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Introduction to Home Loan
Buying a home can be a dream for many people. However, it can be extremely expensive to purchase or build a house. Banks offer home loans at attractive interest rates to appeal to home buyers.In fact, home loans are an exception amongst other loans where it is not recommended to pre-close a home loan. This is because the additional funds that would go towards pre-closing a home loan could be invested to accumulate higher returns. At the same time, there are many tax benefits around home loans that can reduce the tax burden of taxpayers significantly. Therefore, it may be beneficial to continue repaying the home loan instead of foreclosing it.However, before opting for a home loan , home buyers should be aware of the terms and conditions as well as every component of their home loan to make sound financial decisions.
What are the most integral components of a home loan?
- Amount borrowed: This is the total home loan amount that the home buyer has borrowed. It is typically between 75% to 90% of the value of the home, depending on the credit score of the borrower and other aspects.
- Tenure of the Loan : This is the duration during which the home buyer will be repaying the loan.
- Interest Rate: This is the rate of interest on the amount due. It is a charge on the amount of the loan that is due.
- Repayment Schedule: This will help home buyers assess how much they will have to repay throughout the tenure of the loan.
- Principal: This is the portion of the instalment that goes towards reducing the amount borrowed. Let's understand this with the help of an example:
Let's assume a home buyer purchases a house worth Rs. 60 lakhs by taking a home loan of Rs. 50 lakhs. The tenure of this home loan is 20 years while the interest will be 7.5% per year. As per the repayment schedule, the monthly instalments are of Rs. 40,280 per month. These monthly instalments will have two components - interest amount and principal amount.The principal amount reduces the amount borrowed, which is the most essential part of taking a loan. A loan is considered repaid only when the amount borrowed is returned. The interest amount does not reduce the amount borrowed. It is simply a charge given to the home loan provider for providing a lump sum amount now that the borrower can repay slowly over 20 years. Also Read: Top 5 Ways To Reduce Home Loans Burden
How is the Principal Amount Calculated Every Month?
The home loan providers (lender) develop an amortization schedule which gives the installment-wise split of interest amount and principal amount. Typically, the interest amount is higher during the first instalments because the interest amount is computed on the amount due. It will progressively reduce as more and more principal is repaid.At the same time, the principal amount progressively increases as more and more instalments are repaid. Any additional amount paid towards partially closing the home loan will be considered as a principal amount repayment and will directly reduce the amount due. However, foreclosing a loan is not allowed by all home loan providers, and the borrower must carefully assess the terms and conditions for any additional charges that the lender may levy if the borrower chooses to foreclose the home loan .
Tax Benefits Related to Home Loans
The Income Tax Act offers many tax benefits for homeowners who have taken a home loan. These benefits are split between the principal amount and the interest amount.The principal amount portion of a home loan is only tied to one tax benefit. Individuals who have taken a home loan can get a deduction under Section 80C up to Rs. 1,50,000 or the actual principal amount paid annually, whichever is lower.However, Section 80C is a combination of many tax benefits like EPF contributions, interest on fixed deposits, life insurance premiums paid and many more. The maximum deduction that a taxpayer can claim under Section 80C is Rs. 1.5 lakhs. Therefore, if a taxpayer has other tax benefits as per Section 80C and pays the principal amount of the home loan, the taxpayer will have to aggregate all these tax benefits and cap it at Rs. 1.5 lakhs as per the regulations of Section 80C.This is the only deduction available for the principal amount of a home loan instalment, whether the property is rented out or self-occupied by the home buyer. However, the interest amount is tied to many other tax benefits that the taxpayer with a home loan can take leverage to decrease the total taxable income.
FAQS - FREQUENTLY ASKED QUESTIONS
What is the formula for calculating the principal amount of a home loan ?
The amortization schedule is created by the home loan providers, and it contains the details of the principal amount and interest amount components in the monthly instalments. The principal amount portion in an instalment tends to increase as the tenure of the home loan progresses because the interest is charged on the amount due, which keeps progressively reducing as the loan is slowly repaid. In order to assess the principal amount of a home loan, the home buyer can check the amortization schedule. The principal amount will be the total monthly EMI minus the interest amount of each month.
What other tax benefits can a taxpayer with a home loan get ?
Apart from the tax benefit on the principal amount of the home loan under Section 80C, a taxpayer with a home loan can also get tax benefits around the interest amount of the home loan. These are claimed under Section 24B, which falls under the income head of income from house property. Other Chapter VI-A deductions on the interest amount can be claimed under Sections 80EE and 80EEA based on eligibility. The Government also launches schemes for homeowners from time to time, like the Pradhan Mantri Awas Yojana, which gives additional benefits to first-time home buyers.
What are the eligibility criteria for Section 80EE and Section 80EEA ?
Section 80EE allows income tax benefits only on the interest amount components of the home loan. This loan has to be availed from a recognized financial institution. As per the regulations of Section 80EE, a deduction of up to Rs. 50,000 can be availed per financial year. This deduction can be availed every year until the entire loan amount has been repaid.
Only individuals are eligible for deductions under Section 80EE. This means that HUF (Hindu Undivided Family), AOP (Association of Persons), any other kind of taxpayer or a company cannot claim any benefits from this section.
Section 80EEA was introduced by the Government with the objective of providing 'housing for all'. This allows a tax benefit for low-cost housing loans that were taken between 1st April 2019 to 31st March 2022.
Under section 80EEA, only individuals can avail of deductions. Any company, partnership firm, HUL (Hindu Undivided Family), AOP (Association of Persons) or any other kind of taxpayer cannot claim benefit under Section 80EEA.
Here, a deduction for interest payments up to Rs. 1.5 lakhs can be availed. The stamp value of the house against which the loan is taken should be Rs. 45 lakhs or less. The individual should only own this one house on the date of the sanction of the home loan.
Can a taxpayer claim deductions under Section 24B and Section 80EE ?
Section 24B and Section 80EE of the Income Tax Act can be claimed together in a financial year only if the taxpayer satisfies the individual conditions of both sections.
Section 24B can be availed for purchasing, repairing, or reconstructing homes. The tax benefit is only available on the interest component paid during the financial year. The deduction limit on home loan interest is Rs. 2 lakhs. If the property is let out, the entire interest amount portion can be claimed as a deduction. The benefit is available even if the house is rented out to someone else or occupied by the taxpayer. However, to avail of this deduction, the taxpayer should be the registered owner of the house and have the home loan in their name. In the case of a joint property where there are two owners, both can benefit by claiming a deduction of Rs. 2 lakhs.
Section 80EE allows a deduction of Rs. 50,000. This loan should have been sanctioned only between these dates - from 1st April 2016 to 31st March 2017. It is applicable on residential house property. This should be the first home purchased by the buyer. The total value of the house should not exceed Rs. 50 lakhs and the home loan amount should not be more than Rs. 35 lakhs. The benefits can be availed till the time the home repayment is not entirely paid.
The tax benefits of Section 24B and Section 80EE can be taken in the same financial year. First, the Section 24B limit has to be exhausted, and the balance can be claimed as a benefit under Section 80EE.
For a property which is under construction, Section 24 tax benefits can be availed only if the house is built fully and occupied within 5 years. If this condition is not met, then the maximum tax deduction is reduced to Rs. 30,000 only. Benefits of Section 80EE will not be allowed in such a case.
Is the amount borrowed also called the principal amount of a home loan ?
Yes, the initial amount borrowed from the banks is called the principal amount of a home loan. The principal amount of a monthly instalment goes towards reducing this amount borrowed. The principal amount always refers to the amount of funds borrowed/repaid without the additional charge of interest.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
