Buying a Home on Loan - Some calculations demystified

Note on Buying a Home on Loan

Buying a home does not only ensure financial security for you and your family, but also saves plenty of money that you would otherwise pay just for living in a rented house. Banks have, in fact, simplified the entire process of home loan financing in a bid to ride this wave, which comes with a huge sentimental aspiration.

Banks make money on the interest they charge on loans. Typically, up to 85% of the property value is provided as loan, while 15% margin has to be borne by the borrower using his/her own savings/resources.

ü  A majority of home buyers take their purchase decision taking into consideration the EMI as their affordability factor. However, one pertinent question that usually haunts a home buyer is: 'How much do I actually pay for my dream home?'
We are trying to answer this question with a practical example and for this we are decoding home loans under two heads -- one is principal and interest, while the second one is tax implications.

ü  Mr. M. Cool decided to buy a 3 BHK flat in Navi Mumbai. The total cost of the flat, including amenities, was INR 63 lakhs. As per norms, he paid 15% of the down payment amount using his cash reserves, which came to around INR 9.45 lakhs. He approached two different banks (One PSB and other is Private) for availing a loan of INR 53.55 lakhs. One bank offered him the loan at 10.25% interest rate while the other loan was available at 10.15%. Obviously he decided to borrow from the bank which offered him loan at 10.15%. Duration of loan is 20 years and EMI is at around INR 52,210/-

Home Loan	INR 53,50,000/-
Interest Rate	10.15% p.a.
Duration of the Loan	20 years
EMI	INR 52,210/-

ü  At the end of the loan tenure of 20 years - presuming that the interest rate remains the same, Mr. M. Cool would pay INR 53.55 lakhs as the principal amount, while a whopping sum of INR 71.75 lakhs would be paid as interest. This means he would pay 135% of the total borrowed amount as interest alone

The below table illustrates this

Time Frame	Interest Paid (INR)	Principal Paid (INR)	O/s. Balance (INR)
1 year	5,39,560	86,861	52,68,039
5 years	25,94,942	5,37,671	48,17,329
10 years	48,36,315	14,28,910	39,26,090
15 years	64,91,618	29,06,221	24,48,779
20 years	71,75,453	53,55,000	NIL

ü  From the table it is clear that the major component of EMIs paid to the bank in the early years of loan repayment is deducted as interest. At the end of the 5th year, Mr. Cool would pay an amount of Rs 25,94,942 as interest, while the principal component is only Rs 5,37,671. If he continues to repay the loan over a span of 20 years, then the total amount to be paid to the bank comes out at around Rs 1,25,30,453.

ü  Now let us consider a situation where He has some surplus amount with him. Then he would have two options:

1. One, he can foreclose the loan by pre-paying it with his surplus amount. By pre-paying the loan amount, he will reduce the number of EMIs and can invest the amount saved from EMIs 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 portfolio.

Scenario 1

In this scenario let us consider that he prepays an amount of Rs 5,00,000 at the end of the 5th year. Then his outstanding principal amount (ie, Rs 48,17,329) will get reduced to Rs 43,17,328 and the EMI of Rs 52,210 will get reduced to Rs 46,791 where he can save Rs 5,419 every month, which he invests into diversified portfolios. At the end of the loan tenure, he will save an amount of Rs 22,64,732 (assuming the rate of return at 10%) from the invested amount. Additionally, he will also save Rs 4,75,420 on interest. So, on the whole, he will save Rs 27,40,152 at the end of the loan tenure.

Scenario 2

In this scenario let us assume that Mr Cool invests his surplus amount of Rs 5,00,000 into diversified portfolios and continues with the same EMI for loan repayment. In this case he will save Rs 20,88,642 (assuming the rate of return at 10%), which is lesser than the amount saved in the first scenario.

Therefore, out of the two options, it's advisable to choose the first option because that will not only help you save more amount, but also reduce your liability to a great extent.

What is more, home loan repayments also attract tax benefits. So, under Section 80C of the I-T Act, tax deduction up to Rs 1.5 lakh can be availed for repayment of the principal amount. Under Section 24B, tax deduction of up to Rs 2 lakh can be availed on the interest paid for home loan for a self-occupied home. In case a loan is availed for a second home or property which is not self-occupied, then the actual interest paid for the year is allowed for deduction under Section 24B

Conclusion

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 being 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, and foreclosure charges, among others. It is, therefore, always wise to choose a home loan which will not  disturb your financial health.

Chirag Chordia

AIR CA, CS, B.Com

Can be reached at +91-8384805324

Email – chiragb.chordia@gmail.com