Budget good for home loan borrower!

With the finance Minister deciding in budget 200-06 to do away with the internal ceiling among various instruments under Section 88, the net interest rate on home loans is set to go down further. Earlier, an investor was allowed to take the benefit of only up to Rs 3,000 against principal repayment. Now this limit has gone up to Rs 30,000. Earlier the tax benefit against principal repayment was allowed only to those whose taxable income was less than 5 Lakhs. But in the new proposals, there is no such limit, and anybody can avail the tax deduction on home loans.

Section 88

So far, under Section 88, you could invest up to Rs 1 lakh to avail a maximum benefit of Rs 15,000 if your income was between Rs 1.50 lakhs and Rs. 5 lakhs. To avail these deductions, one had to select amongst various instruments; and even within the overall limit of Rs 1 lakh there was a cap for each instrument. For instance, one could have invested up to Rs 70,000 in instruments like Public Provident Fund (PPF), National Saving Certificate (NSC), insurance polices, units of equity oriented mutual fund schemes, & repayment of principal on housing loan. But limits were fixed on the investments within the Rs 70,000 limit by investing in any of the instruments like PPF, NSC, insurance or in any combination thereof.

But if you had taken a home loan to buy a house for self-use, there was a cap of Rs 20,000 on the repayment of principal on which tax rebate at the rate of 15% was allowed. This meant that even if your principal repayment during a year was more than Rs 20,000, you could not have claimed tax rebate beyond Rs 20,000. Similarly, the cap on taking tax rebate at the of 15% on investment made in mutual funds units was capped at Rs 10,000. If you wanted to take advantage of the entire Rs 15000 by invest at least Rs 30,000 in infrastructure bonds, which gave low returns.

Home loan

If you have bought a house after 1999 by taking a loan from a bank or a finance company, you get tax concessions when you repay the loan. During a year, interest payment up to Rs. 1.50 lakhs on a home loan is deducted from your income while computing your income while computing your tax liabilities. This means if your income falls in the 30% tax bracket, you will save tax of Rs 45,000 if the interest portion in your EMI (equated monthly installment) is Rs 1.50 lakhs.

Besides, principal repaid up to Rs 20,000 also qualified for a tax rebate at the rate of 15% if your income is between Rs 1.50 lakhs and Rs 5 lakhs. If the income was more than Rs 5 lakhs, no rebate was allowed. If it was less than Rs 1.50 lakhs, rebate at the rate of 20% was allowed.

New system

Under the new system, the Finance Minister has proposed to do away with the internal caps on investments in various instruments. Now, one can exhaust the entire Rs 1 lakh by investing in any of the instruments. This means that principal repayment up to Rs 1 lakh can be used to avail tax benefits.

In addition, under the new system, investment or repayment against principal will qualify against principal will qulify for deduction from the income. If you have paid Rs 30,000 as principal repayment against the home loan during a financial year, you will save tax up to Rs 9,000 (30% of Rs 30,000)

If you have brought a house for self-use, then you can avail deduction up to Rs 2.50 lakhs against repayment of home loan. It means that the maximum tax benefit during a year will be Rs 75,000. Take for example, a borrowed who has borrowed Rs 30 lakhs to buy a house at 7.5% per annum interest rate. The loan has to be repaid in 20 years. His monthly installment is Rs 24,168.

This works out to an annual outgo of Rs 2,22,719 and the principal portion will be Rs 67,297.

Budget…

Therefore, he will get a deduction of Rs 1.50 lakhs (the maximum allowed limit) against interest payment and Rs 67,297 (the maximum limit here is Rs 1 lakh) against principal repayment. Therefore, he will get a total deduction of Rs 2,17,297 from his taxable down his tax liability by Rs 65,189.

As he got the tax benefit because of the home loan, this against the total interest payment. This will bring down his net tax liability to Rs 1,57,530. Therefore, his effective interest rate in the first year will be only 5.25% much lower than the 7.5% rate at which he had contracted the loan.

From the second year onwards, his benefit will keep increasing further so long as the principal portion keeps on increasing to reach Rs 1 lakh, and the interest portion, which will keep on declining, dose not reach Rs 1.50 lakhs. In this case, between 7th and 10th year when the principal portion will be more than Rs 1 lakh and interest repayment portion will also be more than Rs 1.50 lakhs, the investor will get a year. The net interest rate in the 7th year will be 4.37% and in the 10th year it will be 3.8 %