We have been running a series of articles on various aspects related to the purchase of real estate. We have already examined issues, such as tax deductions on interest payable, service tax, stamp duty as well as TDS. This week we shall look at some interesting nuances related to housing finance.
While buying a house property, it is advisable to take a loan, even if you can buy it with your own funds. Tax breaks are available only on borrowed funds and the direct cost of borrowing is much less than the tax saved. Housing finance has become quite competitive with many aggressive entrants. Loans can be procured even to (i) purchase a piece of land (ii) pay stamp duty, and (iii) extend or improve an existing house. Home Conversion Loans are available which transfer the loan to the new house and provides additional finance. The loan is disbursed after you have selected the property, completed all the legal documentation and invested your own contribution in full. If it is an under-construction property, the disbursement is made in parts on demands of the builder. A bridge loan may provide temporary support before the disbursal of the main loan.
The speed of approval and processing of paperwork, however, varies with lenders. Some companies even offer consultation on property and the financial aspects of the loan. Free credit cards, free ATM cards, accident insurance, discounted consumer loans, etc., are amongst the many freebies. Some companies send a representative to your home to discuss and deliver the loan and also to pick up the EMI cheques. Some even offer to search for a property fulfilling your requirement at brokerage of up to 2%.
Security
The security for the loan is always by way of creating equitable mortgage of the property in favour of the lender.
There is an additional requirement that is preferred but not insisted upon. Any existing or a new life insurance policy equal to the loan amount sanctioned should be assigned as collateral security for the loan. It is this single aspect that accelerates grant of the loan without any hesitation. However, the borrower is forced to take a life policy even if he does not need one and consequently, the cost of the loan for him increases. If forced to do so, you may go in for ‘Loan Cover Term Assurance Policy’ where the premiums are much lower than the normal ones and what is insured is the home loan and not the home itself. Sometimes, the lender also demands assignment of bank FDs, shares, units of MFs, NSCs, etc., as additional security. Then again two guarantors may be required. However nowadays with the keen competition, many such requirements stand relaxed.
The sanction is around 85% of the property cost. The upper limit depends on the repayment capacity as gauged by the age and income profile of the borrower. All the proposed owners of the property will have to be co-applicants for the loan.
Recently, for housing loans up to ` 10 lakh, the RBI has allowed the banks to include stamp duty, registration and other documentation charges to the cost of the unit for calculating loan to value ratio to the cost of the unit. These charges form around 15% of the cost of the house and place an added burden on borrowers from economically weaker sections and low income groups. The RBI also said that in cases of projects sponsored by government, statutory authorities, banks may disburse the loans as per the payment stages prescribed by such authorities, even where payments sought from house buyers are not linked to the stages of construction.
Equated Monthly Installments (EMI)
This is the fixed amount, required to be paid by the borrower every month till the end of the loan tenure. It consists of part principal and part interest. At start, the component of interest is understandably high. As time passes, it reduces and the component towards repayment of capital correspondingly increases.
Interest Rates
Interest rates are interesting. Different organizations use different perspectives while announcing their rates. Since the EMI is monthly, the right way is to calculate reducing balance on a monthly basis. But some make the reductions quarterly, half-yearly or annually. Then again, there are many terminologies used such as ‘flat rate’, ‘simple rate’, ‘compounded rate’, and what not. This makes comparison difficult. Then there could be upfront charges such as processing fee, legal and incidental costs, administration fee, stamp duty, etc., which, if existing, are not taken into account for computing the rate.
Some multiply the monthly rate simply by 12 to arrive at the annual rate instead of compounding it for 12 months.
Until the regulator imposes some standardization to render the rates of different companies comparable with one another, you will have to compute and arrive at the correct rate yourself for making your choice. Finally, realise that u/s 24 the interest and u/s 80C the capital repayment is deductible. In other words on an EMI of say ` 962, if you are in 30.9% tax zone, the tax saved will be ` 297.26 (= 30.9% of 962). This means that your effective EMI is ` 665. Consequently, the interest on housing loan works out to be much lower than on an absolute basis.
No Prepayment Fine on Home Loans
RBI has made it mandatory for banks to not charge any penalty if borrowers pay back home loans taken on floating interest rates before the end of their repayment schedule. If you are in a fixed interest rate regime, you might face a penalty, which, in some cases may run up to 2% of the outstanding balance.
To Sum
Housing loan is cheap and the tax concessions make it cheaper. At the cost of repetition, allow us to observe that the interest on housing loan is not only deductible but also forms a part of cost of acquisition. Therefore take as large a loan as possible for as long a period as possible, even if you have enough funds on hand.
Ever since the interest rates have become volatile, the housing finance institutions have started offering floating rates which can be adjusted from time to time depending upon the market conditions. The fixed interest rates are also available, but understandably are at much higher levels, so high that you may do well by choosing the floating rate. Lastly, do not buy a house just because of the tax benefits. There are better methods to save the tax. This weekly column discusses many of these. Next week will be a discussion on another interesting tax saving avenue.
(The authors may be contacted at wonderlandconsultants@yahoo.com)
