Properties, Homes & more

The Government of India (GOI) may modify the draft direct tax code to retain tax shelters on interest and principal repayments for home loans to make the proposed new code more attractive for the average Indian, a finance ministry official told The Economic Times. The proposed direct taxes code, which has been unveiled for public debate and is due to become operational from April 2010, does not provide tax incentives to loan-funded house purchases that are for personal use.

At present, taxpayers are allowed to deduct from their income the interest paid on home loans to a maximum of Rs 1.5 lakh every year. In addition, the repayment of the principal amount is also allowed to be included within the rebate available under section 80C, which has a maximum limit of Rs 1 lakh.

The draft code, billed as a comprehensive reform of the direct taxes regime, has suggested increasing the exemption limit under section 80C to Rs 3 lakh, but the list of eligible expenditure/savings does not include the principal payment. The code also restricts the interest deduction only to in respect houses rented out and where such income is included in the income of the assessee. At present, if a home buyer in the highest 30% tax slab were to avail the maximum tax exemption available on home loans then government loses over Rs 77,000 in tax.

The planned move to discontinue tax benefits for housing has faced widespread criticism and the finance ministry official said that they are looking at provisions (in the direct taxes code) that concern common man directly, including tax incentives to housing.

Banks say NO to uniform home loan rate cut

The contentious issue of “uniform home loan rates for old & new customers” cropped up when CEOs of large banks recently met senior RBI officials to suggest possible measures that the central bank could consider for the January 29 monetary policy. At the meeting, RBI deputy governor KC Chakrabarty reprimanded bank chiefs over their inability to pass on the benefit of lower interest rates uniformly to all customers - including old customers. It should be remembered that this has been a common practice among lenders that while they are slow to pass on a rate cut, they are quick to hike either the loan term or the EMI when rates go up.

Bankers argued that since the incremental cost of fund had softened, they could charge lower rates only to new customers while old customers had to pay more as old funds were raised at a higher cost. Countering this, RBI said that reduction in incremental cost of funds also brings down the average cost of fund for a bank which should then be in a position to offer the new, lower lending rate to old as well as new borrowers. Some banks even said that offering the same rate to all customers could spark legal feuds since interest spreads (over or below the PLR) varied from customer to customer, each of whom sign separate loan contracts with banks.

Cheaper home loans to old customers not feasible: IBA

Amid a debate over teaser rates, bankers have turned down the RBI’s suggestion to extend the cheaper home loans to existing customers saying that the move will impact their bottom lines. The IBA said if banks offer lower rates to old customers as well, this will affect their earnings as it is not feasible for them to change their deposit rates accordingly to compensate this loss of interest arising from such a move.

Banks will not withdraw prepayment penalty on forclosure

Competition Commission of India (CCI), the apex body that operates to sustain and promote competition, recently sent notices to atleast 15 banks, NBFCs and IBA seeking explanation on why they penalise borrowers who choose to foreclose loans. Many of these institutions have already replied to CCI, to make it clear that the removal of prepayment penalty will result in higher lending risk and may cause asset-liability mismatch in banks.

As I have written in my previous post: Beware of “teaser” home loans, I have mentioned that advisers are warning individuals against obtaining a “teaser loan” only because of the lower interest rate, as it could have serious impact on their finances if the interest rates were to shoot up when the floating rate kicks in after the initial years.

Although all prominent banks have introduced teaser home loan rates as they are flush with money due to lack of demand from companies for funds, the Reserve Bank of India (RBI) has taken a stern stand on this “bad practice” and have categorically asked all the participating banks to END TEASER LOANS. As reported by Economic Times, RBI is concerned mainly because borrowers may subsequently find it tough to repay the loans, once interest rates go up after the first couple of months (during which the rates are fixed at a fixed rate). I hope banks are ensuring that borrowers are well aware of the implications of such rates and the appraisal takes into account repaying capacity of the borrowers when the rates become normal. [Refer: RBI sees red over teaser home loan rates]

As per RBI’s directions, SBI will be terminating its teaser loans offers by March End, and HDFC will continue till end of February. However, ICICI Bank has immediately withdrawn all its teaser loan schemes. [Ref: Economic Times]

Suddenly, it’s raining home loans! Banks, which were, until recently, reluctant to open their purse strings to home loan customers, are busy chasing them with teaser rates - where the interest rate is kept lower in the initial few years.

However, advisers warn individuals against obtaining such a loan only because of the lower interest rate, as it could have serious impact on their finances if the interest rates were to shoot up when the floating rate kicks in after the initial years. All prominent banks have introduced teaser home loan rates as they are flush with money due to lack of demand from companies for funds.

Ideally, one should buy a house only because one needs it and can afford it. Lower interest rate shouldn’t be the reason one should be going for a housing loan. ‘Taking a decision on the basis of current interest rate wouldn’t be right and wise, especially if you are going to switch to the floating rate after the initial period. The reason is: the teaser interest rate may be only 8% or max 8.5% in the first year or for the first three years, but after the initial period is over, you would be paying prevailing floating rates, which is not so easy to predict. And it may not be in your favour as well!

A lot of people make (incorrect) assumption about the future rate on the basis of the current benchmark rates. This method of reaching indicative rate only proves to be costly for them in the long run. For example, because of some unforeseen events, if the interest rate hardens suddenly, people might find it difficult to service their home loan, as the EMIs could shoot up beyond their ability to take care of them. So take a very serious look at your cash flow & finances before opting for such a teaser loan.

A loan tenure is the duration of that loan. In case of housing loans, generally, the tenure is long. It may vary anywhere between five and 20 years. Most borrowers prefer to borrow for a longer period of time. The reason is quite obvious. The amount borrowed is quite large. Also, the amount of monthly repayment through equated monthly installments (EMIs) depends on the tenure of the loan – the longer the tenure, the lower will be the EMI and vice versa. On shorter loan tenures, the interest amount paid will be lesser as against the longer tenure loans, where the interest amount increases over time.

There are various factors that influence the determination of a loan tenure. The first factor is the income of the borrower. The disposable income of the borrower makes a lot of difference and is, usually, the deciding factor. The reason is that it is from this part of the income that a borrower will be repaying EMIs. So, if the net disposable income is low, it is advisable to go in for a longer tenure loan rather than opting for short tenure one (assuming the loan amount remains same). This way the EMI portion is reduced. The loan amount is spread over a longer period of time. The immediate burden on the borrower is lower. This is despite the fact that the borrower is required to pay interest through the extended period of borrowing – means higher interest being paid by the borrower.

The other factor is the amount of loan. The amount borrowed determines whether one should opt for a longer or shorter tenure. In case the amount borrowed is huge, the borrower may prefer to go for longer tenure. Generally, short tenure loans attract lower rates of interest as compared to longer ones. This is because banks can estimate the near-term interest rate movements more accurately as compared to movements in the long term. So, in case one has adequate liquidity and resources to repay the loan faster, it is advisable that he should opt for a shorter duration loan and thus take advantage of the lower interest rate.

Another factor that influences the loan tenure is the objective of the borrower. Whether a borrower is intending to take the loan to purchase a property for his own use or as an investment has a bearing. Generally, if a borrower is borrowing for the purpose of investing, he may just go for a shorter duration loan so as to avoid the exit charges payable in case of early termination of the loan, and to maintain liquidity of his capital.

Another important element to be considered is the future income of the borrower. In case the borrower is expecting an increase or reduction in his income, he has to decide on the tenure accordingly. For example, in case a person is to retire in another five years, he may look at a maximum of five years’ tenure, and may not like to stretch it beyond his retirement age. On the other hand, a 30-year-old can think of a longer tenure loan, stretching up to 15-20 years, because gradually his income would also be increasing. So, one may opt for a longer duration loan and reduce the present burden. None of these factors can be individually taken to decide on the loan tenure.

All these factors are interlinked and need to be analysed in totality so as to arrive at an ideal loan tenure.