Tax planning tool 

The current tax rules offer the following tax breaks to individuals who take a loan to fund the Purchase of a Home:

    Actual interest paid each year will be deduction from taxable income.
The maximum deduction allowed in this category is Rs. 75000 p.a.. Remember that only a part of the monthly installment goes towards interest cost. This component is high in the initial years but will gradual fall over the period of the loan. Thus, you may not use the full tax break of Rs. 75000 in the later periods of the loan though you continue to pay the same EMI amount each month.

e.g. Let EMI = Rs. 10,000 per month

Then total repayment is Rs. 1,20,000 per annum

Out of this let us assume that the interest repayment is Rs. 65,000 (the remaining Rs.

55000 has gone towards repaying the Loan principal)

The tax break allowed on Interest repaid is Rs. 65000

If the person’s taxable income in that year was Rs, 5,00,000 then the taxable income falls

to Rs. 4,35,000 ( which is 5,00,000 less 65,000)

He saves a tax of 33% of Rs. 65,0000, which is equal to Rs. 21450

2. Tax break on principle payments:

There is a direct tax saving of 20% of the loan principal that you have repaid in a year. However, there are two limitations to this:

      The maximum tax saving that you can claim in a year is Rs. 2000.
b) This saving is a part of savings under Section 88. The total tax saving per annum allowed under Section 88 is Rs.12000. If you have already claimed the full Rs. 12000 p.a. allowed under Section 88 through investments in approved Mutual Funds, PF,Insurance premium payments, you will not be allowed to claim this deduction. The best way to check your eligibility under Section 88 is to add up your annual proposed investments in Approved Mutual Funds, PF and Insurance premium payments that you will make and take 20% of the total. If there is a gap between this value and Rs. 12000, you can use the tax break on Loan Principal repayment. e.g. 

Assume that total investments in Mutual Funds, PF contributions

and insurance premium Rs. 55000.

Tax deduction under Section 88 : (20% of Rs. 55000) Rs. 11,000

Unused tax break under Section 88: Rs. 1000

( Rs. 12,000 less Rs. 11,000)

You can avail off this using the Housing Loan monthly payments as shown below:
 
 

Assume that your loan principal repayments is : Rs. 4000

The tax break you can claim under Section 88: ( 20% of Rs. 800). Rs. 800

Unused tax break: (Rs. 1000 less Rs. 800) Rs. 200

You can fully utilise this by taking a larger loan or reducing the period of the loan.
 
 

 The TPT decomposes the EMI amount into annual interest and principal repayment amounts. It then calculates the tax break that you get on each component based on you tax bracket and the extent to which you have already availed tax breaks under Section 88. You can construct various scenarios for loan amounts, tenure and tax break levels to see how your Total Post Tax Effective Cost (TPTEC) changes for each company that you are exploring.

Keep in mind that the tax breaks provided by the Government on Housing Loans can be availed only to the extent that the client actually repays as the interest and principal component each year. The Government will continue to make these tax breaks more attractive. Last year the tax break on the interest component was just Rs. 35000 p.a. This increased to Rs. 75000 p.a. in the FY2000 Budget. Going forward, we expect this tax break to move up progressively to Rs. 1.5 lacs over a 3-4 year period. If you have locked yourself into a 15 year loan, without due consideration, you might find that the changed tax benefits are being used sub- optimally. Please spend some time constructing various scenarios to help your client reduce the overall cost of the loan – and always use the Total post tax effective rate (TPTEC) to compare loan costs.

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