Why annual interest outgo of your home loan is most critical
You can save income tax on the home loan principal repayment amount up to Rs 1.5 lakh each year under section 80C of the Income-tax Act, 1961. However, this is a crowded avenue which has many other alternatives such as deductions available on EPF and PPF contributions, investments in ELSS, ULIPs, tax benefits on payment of school fee, life insurance premiums, and many more, due to which there is hardly any scope left for one to claim deduction on the home loan principal amount.
On the other hand, the tax saving that is offered on home loan interest payment under section 24b does not have any replacement and you can use this tax saving only when you are paying interest on a home loan. So, the annual interest outgo becomes a deciding factor as to how much tax you can save through your home loan. If you fall in the 30% income tax bracket you can save Rs 60,000 each year if your annual interest outgo is Rs 2 lakh or above. The lesser interest outgo you have, the lesser would be your tax saving.
“The deduction to claim interest paid is available for up to Rs 2 lakh within the overall limit of Section 24b in a financial year. In case of Let out property, there is no limit on the maximum interest that can be claimed. However, the loss that will be adjusted against other income heads such as salary etc. cannot exceed Rs 2 lakh in a financial year. The remaining loss under the head ‘Income from house property’ can be carried forward for 8 successive years to be adjusted against the income from house property only,” says Rishi Mehra, CEO Wishfin.com, an online financial market place.
Loan amount and tenure that delivers biggest tax saving
If you were to just look at tax saving, you need to go for a higher loan amount and the longest tenure to give you the maximum possible tax saving. For instance, if you take a Rs 30 lakh home loan for 15 years at 7% per annum interest rate, the total tax that you can save in 15 years is Rs 5.54 lakh, if you fall in 30% income tax bracket. On the other hand, if you have a home loan of Rs 50 lakh with a tenure of 30 years, the tax saving amounts to Rs 13.93 lakh in a similar situation.
However, the longer tenure will also mean that your total interest outgo is much higher. Instead of paying a total interest of Rs 18.53 lakh on a Rs 30 lakh home loan, you would end up paying a total interest of Rs 52.59 lakh on a Rs 50 lakh loan. As a result, your interest liability rises much more than the increase in the tax saving. The best way to strike a balance and find an optimum amount is by comparing the net interest rate after considering the tax saving benefits. Net interest rate is the effective rate of your home loan with which you would pay the same amount of interest that you would get by deducting the tax saving from the original interest charged by the lender. At the current prevailing rate of interest a home loan which is close to Rs 30 lakh with 15 years tenure can give one of the lowest net interest rates.
Why this is so?
Excess interest payment in higher loan amount
It is a myth that if you take home loan of a higher amount you would save more tax. The interest portion in a home loan monthly installment comes down each month as principal repayment increases correspondingly. So, the annual interest payment remains higher in the initial years while it comes down sharply in the second half of the tenure towards the end. However, the maximum tax saving that you can do on account of interest payment under section 24b is limited to Rs 2 lakh.
So, any amount of interest that you pay over and above Rs 2 lakh annually does not help you in saving taxes. During the first half of repayment if there are many years in which you are paying interest above Rs 2 lakh in a year, then it remains unproductive and will not help in saving taxes.
High loan amount with longer tenure comes with the dual disadvantage of higher interest outgo without any tax saving and longer period of debt outstanding. To optimise the best mix of lower interest outgo and higher income tax saving you can use partial prepayments to bring down your loan outstanding to a level where the annual interest is close to the Rs 2 lakh annual limit. This is the optimum level which will help you capture the best interest saving and keep your interest outgo at a level where it enjoys income tax deduction on the entire amount.
Not many want long tenure just for tax saving
Only a few are comfortable with a debt outstanding for longer periods just for the sake of saving taxes. Borrowers often looks for ways as how to use their home loan in a way that it offers a combination of best tax saving and timely payment of debt.
In this scenario keeping the tenure short will help you keep the interest cost lower and pay off your loan quickly. However, once your annual interest outgo comes significantly below Rs 2 lakh you will have unused tax savings. In such a situation, if you have the requirement to upgrade your house to a bigger one or plan to go for a second house then you can utilise the tax saving avenue offered on home loans again. This will ensure that you always keep the debt at lower levels and utilise the tax saving for longer periods at an optimum level.
Boost your tax saving with a joint home loan
If both spouses are paying a high amount of income tax, then they can take a higher home loan and enjoy the principal and interest deduction on the home loan separately. As a result, the couple can get a total deduction of Rs 3 lakh under section 80C (Rs 1.5 lakh plus Rs 1.5 lakh) on the principal repayment and Rs 4 lakh (Rs 2 lakh plus Rs 2 lakh) towards interest payment under section 24b. This means a bigger home loan of Rs 60 lakh with shorter tenure of 15 years could give them the optimum mix of greater tax saving and faster repayment of the loan. “All the applicants should also be co-owners of the property in order to claim this deduction,” says Mehra.
Extra deduction on buying an affordable house
If you have bought the house under the affordable housing category then an additional deduction of Rs 1.5 lakh is available under section 80 EEA. “The timeline to avail this additional deduction has been extended to 31st March 2022. So, all home loan related deductions put together can help you help you get a maximum deduction of Rs 5 lakh (Rs 2 lakh u/s 24, Rs 1.5 lakh u/s 80C and Rs 1.5 lakh u./s 80EEA) if it meets the specified conditions,” says Mehra.