Delaying Loan Pre-Payment To Enjoy Tax Benefits? You May Have Miscalculated
As years progressed, you grew professionally – you changed jobs, got increments, your allowances increased – and your earnings rose substantially. Your home loan EMI (equated monthly instalment) now looks much less like a burden than it did when you took the loan seven years or so earlier.
You often think that you should start saving your increased earning and use it to pre-pay your loan, but a number of concerns hold you back. For one, the tax benefits that you enjoy on your home loan would no longer be there if you pre-paid your loan. However, there are several benefits of pre-paying your loan – for starters, you would rid yourself of the monthly payment liability and get in a position to use a larger chunk of your income in an investment instrument of choice. But let us not go there as yet; let us think it through.
Also read: An Explainer: Loan Prepayment
The mental debate over whether to pre-pay your home loan or not can be a draining one. But before you take a call, you need to carefully evaluate the benefits of both maintaining a running home loan and closing it, and then weigh for yourself.
First, let us consider the benefits that you enjoy when you have a home loan running:
Section 80C: Under Section 80C of the Income Tax (I-T) Act, you enjoy an annual deduction of up to Rs 1 lakh on the principal loan amount. This deduction, however, is clubbed with other premiums that you pay towards your insurance policies, employee provident fund, equity-linked savings scheme, national savings certificate, stamp duty and registration charges, etc. The deduction under this Section is only available for buying or constructing a residential property, and not a commercial one. Also, the deductions on the principal amount are applicable only on self-occupied properties.
Section 24(b) : Under Section 24(b) of the I-T Act, you enjoy an annual deduction of up to Rs 2 lakh on the interest component of your home loan. Deductions under this Section are available for buying, constructing and renovating both residential and commercial properties. For self-occupied, as well as properties you let out, you can claim deductions under this Section. And, guess what! You can also club your home loan deduction fee for deductions under this category. Certainly, the benefits of paying an interest on your EMI look big.
Pre-paying your loan would mean letting go of the benefits mentioned above. Also, you might have to pay a fee for pre-paying your loan if your loan is on a fixed rate of interest. For home loans availed of on a floating rate of interest, the Reserve Bank of India (RBI) had in 2012 directed banks to stop levying foreclosure charges and pre-payment penalties.
You might also like to consider saving your extra money and investing in an instrument that gives you a high return. Additionally, there is also the question as to why you should go through the trouble of pre-paying when a fixed EMI outgo helps you maintain financial discipline.
All the points mentioned so far seem fair, don't they?
But before you make up your mind against pre-paying, it will be fair to dive deeper into the calculations and look at the positives of paying or part-paying your loan ahead of schedule.
Also read: 7 Things You Must Do Upon Your Home Loan Pre-Closure
Do the math, again
According to experts, if you sit down and do the calculations, you will find that the monetary benefits of pre-paying your home loan would far exceed the losses you incur while doing so. Let us understand this by a case study.
Ram Saran bought a house for Rs 50 lakh in 2010, of which Rs 40 lakh was a loan that he took from a bank on an interest rate of 10.15 per cent, the prevailing interest rate at that time, for a period of 20 years. Aside from the one-time processing fee and other sundry initial expenses for his self-occupied property, he would have to pay 240 EMIs of Rs 39,000 – a total cost of about Rs 93.6 lakh, including about Rs 53.6 lakh of interest payable.
Also read: What Constitutes Income From House Property?
Assuming that Saran has already paid his EMIs for six years, his total outgo towards the interest component would be about Rs 3.48 lakh during the seventh year of his loan repayment. But the total deduction that he can claim is capped at Rs 2 lakh.
On the other hand, he stands to further lose as he is not eligible to claim deductions on house rent allowance (HRA) under Section 10(13A) of the I-T Act, 1961, which makes the HRA component of his salary exempt from income tax.
What if you invest elsewhere?
Now assume Saran got an annual bonus of Rs 3 lakh from his company. He would like to explore options to gain greater returns on his investment than pre-paying his home loan. He has been considering putting this money in a fixed deposit or a post office savings scheme. He can also pick options like public provident fund (PPF) and mutual funds. Considering that the returns on these investment options would be up to 8.5 per cent, if Saran invests Rs 3 lakh in one of these categories, he will likely gain Rs 25,500 a year. But, if he chooses to use this Rs 3 lakh to part-prepay his home loan without reducing the tenure of the loan, he would be able to bring down his EMI by about Rs 3,000, or Rs 36,000 a year – a gain of Rs 10,500.
Also read: How Income From House Property Is Taxed
Set yourself free
And, if a gain of Rs 10,500 a year does not sound attractive enough, there's more: The psychological impact of pre-paying your home loan.
Despite the fact that borrowing for investing in property is counted among positive financial liabilities, a loan is a liability nonetheless. The sooner you are done with it, the better it is on a psychological level. The sense of security that comes from property ownership is often undermined by the fact that you live with a burden. This might be harmful in many ways. As far as financial discipline goes, we do not necessarily need a debt burden to teach us that.
Why not be future ready?
As you age, a new set of financial needs arises — you may have to take a personal loan to fund your child's education or wedding; you may even need money for a trip abroad. At such an occasion, if you are already burdened with home loan, you might find it difficult to borrow more. By prepaying your home loan, you replenish your capacity to borrow further and that means making yourself future ready.
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