Sunday, October 30, 2005

Tax Incentives on Home Loans

Yes, such a thing exists when you buy a home. The tax laws allow incentive to encourage people to buy homes. Hence, make full use of them.

Incentive 1 : Interest on housing loans is exempt up to a ceiling of Rs. 1,50,000 (sec 24)

Incentive 2 : A Deduction of Rs. 1,00,000 from taxable income is available for the repayment of principal amount on home loan. (Note: This is the consolidated ceiling amount under section 80C which allows the rebate for investments like contribution to Provident Fund, Life Insurance Premium, Mutual Funds etc)

Tax Incentives – Make your Home Loan cheaper than you think

How can working professionals plan their home loan to maximise interest and tax savings?

From the point of view of economics, the ideal loan investor should avail of is Rs.20 lakh. The rate of interest on this amount would be just about 3.525% per annum only. How ???

Let us presume that a senior executive receiving a salary of Rs.5 lakh per annum is interested in a loan of Rs.20 lakh. The rate of interest charged on this loan is 7.5% per annum.

Thus the total interest payable for one year on Rs.20 lakh comes to only Rs.1,50,000. The maximum amount of interest that will be allowed as a deduction while computing the income of the individual from all sources taken together is restricted to a maximum sum of Rs.1,50,000/- per annum.

Thus, the entire interest payment of say Rs.1,50,000/- would be allowed as a deduction to this executive from his salary income of Rs. 5 lakh. This implies that the executive would be saving income tax on Rs.1,50,000/- being the interest payment. The tax saving would be at the rate of 33% being the maximum marginal rate of income tax applicable to him.Thus, the saving on account of deduction of interest from the total income for salaried executive comes to 49,500.

Hence, we find that from the total interest payment of Rs.1,50,000/- payable by the executive on loan of Rs. 20 lakh @ 7.5 % interest has actually been paid by the income tax department by granting him full deduction in respect of such interest payment on loan. There by the net outgo of interest on the loan comes to Rs.1,00,500/- (Rs.1,50,000 – Rs.49,500).

Thus the net impact of interest on the executive’s loan of Rs.20 lakh comes to Rs.1,00,500/-. This in fact, is just 5.02% rate of interest per annum.

If we go a step further and take into consideration the impact of tax saving as a result of the deduction from taxable income on account of home loan principal repayment.

We find that the said executive is able to save income tax to the tune of Rs. 30,000/-. Hence from the above amount of Rs 1,00,500/- if we deduct Rs.30,000/- the net impact comes to a mere Rs 70,500 - Rs.1,50,000 interest Rs.49,500/- tax saving on interest payment Rs.30,000/- cash flow saving as a result of principal repayment.

Thus, on a total loan of Rs.20 lakh, the net impact of out flow after tax comes to Rs.70,500/- which means effective interest rate of merely 3.525% in respect of a Rs. 20 lakh loan.