It is time of the year when tax saving stories start to make it to the front page of newspapers, as the finance minister gets ready to present the annual budget of the government of India.
Today’s edition of The Hindustan Times has one such a story according to which the “the government is considering hiking the tax deduction limit on home loan interest from the present Rs 1.5 lakh to more than Rs 2 lakh per annum.”
The story goes on to quote an expert to state that this increase in tax deduction will lead to an “increase the demand for housing units and have a multiplier effect on the economy through increased demand for steel, cement and labour.”
This is what we call kite flying of the highest order. Lets try and understand why.
Currently a deduction of upto a maximum of Rs 1.5 lakh is allowed for interest paid on a home loan. At the highest tax level of 30.9% (30% tax + 3% education cess) this means a tax saving of Rs 46,350 (30.9% of Rs 1,50,000).
Now let us say this is increased to Rs 2 lakh. At the highest tax level of 30.9% this would mean a tax saving of Rs 61,800 (30.9% of Rs 2,00,000). This implies an increased tax saving of Rs 15,450 per year (Rs 61,800 minues Rs 45,350) or Rs 1287.5 per month.
So basically what The Hindustan Times story really tells us is that people of this country will buy homes because they will save Rs 1287.5 more every month. But what it does not tell us is the amount of money they will have to spend to get this extra tax saving.
Let me throw more numbers at you. The story points out “The average home loan size has grown from about Rs 17 lakh about three years ago to close to Rs 22 lakh currently.” Let us consider a 20 year home loan of Rs 22 lakh taken at an interest rate of 10% (the actual home loan interest rates might be higher currently though).
The EMI (equated monthly instalment) on this loan would be Rs 21,230.48. Hence to get an extra tax deduction of Rs 1287.5 per month any individual taking a home loan would have to first spend Rs 21,230.48 which is 16.5 times more.
I guess people of India are clearly more intelligent than that. And I don’t see many people doing that.
People don’t buy homes to get a tax deduction. The average middle class Indian buys a home to stay in it. And for that to happen a couple of things need to happen. First and foremost real estate prices need to come down because only then will EMIs become affordable.
As The Hindustan Times story points out that three years back the average home loan size was Rs 17 lakh and now it is Rs 22 lakh. This has happened because home prices have gone up since then.
A home loan of Rs 17 lakh at an interest of 10% for a period of 20 years would mean an EMI of Rs 16,405.37. Hence, EMIs have gone up by around 29.4% in the last three years. And that makes it difficult for individuals looking to buy a home to live in.
The difference between the EMIs on a home loan of Rs 22 lakh and a home loan of Rs 17 lakh is around Rs 4825. This is 3.75 times more than the extra tax saving of Rs 1287.5 that would happen when the tax deduction limit on home loan interest goes upto Rs 2 lakh per year from the current Rs 1.5 lakh.
Also to get a bigger home loan one needs a higher income as well. Hence, an income required to get a Rs 22 lakh home loan is higher than the income required to get a Rs 17 lakh home loan.
So for people to start buying homes to live in real estate prices need to fall from their current atrocious levels. Whether that happens remains to be seen. As my paternal grandfather told me late last evening “roti kapda aur makaan ka daam kabhi nahi girta. (The price of food, clothes and houses never falls).”
The second thing that needs to happen for sales of homes to pick up is a fall in interest rates. At an interest rate of 8%, a 20 year home loan of Rs 22 lakh would imply an EMI of Rs 18,401.68. This would imply a lower EMI of Rs 2828.8 than at the 10% level.
In fact I have made all the calculations at the highest rate of tax of 30%. At lower rates of tax it makes even less sense to buy a home to get an extra tax deduction. Also, the average home loan in cities is obviously higher than the Rs 22 lakh used here. In cities, it is highly unlikely one would be able to buy anything for that kind of home loan value. Hence, the argument holds even greater value for cities where prices are much higher.
To conclude, the real estate market in India has been taken over by speculators looking to put their black money to some use. And currently it is these speculators playing a game of passing the parcel among themselves. Unless that breaks people won’t start buying homes, higher tax deductions notwithstanding.
This article originally appeared on www.firstpost.com on February 4, 2013
(Vivek Kaul is a writer. He can be reached at [email protected])