Home loans are a type of secured loans. Funds received as home loans can be utilized only on housing related activities like purchase, construction, renovation and reconstruction. As home loans are secured loans, they are offered at a lower interest rate when compared to personal loans.
Aspiring home owners would opt to avail a home loan when they cannot fund their dream house. Home loans come with a lot of tax benefits. Both principal and interest on home loans are eligible for tax deductions under the Income Tax Act.
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1) There are individuals who avail home loans just for the sake of enjoying tax benefits. These borrowers are over obsessed with tax deductions and won’t look at the overall cost attached to home loans.
2) There are many individuals who can easily prepay and foreclose the home loan account, but they prefer not to do so, as they want to enjoy tax deductions for a few more years. But, little do these borrowers know that they are paying more interest than what they would save if they were to foreclose the home loan account.
3) There are individuals who avail home loans to purchase a property as an investment. While investing in properties by availing home loans is not a good idea, many people still do so.
4) There are borrowers who don’t increase the EMI with increase in income. This is because they feel they will miss out on tax benefits if they close the loan earlier. But, they don’t realize that they would have paid more interest vis-a-vis saving taxes.
1) Interest On Home Loan: Interest paid on home loans is eligible for tax deduction under Section 24 of the Income Tax Act, 1961. Tax benefits on home loan interest paid for a self occupied property is capped at Rs 2 Lakh a year, while the entire amount paid as interest is eligible for tax deductions in case the property is let out. After initial few years of the home loan repayment, the interest component in the EMI would decrease and you cannot deduct full Rs 2 Lakh under Section 24, in case of self occupied property.
2) Home Loan Principal: You can avail tax deduction on the principal repayment of home loan as per Section 80C of the Income Tax Act, 1961. However, Section 80C also covers investment in NSC, PPF, Tax Saving FDs, ELSS and so on. Maximum tax deductions allowed under Section 80C is Rs 1.5 Lakhs a year and is a collective deduction across various investments and expenses. This may not be sufficient as interest paid in the first few years will be well over Rs 1.5 Lakhs and it would not offer much of a tax benefit.
Most individuals availing home loans would also invest in schemes like EPF and PPF, which negates tax exemption offered on principal. In the initial few years of repayment, the EMI’s principal component would be low and this Rs 1.5 Lakh exemption would not be much of a help. However, after a few years, the principal component would increase in the EMI and would be of great help in saving taxes. In the last few years of the loan repayment, the principal component of the EMI would be really high which is sure to exceed Rs 1.5 Lakhs a year and the amount paid over and above Rs 1.5 Lakhs would not enjoy Section 80C deductions.
SEE ALSO: Tax Benefit For Home Loan
As mentioned above, home loans are a powerful tool to save taxes. However, they come with a lot of restrictions. Amount paid towards both interest and principal repayment is capped for deductions. This capping and restrictions may not ultimately translate into considerable tax savings.
Consider the following example: Home Loan interest of up to Rs 2 Lakhs is covered for tax deductions and any interest paid over and above Rs 2 Lakhs is not eligible for tax exemption. You pay Rs 4.4 Lakhs towards interest on the home loan. In this case, 2.4 Lakhs (4.4 Lakhs – 2 Lakhs = 2.4 Lakhs) is not eligible for tax deduction and you have to pay tax as per your income tax bracket.
Similarly, tax deductions for principal repayment are capped at Rs 1.5 Lakhs under Section 80C. Section 80C also covers investments in EPF, PPF and many other options. Home loan tax benefits would not be of much help when the loan principal is high, especially because Section 80C is a shared deduction. In this case, you must consider prepaying and foreclosing the loan account.
You can apply for more than one home loan at the same time. Irrespective of the number of home loans you are repaying, you can claim a maximum of Rs 1.5 Lakhs a year under Section 80C on home loan principal repayments. You are entitled to this tax deduction, only after possession of property.
As per the Union budget proposals, you are allowed two properties as self-occupied, but the deduction vis-a-vis home loan interest, continues to be Rs two lakhs for both the properties taken together.
You get Section 80C benefits only if the house is retained for 5 years. If you sell the house after attaining possession within 5 years, tax benefits are reversed. The entire deducted amount is added to taxable salary and is taxed in the next financial year.
When you think of availing a home loan, you must evaluate your financial capabilities. Try to make a high down payment. Higher loan amount increases the debt burden. Home loan tax benefits are offered with a lot of restrictions and it may not always help in saving taxes. If you are extracting any tax benefits from your home loan, then you must consider closing your loan account at the earliest.
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