How to save Tax with Home Loan

or, Save taxes with a Housing Loan. Er, this title has been chosen deliberately for SEO. And it is a noble thought at that cos most of you who've meandered here from Google or other search engines wouldn't have been here had it not been for SEO and my submissions of the Aryan Expedition on search engines! He he...

So, I'm writing about this here as a matter of need rather than just for plain tax saving. As one's salary increases over time, there is very little one can do to save taxes; the Rs 1 Lakh limit for Section 80C just does not help. Higher salary means higher tax bracket(soon the highest tax bracket) and therefore more and more taxes. As a matter of fact, my employer deducts tax at source from my present salary today which is as much as about 65 % of my salary when I started working about 4 years ago! So what do you do? Having utilised the Section 80C to the maximum extent possible, the best way out is to go for a Home Loan.

Presented here are some of the best links to scout for information on home loans. The best way is to compare Home Loan offers from various banks and HFCs and go for the best offer:

http://www.indianpropertyloans.com/
http://www.honeybeeindia.com/

Here is an illustration on how much tax you can expect to save by taking a home loan. You can find your own tax savings by entering you info here. Very good tool.

For this illustration, we've considered a Floating rate Home Loan of Rs 30 Lacs, for 20 years and considered the taxable income of our friend Ramu to be Rs 5 Lacs. We've taken this loan from IDBI Home Finance which offers probably the cheapest floating rate home loan @ 10.25% p.a. Monthly rest.

Here is what we get:

For the first year, Loan Repayment(before tax benefits) is Rs 3,53,392 which is the summation of Rs 3,05,281 of Principal and Rs 48,110 of interest. The Tax payable(without the Home Loan) is Rs 1,18,830 (We haven't considered the other rebates / deductions like Section 80 C here for the sake of simplicity). Now here is the best part - with the Home Loan, the tax payable comes out to only Rs. 72,930. The Annual Tax saved comes to Rs 55,522 (Rs 45,900 + Rs 9,622). So, Ramu's Annual Repayment(after tax benefits) comes to only Rs 2,97,870. This has also reduced the Post Tax Effective Interest Rate(PTEIR) of the loan to 7.69% p.a. Monthly rest.

The Total Tax saved over the period of this loan, that is 20 years comes out to a neat Rs 11,60,565(A-B):
(A)Total repayment over the period of the loan WITHOUT tax incentives : Rs 70,67,832
(B)Total repayment over the period of the loan WITH tax incentives : Rs 59,07,267

The Annual Tax saved figure will keep on increasing with each passing year except the last 4-5 years when Ramu won't get the full tax benefits. The explanation which is given on the link I provided above is reproduced here:

You will notice a drastic fall in the effective interest rate that you pay after TAX benefits.

The above table examines for you the year from which you are not getting your full tax benefit. Normally, in the last couple of years you may not be able to avail the full tax benefit as the level of interest & principal payments are low. However if you don't have the full tax break even earlier than that you may not be efficiently using the Tax Policy. Go back and try to reduce the tenure of the loan (or take a larger loan) to get higher tax breaks.

You might also want to see how post tax effective interest rate changes as the Tax Policy changes in the future or the tax rate that is applicable to you changes.

So there you have it! Saving income tax by taking a home loan. Works like a charm I'm told, although I have to give it a try soon myself...