Home Loan Vs Using Own Funds To Buy A Home: How To Do The Math

Not all buyers require the assistance of housing finance to make property purchases. For them, applying for a home loan is more of a tax-and-money-saving exercise. With interest rates coming down to record lows and the government increasing the tax deduction limit on loans meant for homes below Rs 45 lakhs, it makes perfect sense for buyers to avail housing finance, to enhance their gains. However, this is not the only reason why this category of buyers should apply for home loans.

The thumb rule of financing a home purchase

Here is the basic rule buyers must follow.

*If interest earned on deposits is higher than the interest paid on home loan, apply for home loan. 

*If interest earned on deposits is lower than the interest paid on home loan, use your own funds.

Suppose you are paying eight per cent annual interest on your home loan. Applying for a home loan would make sense only if you are getting a similar rate on your deposits. You also need to factor in tax benefits here.

How to calculate tax gains:

 Now, here is what you should do.  

*Calculate your interest income i.e. the amount you have earned from FD interest, after paying taxes.

*Calculate the total interest that you have to pay on your home loan every year.

*Calculate the tax benefit you would receive on the interest paid on your home loan.

Note here that if you have opted for a home loan for a unit priced below Rs 45 lakhs, you can claim tax benefit on interest repayment of Rs 3.5 lakhs. For property priced above Rs 45 lakhs, the tax payer can claim up to Rs 2 lakhs rebate.

*Calculate the net benefit of taking the loan by evaluating the total tax benefit you would enjoy on interest payment during the entire tenure. Also factor in the fact that though in the initial years of repayment, the interest outflow will be higher and will reduce subsequently, as you will be repaying larger portions of the principal.

Now, you can compare the interest income after tax and the net benefit of taking a loan.

For instance, if you take a Rs 25 lakh loan at eight per cent interest for 20 years, your total interest outgo will be Rs 50.18 lakhs, when you factor in the tax benefits. However, if you put the same amount in the FD for 20 years, which earns eight per cent interest annually, your maturity amount would be Rs 1.23 crores. That means an interest income of Rs 98 lakhs.

A home buyer needs to understand that the compounding interest received for parking the funds in an FD will create a huge difference. The total FD returns over a 20 year period would amount to a significant money inflow compared to the loan that you need to take and pay an approximate total loan cost (principal + interest).