In India, buying a house is an important social milestone for a family. It is also a crucial financial decision as, on an average, house prices are 5.5 times the annual income. Considering the significant financial commitment involved in buying a house, the decision regarding funding it through borrowings or personal savings should be based on smart financial planning rather than on sentiments.
GOVERNMENT POLICY TO BOOST MORTGAGE INDUSTRY
Over the past couple of decades, successive governments at the Centre have tried to incentivise house ownership by providing tax benefits on home loan repayments, both for principal and interest components. The benefits have only increased over the years. Presently, a borrower can claim tax deduction of up to Rs 1.5 lakh for the principal component, and up to Rs 2 lakh for interest payment.
The current government has extended the credit-linked subsidy scheme (CLSS) under the Pradhan Mantri Awas Yojana (PMAY) to encourage families having annual income up to Rs 18 lakh to buy houses. Under PMAY, the government provides subsidy of up to Rs 2.67 lakh on borrowings by first-time house buyers.
Considering the cumulative benefits of tax deduction and PMAY subsidy, the effective interest rate on a housing loan of Rs 24 lakh taken at prime lending rate of 8.40 per cent per annum is a mere 0.34 per cent per annum. Contrast this with the average rental yield in top 12 Indian cities, which is around 3.2 per cent per annum. Hence, it makes considerable economic sense to buy a house with a housing loan rather than renting one, especially when property values appreciate over 5 per cent per annum in the long term.
LOAN PREPAYMENT: AN EMOTIONAL DECISION RATHER THAN A FINANCIAL ONE
India has traditionally been a nation of savers and has a deeply embedded culture of aspiring to be debt-free. Hence, most borrowers seek to accelerate home loan repayment using their disposable income. However, considering that the effective interest rate on a home loan is as low as 0.34 per cent per annum and the loan term is 20 years, it is financially beneficial for borrowers to invest their savings in long-term financial assets, which offer relatively higher returns than the effective housing loan rate.
INVESTMENT OPTIONS THAT OFFER BETTER RETURNS THAN HOME LOAN PREPAYMENT
Equities, government savings schemes and debt mutual funds are few options one can consider while looking to invest in Indian financial markets.
Investments in Indian equity market have generated 16 per cent annualised returns over the past 15 years, which is about 8 per cent higher than the inflation rate. Return generated from equity investments is one of the highest among various asset classes, and attract only 10 per cent tax if held for more than one year. However, there are no fixed or guaranteed returns in equity, and investors must be willing to accept fluctuations in the market. Investors who prefer limited risk can consider relatively safer avenues of investments such as government saving schemes or debt mutual funds.
Government saving schemes such as Public Provident Fund, Post Office Saving Scheme and Kisan Vikas Patra offer relatively lower returns than equities in the long term, but have near-zero risk to principal compared to equities. Moreover, contribution to PPF account is eligible for tax deduction, including the interest earned on contribution as well as the maturity proceeds. PPF has generated 8.2 per cent annualised returns over the past 15 years. Debt mutual funds have given an average return of around 9 per cent per annum, which is marginally higher than the return from government saving schemes, but lower than that from equity investments. Debt mutual funds, if held for more than three years, qualify for long-term capital gains tax with indexation bringing down the tax rate to below 10 per cent, thus delivering superior post-tax returns compared to fixed deposits.
FINANCIALLY LOGICAL CONCLUSION
It makes considerable financial sense to avail a home loan and buy a house than to rent one. And, considering the significantly higher returns from financial assets compared to the effective interest rate of 0.34 per cent on mortgages, it is not ‘home loan or savings’, but ‘home loan and savings’.
Hooda is deputy managing director, Indiabulls Housing Finance Ltd.