Buying a home is one of the most common financial goals in India. Buying a home would ensure you and your family a financial security. It will also save money that you pay for your rented house. During past decade buying a home has picked up tremendously because of the easy availability of the home loans. Banks have simplified the entire process of home loans to ride this wave which comes with a huge sentimental aspiration.
Banks make profit by easily giving a home loan to the borrower. Typically, 85% of cost of the property is provided as a home loan by the banks. The differential amount of 15% has to be borne by the borrower using his own savings/resources. Majority of the home buyers decide the home to be bought taking into consideration the EMI as their affordability factor. One pertinent question that haunts a home buyer always is “How much do I actually pay for my dream home?”.
We answer this question with a real life example and try to decode home loans under two heads, one is principal and interest. 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 INR 63, 00,000. As per norms he paid 15% of the down payment using his cash reserves, which came to INR 9, 45,000. He approached to different banks to avail a loan for the rest of the 85% which was INR 53, 55,000. One bank offered him the home loan at 10.25% while other offered him 10.15%. Obviously he decided to borrow from the bank which offered him 10.15%. Duration of the home loan was 20 years, and the EMI came to INR 52,210.
|Home Loan amount||INR 53,55,000|
At the end of the loan tenure of 20 years, Mr. Varma could have replayed the entire principal amount of INR 53, 55,000 and in addition to that he would have paid a mind-blowing amount of only as the interest of home loan INR 71, 75,453. This means Mr. Varma paid 135% of the total borrowed amount as an interest!
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 EMI paid to the bank in the early years of loan repayment is deducted under interest payment. At the end of the 5th year Mr. Varma would pay an amount of INR 25, 94,942 as interest while the amount paid for Principal amount is only INR 5, 37,671. If he continues to repay the loan over a span of 20 years, then the total amount he repays to the bank is INR 1, 25,30,453.
Let us consider a situation where Mr. Varma has surplus amount with him, then he would have two options:
1.One is he can foreclose the loan by pre-paying the loan amount with his surplus amount. By pre-paying the loan amount he will reduce EMI and can invest the amount saved from EMI 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 scenarios:
In this Scenario let us consider that he prepays an amount of INR 5, 00,000 at the end of the 5th year. Then his outstanding principal amount INR 48, 17,329 will be reduced to INR 43, 17,328 and EMI of INR 52,510 will be reduced to INR 46,791 where he can save INR 5,419 every month which he invests this amount into diversified portfolios. At the end of the loan tenure he will save an amount INR 22, 64,732 (assuming the rate of return at 10%) from the invested amount. Additionally he will also save money from the interest paid to the bank as by pre-paying INR 5, 00,000 then the interest reduced from INR 71, 75,453 to INR 67, 00,032 where he will save INR 4, 75,420. So, on whole he will save INR 27, 40,152 at the end of the loan tenure.
In this Scenario let us consider that he will invest his surplus amount INR 5, 00,000 into diversified portfolios and continue with the same EMI for loan repayment then he will save an amount of INR 20, 88,642 (assuming the rate of return at 10%) which is lesser than the amount he saved in the first scenario.
From the two options, it’s advisable to choose the first option because you will not only save more amounts but also clear the liability. If the loan taken by you is not insured and you prefer to invest your surplus amount into market rather than clearing the existing debt then it might ruin your personal finance If you have cash in hand, it will be prudent to pre-pay the loan as early as possible because it could save you from paying more interest to the bank. Before pre-paying the loan, you need to check with the bank regarding the reviving charges for the loan pre-payment. After pre-paying the loan you can either continue with the initial EMI that you used to pay before loan pre-payment or you can continue with the reduced EMI. In order to close the loan at faster pace it is ideal to continue with the initial EMI, this is advisable to the people who are considering an early retirement.
Home loan payments also attract tax benefits. Under section 80 C of IT act, tax deduction up to INR 1.5 Lakhs can be availed on the principal amount. Under section 24 B, the tax deduction of up to INR 2 Lakhs can be availed on the interest paid for the home loan for a self-occupied home. In case if a loan is availed for a second home or a property which is not self-occupied then the actual interest paid for the year is allowed for deduction under section 24 B.
Home loan rates depend largely on the prevailing interest rates at which the banks borrow money from the central bank (Repo Rate). When there is a repo rate cut by RBI, then the home loan rate of interest would also go down. This change should be reflected for the existing home loan borrowers, as the EMI amount should reduce. In case the bank not reducing rate of interest, then Re-financing of loan would ensure that the same loan can be transferred to another bank on a lower rate of interest. You can also negotiate with your banker to reduce your rate of interest. But refinancing may consume some charges from the new bank which should also be evaluated before making the re-finance decision.
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 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, foreclosure charges etc. so, it would always be wise to choose a home loan which will not disturb your financial health.