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Why You Must Not Take Loan Against PPF?

IndianMoney.com Research Team | Posted On Monday, February 17,2020, 05:05 PM

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Why You Must Not Take Loan Against PPF?

 

 

PPF or Public Provident Fund is a favorite of conservative investors in India. Many people avail loan against PPF to meet emergency needs. According to changes which were made in the PPF scheme, Loan against PPF taken on or after December 12th 2019 enjoys an interest rate of 1% a year, instead of 2%.

However, experts are of the opinion that you must not avail Loan against PPF. Why is this so, in spite of Loan against PPF rates being lower than personal loans or credit cards? Let’s find out.

See Also: How to Transfer PPF Account?

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Why You Must Not Take Loan Against PPF?

You Lose the PPF Tax Benefits:

PPF is an excellent tax-saving instrument. It offers the EEE tax benefit. The investment enjoys Section 80C tax deduction up to Rs 1.5 Lakhs a year. The interest and amount withdrawn at maturity are tax free.

Well, if you avail loan against PPF, you lose out on the tax benefits. Interest rate charged on loan against PPF is a mere 1%, but it comes at the cost of PPF tax benefits.

Note: Loan against PPF interest rate is 1% above 7.9%, which is 8.9%.

No interest is paid on the PPF account to the extent of Loan against PPF taken. This happens till Principal and Interest are repaid. The balance left behind in the PPF continues to earn interest. So yes, taking loan against PPF is a bad idea as you lose tax benefits, in spite of just 1% interest charged on the loan.

See Also: How PPF Rules Affect your Investments?

You Lose Compounding Benefit on PPF                                            

PPF enjoys the advantage of compounding returns. But, the PPF account must earn interest without breaks to get a huge sum at maturity. If you avail loan against PPF, the PPF account doesn’t earn interest till the loan is repaid. You lose the benefit of interest on interest or the compounding benefit of PPF. This means a lower corpus at retirement. Now, PPF has a 15-year lock in period. You can take a loan against PPF account from the third to sixth year of opening the PPF account. This is the earlier part of the PPF tenure and you lose out on the compounding benefit.

PPF loan is very small

This is one big reason why loan against PPF is a big No. You just don’t get enough loan on availing Loan against PPF. Let’s understand this with an example.

  • You can avail a loan against PPF from the third to the sixth year of opening this account.
  • You get a loan amount which cannot exceed 25% of the amount available in PPF account at the end of the second year which immediately precedes the year in which you applied for the loan. Let’s find out what this means.

See Also: Why PPF is a Great Investment?

You have opened PPF account in July 2018-19. Let’s say the average PPF interest is 7.9% a year. You can apply for loan against PPF from the year 2020-21 (This is the third year) till the 6th year. (This is the year 2023-24).

You have availed loan against PPF in the 5th year. We assume deposits made at the start of the year and interest rates remain same at 7.9%.

Year

Opening Balance (Rs)

New Deposits (Rs)

Interest Rate (%)

Closing Balance (Rs)

2018-19

0

1,50,000

7.90%

1,61,850

2019-20

1,61,850

1,50,000

7.90%

3,36,486

2020-21

3,36,486

1,50,000

7.90%

5,24,918

2021-22

5,24,918

1,50,000

7.90%

7,28,237

2022-23

7,28,237

1,50,000

7.90%

9,47,618

You have applied for the loan in the year 2022-23 and are eligible for 25% of the closing balance as of the year 2020-2021. This translates to 25% of Rs 5,24,918 which is Rs 1,31,230.  This is really a small amount and there isn’t much point in availing loan against PPF.

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