks for so many varied activities that our lawmakers wish to encourage that it has a different connotation for different age groups or different income levels. The tax breaks for long-term investments range from zero risk investments like PPF to risky options like equity-linked savings scheme (ELSS). The section encourages spending for insurance protection and it also provides relief for those spending on their dependents. Therefore, there is no ‘one-size-fitsall’ formula for this Section. The only way to go about planning taxes is to define your age and income group and choose the appropriate options.
AGE: 25 YEARS
Gross taxable income: Rs 3,00,000
If an individual, who earns a taxable annual income of Rs 3 lakh with the mandatory provident fund deduction of Rs 20,000 per year, does not take any tax-saving measures except paying a life insurance premium of Rs 10,000, he might have to shell out Rs 12,360 in taxes. But, if he invests Rs 1 lakh under section 80C and buys a health cover, entailing a premium of Rs 10,000, he can bring down his tax payable to Rs 4,120. In the case of women, the tax liability will be merely Rs 1,030, since the threshold exemption limit for women is Rs 1,80,000. This apart, if she is repaying an education loan, the tax liability might be nil as the entire interest amount paid on the loan is exempt under section 80E. Also, if the individual does not have any dependents, it would be prudent to reconsider the need for life insurance. While many financial planners recommend ELSS for people in this age group, others contend that even public provident fund (PPF) is an attractive avenue. “Our recommendation for this category is that they should invest 50% in ELSS and 50% in PPF,” said financial planner Amar Pandit.
AGE: 30 YEARS
Gross taxable income: Rs 5,00,000
If an individual’s taxable income is around Rs 5 lakh per annum, he will fall in the next bracket — the one attracting a tax rate of 20% (Assumptions: PF contribution of Rs 36,000 and life insurance premium of Rs 10,000). However, proper tax planning could result in considerable savings. Against paying a tax of Rs 47,174 before investing in instruments under 80C and paying a health insurance premium of Rs 15,000, he will end up paying just Rs 32,960. Since most individuals may not have to shoulder any major responsibilities at this age, again, a combination of ELSS and PPF could be a good bet. “A point to be borne in mind here is that all investment decisions need to be taken after evaluating individual needs and risk profile, and not merely on the basis of age and income level,” pointed out financial planner Kartik Jhaveri.
AGE: 35 YEARS
Gross taxable income: Rs 7,00,000
Here, if an individual (married with kids) has availed of a home loan this year, the opportunities for maximising the tax breaks are immense. If he is servicing a home loan of Rs 40 lakh, he can claim deductions on interest and principal repaid. In fact, the amount of principal repaid itself will help in exhausting the entire Rs 1 lakh limit. Besides, the deduction of Rs 1,50,000 for interest paid on home loan will lower his tax liability further. The combined impact of all deductions will be huge: from paying a tax of Rs 96,820 — prior to availing of these exemptions, the tax payable will come down to Rs 43,260. In case he has not opted for a home loan, he can claim deductions under section 80C for tuition fee paid for his children’s education.
AGE: 40 YEARS
Gross taxable income: Rs 10,00,000
At these income levels, the tax-saving options are almost similar to the Rs 7,00,000 bracket. A home loan repayment would circumvent the need for making any investments under section 80C. Exemptions claimed under various sections (80C, 80D and 24) would result in the tax payable decreasing from Rs 1,83,340 to Rs 1,29,265. If the individual has started making contribution to PPF since the age 25, the mandatory 15-year lock-in tenure would have come to an end. Under these circumstances, if he is not repaying his home loan and consequently, is scouting for avenues to invest under section 80C, he can consider extending the PPF tenure for another five years. For senior citizens, the income up to Rs 2,25,000 per annum is exempt from tax. For this category of assessees, experts recommend avoiding instruments entailing a prolonged lock-in period. However, the 9% senior citizens scheme and post office time deposits (investments under which are deductible under section 80C) are recommended.
It’s better to have a lower home loan exposure in times of falling real estate prices.
The softening in real estate prices, which are now down in most places by as much as 25%, has not been the best piece of news for existing home loan borrowers. This is thanks to the “depreciation of security” clause that is mentioned in home loan agreements.
Simply stated, if the value of the property — which is mortgaged as security for a home loan — falls to below the outstanding loan amount, the borrower is required to pay the difference as a one-time margin amount to the bank. The other option is to provide additional collateral for the equivalent amount. If none of this happens, the bank reserves the right to seize the flat and a borrower, in turn, becomes an unenviable defaulter irrespective of his repayment record.
Let us take the example of a person who has bought a house for Rs 50 lakh. In line with the stipulated loan-to-value ratio, the bank cannot lend more than Rs 42.5 lakh. In today’s market, the value of that property drops by, let’s say, a quarter. The value of that house consequently is now Rs 37.5 lakh. Suddenly, the borrowed amount is less than the collateral, which leaves the bank with a situation where it can ask for additional collateral. This may be in the form of gold, property or any other asset. If none of that materialises, the borrower makes the margin money payment out of his/her pocket.
The way out for the borrower, according to experts, is to have higher home equity. Sujan Sinha, senior vicepresident, retails assets, Axis Bank, says that the clause becomes vital only if the bank has a higher equity component than the borrower.
“If the borrower holds substantial home equity component through his personal funding and pays EMIs regularly, then he will not be in a tricky situation,” Mr Sinha points out.
From the bank’s viewpoint, a borrower, who has demonstrated the ability to repay on time, is often the preferred one. “Usually they make some leeway for a borrower with a good payment track record. A disciplined borrower can negotiate with the bank for more time to pay the collateral/margin money,” says Amar Pandit, a certified financial planner.
The collateral issue has changed substantially over the past few years. Banks typically are mandated to lend up to 85% of the property’s value to the borrower. But that has often has been breached with past instances suggesting that the number could be as high as 95%. The borrowers did not have to bring in very much and, as a result, could easily stretch their finances.
Banks undertake valuation exercises for property that is under construction. According to an official at a private sector bank, “If the value (of the property) falls by 25%-30%, we revalue it, especially if we have lent up to 85% of the value. The idea is to ensure that the outstanding loan amount is lower than the property value.”
Interestingly, if a borrower approaches a bank today, he will get a lower loan amount, as the bank discounts the property value. “If a borrower approaches with a property value of Rs 1 crore, we evaluate it at Rs 80 lakh. This is not just in our interest but also augurs well for the borrower,” the banker added.
The crucial part is to ensure that the borrower does not go overboard. “A borrower should not increase his or her loan exposure even if it’s a home loan. A buffer should be created by borrowing only 50%-60% of the house value,” cautions Mr Pandit. Some food for thought for sure.