Do Home Loans save Income Tax??

Now it is almost the end of Financial year 2009-10 and we are loaded with the tension of investments and tax saving.

Have we invested enough to save tax?? Where to invest to save more tax?? How much to invest?? Is the investment in this particular instrument worthy?? These are all the questions that hover in our mind.

Nowadays it is often recommended that if you are a high tax payer then try to buy a flat or house by taking home loan and this will help to save your tax to the maximum. Now even though it seems to be a good option, how much can you literally save through investing in home loan is a BIG Question………

Under Sec 80C, the annual Principal paid back is considered for tax exemption. . The maximum exemption under this section is Rs 1,00,000. (Please Note: Under Section C there are also other tax saving options. Refer to the various deductions under Income Tax Act 1961)

Under Sec 24, the annual Interest paid to bank is considered for exemption. The maximum exemption under this section is Rs 1,50,000.

Does it mean that if you pay total of Rs. 2.50,000 annually then you can save tax to the maximum and you don’t need to do any more investment???

I am sorry to say the answer is “NO”. Lets do a thorough analysis to see if investing in Home Loan can reduce your tax liability.

When we invest in Home loans then we pay back to the bank in Equated Monthly Installments (EMI). Now this EMI consists of 2 parts – Principle and Interest. But the main trick lies in the calculation of Annual Principle and Annual Interest on home loan. Whenever you take a home loan, during the initial days of repayment the principle component is less and Interest component is more.

Lets take an fictitious example to establish the fact :

Mr. Sethi took a home loan for 10years for which monthly EMI is Rs 21,000.

Now if you see the initial years of repayment for home loan, the Principal component is less and is not even Rs 1 lac. For the first 5 years, the amount paid as principle is less than Rs 1 lac and so you need to invest a considerable amount to meet the maximum exemption of Rs 1 lac under Section 80C.
Also during the initial years, the Interest component is more than Rs 1,50,000. So even if you are investing more than Rs 1,50,000 you are not able to get the benefit out of the whole money invested.

But as the tenure matures, the Principle increases while the Interest component decreases. So during the middle of the tenure i.e. during 5th, 6th & 7th year, we can take the maximum benefit by investing in home loan. A minimum investment under Section 80C is required to meet the 1 lac slab for Section 80C.

Again during the later part of the tenure i.e. from 8th year onwards, the Principal component if more than Rs 100000. So even if you are investing more than Rs 1 lac under Section 80C and you are not able to get the 100% benefit of tax exemption from it. But the positive point is that you don’t need to invest anything extra under Section 80C.

While under Section 24, the maximum exemption allowed is Rs 1,50,000, you are able to take benefit of the partial amount only. There is no other investments that can be clubbed under this section.

Thus from the above analysis we can infer that by taking a Home Loan, we make the maximum utilization of the money as the loan tenure matures i.e. during the later part of the repayment period. So during the initial days, even if you are investing in Home Loan, keep provision of some money to be invested under Section 80C to take the full benefit of the tax slabs under Income Tax Act 1961.

Please Note : All the above figures, facts and analysis are based on my experience. It may vary based on various situations.