In the current situation of the real estate market, it is very difficult to buy a house or flat without a housing loan especially in Metros and Mini Metros. It is a good loan because you are building an asset with the loan and getting income tax benefits also. But you must be careful in going for a home loan so that the biggest asset of your life should not become a matter of concern to you.
Please see the following 10 points:-
1. You can borrow only upto 80% of the value of the property, you plan to purchase. So you should plan for the remaining 20% as the down payment. It is better to plan for this atleast 5 year in advance, so that you can accumulate enough money, without opting for additional personal loan etc. You can think of investing systematically through SIPs in debt mutual funds, balanced funds, equity funds or bank RDs for accumulating amount for down payment. Better to accumulate a high amount as down payment so that your EMI burden will be less.
2. While applying for a home loan, you should look at your repayment capacity and not on your loan eligibility. Always limit your EMI within 40% of your take home salary, if you are the sole earning member. If your spouse is also earning, you can think of going for a joint loan with an EMI of upto 50% of the combined take home salary. This will help you in meeting all other financial requirements in life, while repaying the home loan. Also ensure that you are going for an insurance cover equal to the home loan amount, to ensure that your legal heirs can continue in the house in case of your untimely death. Going for a term insurance will be better compared to a single premium Home Loan Insurance.
3. Since most of the current loans are under floating rates, you must be prepared for the adverse effect due to interest rate hike. Otherwise, you will find it difficult to service the loan in case of an interest rate hike. Let us see the effect:
In the case of a home loan of 25 Lakhs given at the rate of 8% interest for a 20 year term, the EMI comes to around 20,911. If the interest rate is increased by 1.5% to 9.5% after 1 year, there are 2 options for the customer – pay the increased EMI of 23,220 for the balance 19 years or pay the same EMI of 20,911 for a further period of 331 months! His EMI payment term has increased by 103 months or 8.5 years!! It is always better to pay the higher EMI because in the other option, your interest outgo will be much higher.
4. Go for a joint loan with your spouse as the co-borrower, to avail the maximum income tax benefits. As per the current tax laws you can claim 1.5 Lakhs deduction for interest paid and 1 Lakh on capital repayment in a year. Both of you can avail this, if the case of a joint loan and if EMIs are paid by both of you.
5. Most of the lending institutions are waiving prepayment penalties, if you are making the prepayment from your own savings. So use your bonus payments and extra savings for part repayment of loan, so that, your EMI will come down or you can close the loan early. But don’t repay the loan, by reducing your savings for retirement etc. because home loan is a good debt because it is used for creating an asset and you get tax benefits also. Please note that, if the house is let out, there is no limit on the interest outgo for which you can claim income tax deduction.1.5 Lakhs limit is only for self occupied house.
6. Before you switch your home loan to another lender, calculate the net effect. Most lenders charge around 2% of the outstanding loan as prepayment penalty in case of a transfer. You may have to pay around 1% of the loan amount as processing fee to the new lender. Also, you have to spend some money on stamp duty etc. Switching home loan will make sense only if the new lender would charge 1- 1.5 % lower interest than the existing loan.
7. Claiming tax benefits in case of under-construction house is bit different. You cannot claim the tax deductions for the principal amount for under-construction house. You need to have possession and certificate of ownership to claim tax benefits under 80C. However Interest part is different. You cannot claim deduction for the home loan interest, unless you get the possession of house. However you can claim the deductions later in 5 equal installments for next 5 yrs from the end of financial year of possession. But the total deduction allowed per year will be 1.5 Lakhs only.
8. If you sell your house before the expiry of 5 yrs, all the money you saved under sec 80C in earlier years will be deemed to be your income in the year of sale and added to your income. For example, if you bought the flat in June 2010 and in next 4 yrs you saved 1 lakh in tax under sec 80C, and then this 1 lakh will become your income in the year of sale and will be taxed. However interest component once saved is saved and this won’t be reversed.
9. In case you want to take loan from your friends, parents or any other person, you can still claim tax benefits for the interest on the loan under sec 24 , which is upto 1.5 lacs per year . However you cannot claim the principal amount under sec 80C, that’s applicable only if you take up the loan from banks or financial institution.
10. If you take a loan for extension or renovation of your existing house, you cannot claim the principal part under sec 80C, but you will be able to claim interest amount under sec 24, but the limit in this case is upto Rs 30,000 for self-occupied properties. However for houses which is let-out (rented or second home which is not occupied), there is not limit for tax deduction.
So go for a home loan and enjoy tax benefits while creating an appreciating asset. But keep the above points in mind to avoid any problems in future. Also ensure that real estate is a part of your overall asset allocation and don’t invest your entire savings for the house. You should always go for more liquid investments, in equity and debt for various financial goals in life.