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I want to buy a new home

Author: Balwant Jain/Sunday, January 7, 2018/Categories: Cover Feature, Expert View

I want to buy a new home

The current generation is more focussed on money matters than earlier generations. Generation of our parents used to buy homes with their retirement money but it’s no longer the case in case of present generation. Buying a house seems to be the most important goal not only for the newly married people but also for those individuals who are earning but are single.  There must be many of you who are planning to buy a house in 2018. This article will help you to decide whether you should go for an under-construction property or buy a ready-to-move-in   house. This article will help you to understand how the home loan eligibilities are decided. This will also give you insights on whether to prepay the home loan or not.

Options to buy a house

You have two options to buy a residential house. Either you can book an under-construction house or you can buy a ready-to-move-in property. I strongly advise you to go for a ready-to-move in house rather than booking an under-construction house. There are various reasons for this advice.

Since the price difference between an under-construction property and a ready-to-move-in   house is substantial, people are lured in to go for an under-construction property without understanding the implication of the decision. There are various pros and cons associated with this decision.

Financial implications: The age old adage

“A bird in hand is better than two in bush”-   aptly fits into the current topic.  The decision to go for an under-construction property has many risks associated with it like the risk of default on the part of the builder in handing over the property in time.  You would have frequently come across various news reports suggesting delay in handing over possession by the builders to home buyers. Delivery of the property on time is an exception in many parts of India rather than a rule. Such delays range from a few months to 2-3 years.  According to real estate analytics firm Prop Equity, around 45% of real estate projects in Mumbai Metropolitan Region for which possession was to be given during 2011-2014 period were not delivered till April 2015. In some cases, delay was up to four years. The situation is even acute in National Capital Region, where around 78% of projects are running behind schedule. Similar is the case in many other regions of the country.

So in case you decide to go for a ready-to-move-in house, you do not carry this risk of delay and default from developer. You get instant gratification for the money paid by you. If you look at the activity around the redevelopment segment, you will find that every Tom, Dick and Harry has become a builder without adequate financial resources which often is the reason behind the delay. The delay can sometimes be attributed to litigation related to title of property.  Also, most of the people exhaust their present savings for paying the booking amount. Home buyers also commit their future savings in the form of EMI in a residential house, so it is not at all advisable to put your whole savings at risk in this manner.  Moreover, in case you are staying in a rented premise, your expenses on rentals continue while you are paying your EMI. This causes double whammy in case of delay. There are also instances where the home buyer had to sell his under-construction house due to difficulty in paying both rentals and EMI.

In contrast, if you buy a ready-to-move-in   house, your rental payments stop, in case you shift to the new house immediately after taking possession. As rentals stop, the EMI payments do not create much burden on your finances. Even if you do not shift to the new house, you can always let that out and part finances your EMI. People fail to appreciate that booking an under-construction property is nothing but lending money to the developer at higher rate of interest with accompanying risks of delay and default. With grim situation of the real estate sector, where many projects have stopped due to liquidity crunch, the prospects are very scary with probability of default of the developer going higher than earlier. This would get mitigated with introduction of RERA to some extent.

Taxation Implications

In addition to the general financial implications discussed above, there are also certain income tax implications in case you buy an under-construction property. With skyrocketing property prices and reduction in average age of home buyers, it is not possible for an average middle class family to own a residential house without resorting to housing loan. For housing loans taken for an under-construction property, the interest payable before getting possession is called pre EMI, which starts even before completion of the property. As per the  income tax provisions, you can claim income tax benefits for home loan taken for a residential house only after completion of construction of the property and taking  possession of the same. Though a limited deduction of Rs 50,000/ is allowed for loans up to Rs 35 lakhs taken during the financial year 2016-2017.  It may also be noted that in respect of the interest paid during pre-construction period, you can claim tax concessions for the same in five equal instalments beginning from the year in which possession is taken... In case of self-occupied house property, the maximum amount of deduction available for interest under Section 24(b) is restricted to Rs 2 lakh. So, in case the interest for the current period exceeds or is equal to Rs 2 lakh, you effectively lose your claim in respect of pre-EMI interest.

Moreover, if you sell the under-construction property before taking possession, you altogether lose the tax benefit in respect of the interest paid during this period.  Also, if you sell your house before five years of taking possession, you lose the claim on pre EMI interest for the balance years. There is another implication in respect of home loan taken for self occupied property if the possession of the property is abnormally delayed. It may be noted that the benefit of Rs 2 lakh with respect to interest under Section 24(b) on self occupied house property is available only if the construction is completed within a period of five years from end of the financial year in which the housing loan was taken. So, in case the construction of your house is not completed within five years  as stipulated,  your eligibility for tax benefit for home loan interest drastically comes down to Rs 30,000  for the residential house property. So, apart from the risks of delay and default, you also carry the risk of lower tax benefits in case of delayed delivery. However, there is no upper limit for interest deduction in case the house property is let out but the loss under the head ‘income from house property’ can only be set off against other incomes up to Rs 2 lakhs. Also, the unabsorbed loss shall be allowed to be carried forward for set off against income under the same head for next eight years. Moreover, repayment of home loan is eligible for deduction of up to Rs 1.50 lakh. This benefit is available only after you have taken possession of the property. So in case you have repaid part of the home loan during the construction period, you lose the tax benefit for such repayment forever as there is no legal provision for amortization of the benefits. 

Notably, Section 54 and 54F of Income Tax Act allow  exemption from tax on capital gains arising from sale of any asset held for more than 24 months if an individual  buys a house within two year after or one year before such transfer. An individual is also entitled to similar exemption in case he constructs a residential house within three years.  So, if the developer fails to complete the construction and handover the possession in the stipulated time period, you again carry the risk of paying capital gains tax.

Lastly, a ready-to-move-in   house will give you peace of mind than opting for an under-construction property.  So, take your own call after evaluating all the options based on your situation.

How do I plan to purchase my house?

The type of house which you can buy will depend on two factors. One is the margin money or down payment which you can deposit at the time of purchase and your income levels. For the sake of illustration, I am evaluating two scenarios here. As per the RBI and National Housing Bank’s directions, housing finance companies as well as banks are not allowed to lend beyond certain percentage of fair market value of the property, which is called as Loan to Value (LTV) ratio. This LTV ratio is dependent on amount of an applied for by the borrower. For loan amount up to Rs 30 Lakhs, you can get loan upto 90% of the value of the property. The LTV for loan between Rs 30 lakh and Rs 75 lakh stands at 80% and beyond Rs75 lakh, it is restricted to 75%. The home buyer has to take care of the cost of stamp duty and the registration charges.  In the light of this information, I would evaluate the amount of home loan you will get and the value of the house which you can afford. .

First scenario: I am 35 and I have a resource of Rs 12.50 lakh. 

Since you have Rs 12.50 lakh to pay as margin money as well as for stamp duty and registration charges, you would certainly be able to take a loan above Rs 30 lakh.  Taking into account these facts, you will be able to buy a property worth Rs 50 lakhs out of  which you will have to provide a margin money of 20% i.e. Rs 10 lakh and stamp duty and registration costs of  Rs 2.50 lakh.  Basing on the margin money payment, you will be able to get a loan of Rs 40 lakh i.e. 80% of the cost of the property excluding stamp duty and registration charges. You should opt for a home loan of 20 years tenure which is feasible as your age at the time of payment of the last instalment would be 55 years, well below 60 years of age mark. At the current home loan rate of 8.35%, your monthly EMI would be Rs. 34,334/-. Presuming the lender considers 50% of your income available for servicing the home loan, you need to have a monthly income of Rs 70,000/- i.e. an annual income of more than Rs 8.50 lakh. So in addition to having a saving of Rs 12.50 lakh, you need to have an annual income of  around Rs 8.50 lakh to be able to buy a house of Rs 50 lakh and service the home loan of Rs 40 lakh with ease.

Second scenario: I am 45 and I have a resource of Rs 20 lakh to shell out. 

Since you have Rs 20 lakh to pay as the margin money and stamp duty and registration charges, you will be able to buy a property worth Rs 85 lakh... Reducing the amount of margin money of Rs 16.15 lakh, the balance amount i.e. Rs 64.60 lakh would have to be financed by way of home loan. Since you have already completed 45 years and presuming a retirement age of 60 years, you will get a home loan for 15 years tenure. At the current home loan rate of 8.35%, your monthly EMI will come to Rs. 63,047/-.  Presuming the lender considers 50% of your income available for servicing the home loan with no other loans running, you need to have a monthly income of Rs 1.25 lakh i.e. an annual income of more than Rs 15 lakh which looks reasonable at your age.

Should you prepay your home loan?

While evaluating the home loan eligibility, let us also discuss about prepayment of this loan in the future.  Generally, when a person takes a home loan, he takes into account his current income and accordingly applies for the loan amount... However, as incomes group, the borrower generally accumulates some surplus. Such borrowers face the dilemma of whether to prepay their home loan or not.  Let us discuss all the factors which affect your decision to prepay your home loan.

Cost of prepaying home loans: The lenders generally charge some prepayment charges if you prepay any home loan. The quantum of such charges is dependent on the agreement executed by you with the lender. Such charges normally vary between 2% to 4%. Some of the lenders do not charge you any prepayment penalty. As per a circular issued by the National Housing Bank, which governs all the housing finance companies, the housing finance firms have been advised not to levy any prepayment penalty if the home loan is given under floating interest rate.  In case of fixed rate home loan scheme, if the borrower has repaid the loan from his own resources, the housing finance company still cannot charge any prepayment penalty.  For this purpose “own Resources” means any source other than shifting the home loan to any other lender. Likewise, the RBI has also advised all the banks not to levy any prepayment penalty on all kinds of loans taken under floating rates. So in case you have taken the home loan under fixed rates and prepay it from your own resources, the banks can still charge you prepayment penalty.

One can prepay the loan fully or partly depending on the funds available. Lending institutions normally do not charge any prepayment penalty if the amount prepaid does not exceed certain percentage of the loan outstanding at the beginning of the year, which is generally 25% of the outstanding amount. So in case you are prepaying partly within the limit of 25% during a year, you can do so without having to pay any penalty.

Tax considerations: The decision to prepay the home loan is also dependent on the impact of such repayment on your eligibility to claim interest deduction under Section 24(b). In case the property is self occupied, you are allowed deduction only up to Rs 2.00 lakhs of interest. So if any part prepayment does not bring down the amount of interest below Rs 2.00 lakh, it will not have any impact on your tax liability. However, if the property is let out, the decision would be different as entire interest payment was fully tax deductible till last year. But from current year onward, the total loss under the head “income from house property”, which can be set off against other income, would be restricted to Rs 2.00 lakh for all the properties taken together. So, evaluate the tax impact due to reduction in interest outgo before prepayment. .

Fund requirement in future: You should take the decision to prepay the home loan only after taking into account the requirement of funds in the near future for any purpose including contingencies. So, your decision whether to prepay and how much to prepay should be based on both these considerations because the home loans are available at relatively cheaper interest rates than other loans like personal loans and gold loans. 

Returns expected from alternative investment avenues available: While evaluating the option of prepayment of the loan, please consider the alternative options available for deployment of your surplus funds. In case the returns expected on such investments are similar, it is advisable not to prepay the loan. One such alternative avenue available for investment is bonds or bond funds scheme of mutual fund houses. The other alternative may be investing the money in equity oriented schemes of mutual funds in case the money can be invested for more than 10 years as the returns on equity oriented funds have been generally far better than the rate of interest on such home loans for such long tenure. While computing the returns from alternative avenues, you need to compare the post tax rates in both the cases so as to arrive at comparable numbers.

So there are many factors which you need to evaluate while taking the decision of prepayment of your home loan. However, there is one psychological factor which also plays its role. People of old school of thought do not want to have any debt on their place of residence and want the house to be debt free. This psychological reason plays a significant role in prepayment of home loans in India.

So the decision is yours whether you belong to the old school of thought or the other. .

In case you wish to prepay the home loan before its original tenure, you have two options. Either you can start a systematic investment plan (SIP) in equity fund with the surplus money. As your salary goes up with time, you can increase the amount of SIP. As and when the value of your investments in such SIPs matches the amount of the loan outstanding, you can redeem the investments in equity funds, after taking into account the exit load and tax implications and foreclose the home loan.

The second option is for the people who do not have much of patience. You can use the surplus money which is not immediately required to prepay the home loan and your home loan will get squared up before the original tenure. In my opinion, the first option is better as the returns generated by the investments in equity funds in the longer run are better than the interest you pay on your home loan.

Now I am sure you are in a position to decide whether to go for under-construction property or opt for a ready-to-move-in   house. This discussion will also help you understand how much home loan you can avail for your dream house planned in the year 2018. You are also in a position to weigh various options before prepayment of your home loan.    

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Balwant Jain
Balwant Jain

Balwant Jain

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