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Home loans and the salaried class

Been dreaming of buying a house? Would like to find out more about home loans, loan providers, loan cover, house insurance, and other nitty-gritties?
In a series of articles that follow, we present everything you wanted to know about home loans.

Kripa Mahalingam in Mumbai

For millions of ordinary Indians, owning a home has remained a cherished dream for decades. Today, a favourable mixture of various factors is helping them realise that dream faster than ever before.

Owning a house brings with it tremendous security -- but that's not the only or most compelling reason to take a home loan, say experts. Even as other tax saving avenues lose their appeal, investing in a home is emerging as an excellent alternative for ordinary investors looking for tax-savings.

More and more individuals are now queuing up to avail of a home loan; after all, building a home offers many tax and other advantages.

For one, individuals can get a maximum deduction of Rs 1,50,000 per annum on interest paid, if the construction or purchase of the house property is completed within three years of taking the loan. In addition, they can also benefit from a 20 per cent tax rebate on that portion of the principal repaid annually, subject to a maximum of Rs 20,000.

Making things easier have been two years of falling interest rates. With a 300-basis point fall in bond yields last year alone, investors have discovered that they can take loans at practically rock-bottom rates.

And if you thought things couldn't get any better for home-loan seekers, think again. Realising the explosive growth potential of home loans, finance companies have been jostling each other to grab more customers with alluring deals.

Already, newspapers are writing about the 'furious price wars' taking place between the giants in the business.

With competition heating by the day, housing finance companies are lowering, and in some cases, waiving processing and administration fees. Usually, these charges amount to two per cent of the total loan amount.

In the case of a Rs 2-million loan, even a one per cent reduction in the service charge translates into a considerable saving of Rs 20,000.

Many institutions waive the processing and administration fees, if you apply for a loan at any of the 'property melas,' organised jointly by the financial institutions and builders.

And there are more temptations in store. Most lenders now offer the possibility of switching to a "monthly rest" method, which can mean lower interest charges for the borrower.

Under the 'annual rest' method, the principal component of annual equated monthly instalments are factored in only at the end of each year. Under monthly rest, the principal is lowered by the appropriate amount each month, resulting in lower interest costs.

For example, the equated monthly instalment on a 15-year fixed-interest loan for Rs 1.5 million will be lower by Rs 840 if you switch from the annual rest to the monthly rest method.

Borrowers of earlier high-interest loans aren't left out either; housing finance companies are making certain they participate in the joys of falling interest rates through the option of refinancing those loans.

Almost all home loan providers also offer floating rate loans, allowing you to take advantage of any further fall in interest rates. Inside, we have a detailed story highlighting the pros and cons of opting for a floating rate loan.

Nevertheless, amid all the euphoria surrounding the scorching growth of home loans, it has to be realised that, in the final analysis, buying a house is a long-term financial commitment.

Often, it is the long-term nature of this commitment that scares off investors, who end up postponing the purchase of that dream house.

But with the savings on tax and rentals, the net outflow on account of the annual equated monthly instalments is not very steep, considering the fact that you are acquiring an asset.

For instance, if you were to take a Rs 2-million loan at 11.25 per cent, your interest outgo in the first year would be Rs 240,000. Total tax saving in the first year would amount to Rs 51,450. Here, the tax savings on interest paid is Rs 47,250 ( 31.5 per cent of Rs 1,50,000, which is the maximum limit that can be claimed as deduction) as well claim a rebate on the principal repaid that year.

You can claim a rebate at 20 per cent up to a maximum amount of Rs 20,000, and the effective tax saving on the principal every year, inclusive of surcharge, would be Rs 4,200 annually.

Therefore, your net outflow after taking account the tax savings would be only Rs 188,000. The effective cost of borrowing, therefore, turns out to be a lot lower for the consumer.

For calculating the effective rate, we've not considered the processing fees and administrative fees, since they vary from lender to lender and can be waived, if you employ some canny negotiating skills.

After accounting for the tax savings on your interest payments, the effective cost of borrowing has come down to 11.25 per cent from 7.71 per cent.

In addition, consider the annual savings on rentals. For instance, if you live in a rented one bedroom flat (about 550 square feet) in Andheri, a suburb in Mumbai, it would probably cost you around Rs 8,000, which means you save around Rs 96,000 on rent annually.

So the excess that you will have to pay after considering the savings on tax and rentals is only Rs 92,000 per year.

Besides, some experts argue that it is a fairly decent investment option as well. With most investment avenues starting to lose sheen, the equity markets listless, and the bond market unlike to provide the sizzling returns of last year, you can also look at investing in residential property to earn rental income.

Indeed, the easy availability of home loans, attractive tax breaks, combined with rental yields and the possibility of modest capital appreciation make property an attractive investment avenue.

If you have more than one self-occupied house, and if the notional income from a house for which a loan has been taken is subject to tax, then the interest paid on the loan will be fully tax deductible.

There are also no restrictions on the quantum of deduction if interest is being paid on loans taken to buy residential property that has been rented out.

Property experts say that you can expect an average rental yield of around 7.5 per cent in a city like Mumbai. After accounting for capital appreciation of at least around six per cent and interest payments, you can expect to earn a post-tax return of around 10 per cent -- which is still relatively more attractive than other investment options.

Considering the overwhelming benefits that accompany taking a home loan, it seems like now may be the right time to go house-hunting!

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There's no denying the fact that housing is a red-hot sector these days: after all, it's tipped to grow at a phenomenal 35 per cent per annum.

A lot of this industry's good fortunes can be credited to the liberal tax incentives doled out by the government in recent years. Riding on the back of these welcome tax breaks, housing finance companies have aggressively pushed their loan products.

The mouth-watering potential has beckoned even banks towards exploration and conquest: State Bank of India, the country's largest commercial bank, Standard Chartered and Citibank have all entered the fray, hoping to grab customers and topple leader Housing Development Finance Corporation off its high perch. And that is proving to be a good thing for consumers.

With the competition heating, players are trying their get one-up on the competition by offering lower rates. Product innovations are also taking place.

Many financiers are willing to go all out to keep their customers satisfied. For the borrower, all this is good news, but it also means that they need to be more informed about the changes happening around them to take full advantage.

That's why we bring you this exclusive issue on the housing sector. Our cover story tells you why it makes imminent sense for you to buy a house, and that too, through a mortgage.

In our second lead story, we analyse the HDFC stock. As it loses its near monopoly status, are best days over for the housing finance major?

Later in this issue, we offer a general perspective on the Indian real estate market. Contrary to what most people think, real estate prices aren't likely to witness any huge upswings in the near term. Industry experts say that real estate price cycles are rather long -- about 12-13 years -- and we have not yet reached that point from where a boom can be expected.

Nevertheless, as we suggest in our cover story, there is still a strong case to be made for investing in residential property, from the tax viewpoint.

For better readability, we've created separate sections for house hunters, home loan seekers and those who already own a house or have taken a house loan. We covers almost all key issues that are relevant for these three types of individuals. So welcome home!

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