Buying a home does not only ensure financial security for you and your family, but also saves plenty of money that you would otherwise pay just for living in a rented house. During the past decade or so, home buying has picked up tremendously also because of the easy availability of home loans. Banks have, in fact, simplified the entire process of home loan financing in a bid to ride this wave, which comes with a huge sentimental aspiration.
Banks make money on the interest they charge on loans. Typically, up to 85% of the property value is provided as loan, while 15% margin has to be borne by the borrower using his/her own savings/resources.
A majority of home buyers take their purchase decision taking into consideration the EMI as their affordability factor. However, one pertinent question that usually haunts a home buyer is: ‘How much do I actually pay for my dream home?’
We are trying to answer this question with a real life example and for this we are decoding home loans under two heads — one is principal and interest, while the second one is tax implications.
Mr. Varma decided to buy a 3 BHK flat in an upcoming neighborhood in Hyderabad. The total cost of the flat, including amenities, was Rs 63, 00,000. As per norms, he paid 15% of the down payment amount using his cash reserves, which came to around Rs 9,45,000. He approached two different banks for availing a loan of Rs 53,55,000. One bank offered him the loan at 10.25% interest rate while the other loan was available at 10.15%. Obviously he decided to borrow from the bank which offered him loan at 10.15%. Duration of the home loan was 20 years, and the EMI came to around Rs 52,210.
|Home Loan amount||INR 53,55,000|
At the end of the loan tenure of 20 years – presuming that the interest rate remains the same — Mr. Varma would pay Rs 53, 55,000 as the principal amount, while a whopping sum of Rs 71,75,453 would be paid as interest. This means he would pay 135% of the total borrowed amount as interest alone!
The below table illustrates this:
|Time Frame||Interest Paid||Principal Paid||Outstanding Loan|
|1 Year||INR 5,39,560||INR 86,961||INR 52,68,039|
|5 Years||INR 25,94,942||INR 5,37,671||INR 48,17,329|
|10 Years||INR 48,36,315||INR 14,28,910||INR 39,26,090|
|15 Years||INR 64,91,618||INR 29,06,221||INR 24,48,779|
|20 Years||INR 71,75,453||INR 53,55,000||INR 0|
“From the table it is clear that the major component of EMIs paid to the bank in the early years of loan repayment is deducted as interest. At the end of the 5th year, Mr. Varma would pay an amount of Rs 25, 94,942 as interest, while the principal component is only Rs 5,37,671. If he continues to repay the loan over a span of 20 years, then the total amount to be paid to the bank comes out at around Rs 1,25,30,453,” says Nitin Vyakaranam, Founder and CEO, ArthaYantra, an online financial planning firm.
Now let us consider a situation where Mr. Varma has some surplus amount with him. Then he would have two options:
1. One, he can foreclose the loan by pre-paying it with his surplus amount. By pre-paying the loan amount, he will reduce the number of EMIs and can invest the amount saved from EMIs into diversified portfolios until he repays the loan.
2. The other option is he can continue with the same EMI and invest his total surplus amount into diversified portfolios.
Let us evaluate the consequences in both the scenarios:
In this scenario let us consider that he prepays an amount of Rs 5,00,000 at the end of the 5th year. Then his outstanding principal amount (ie, Rs 48,17,329) will get reduced to Rs 43,17,328 and the EMI of Rs 52,210 will get reduced to Rs 46,791 where he can save Rs 5,419 every month, which he invests into diversified portfolios. At the end of the loan tenure, he will save an amount of Rs 22,64,732 (assuming the rate of return at 10%) from the invested amount. Additionally, he will also save Rs 4,75,420 on interest. So, on the whole, he will save Rs 27,40,152 at the end of the loan tenure.
In this scenario let us assume that Mr Varma invests his surplus amount of Rs 5,00,000 into diversified portfolios and continues with the same EMI for loan repayment. In this case he will save Rs 20,88,642 (assuming the rate of return at 10%), which is lesser than the amount saved in the first scenario.
“Therefore, out of the two options, it’s advisable to choose the first option because that will not only help you save more amount, but also reduce your liability to a great extent,” advises Mr Vyakaranam.
What is more, home loan repayments also attract tax benefits. So, under Section 80C of the I-T Act, tax deduction up to Rs 1.5 lakh can be availed for repayment of the principal amount. Under Section 24B, tax deduction of up to Rs 2 lakh can be availed on the interest paid for home loan for a self-occupied home. In case a loan is availed for a second home or property which is not self-occupied, then the actual interest paid for the year is allowed for deduction under Section 24B.
Taking a home loan is a long-term debt commitment. So, it is advisable to go for a home loan which you can manage with your existing finances. Although a lot of efforts are being made by the banks to make borrowing lucrative, but care should be taken to understand that there are a lot of hidden costs involved like pre-payment charges, processing charges, and foreclosure charges, among others. It is, therefore, always wise to choose a home loan which will not disturb your financial health.
Sanjeev Sinha, Economic Times