Budget 2016: Does the extra deduction of Rs 50,000 for home-buyers really help?

In the budget speech finance minister Arun Jaitley made yesterday he said: “For the ‘first – home buyers’, I propose to give deduction for additional interest of Rs 50,000 per annum for loans up to Rs 35 lakh sanctioned during the next financial year, provided the value of the house does not exceed Rs 50 lakh.”

How much will this help? Let’s understand it through an example. Let’s take the case of a man borrowing Rs 35 lakh from the State Bank of India at 9.55% per year, repayable over a period of 20 years. The EMI for this works out at Rs 32,739.

Every time an EMI is paid, a part of the principal is repaid as well. And the remaining part goes towards the payment of interest. Hence, with every EMI paid, the principal amount of the loan that still needs to be paid comes down. This means with every EMI, the interest component of the EMI keeps coming down, and the principal repayment keeps going up.

In the first 12 EMIs, a total interest of around Rs 3.32 lakh is paid. Currently, only a deduction of up to Rs 2 lakh is available while calculating the taxable income on, when it comes to the interest paid on a home loan for a self-occupied property. Now a deduction of upto Rs 2.5 lakh can be taken to the condition the loan is upto Rs 35 lakh and value of property is not greater than Rs 50 lakh. Hence, this is a good move to that extent. For those in the top income-tax bracket of 30.9%, it means a tax saving of Rs 15,450.

Assuming the interest rate continues to be the same, how will things pan out. In the second year, the interest paid amounts to around Rs 3.26 lakh. The extra deduction of Rs 50,000 will continue to be available in the second year as well.

How many years is this extra deduction likely to be available? It will be available until the interest part of the EMI continues to be greater than Rs 2 lakh, the deduction which is already available, assuming the government continues with this provision in the years to come.

How long will this last? This will go on for 13 years. After that the interest being paid will fall below Rs 2 lakh per year and hence, this extra deduction of Rs 50,000 will be of no use. Given this, the tax saving will turn out to be reasonably good over a long period of time.

This move will help many people living in cities, which come after the metropolitan cities. It will also benefit those living in cities who are comfortable living on the outskirts.

Will it provide a fillip to the real estate industry? I am not so sure about that. Lack of money is not the only reason that people have stayed away from buying real estate. High prices continue to remain a huge issue. Another major reason is the inability of the industry to deliver a home on time. Further, a few builders have disappeared after taking on money from prospective buyers. All these reasons have kept the home-buyer away.

Also, it needs to be pointed out here that the finance minister could have done the cause of people looking to buy a home to live in even more good, by plugging a huge loophole in the Income Tax Act, when it comes to home loans.

On the self-occupied property, an interest of up to Rs 2 lakh can be claimed as a tax deduction. This limit applies only to the self-occupied property and not on other homes that a tax payer may choose to buy.

Any amount of interest paid on home loans can be claimed as a deduction as long as a “notional rent” is added to the income. We all know that these days “rents” are very low in comparison to the EMIs that need to be paid in order to repay the home loan. The rental yield (rent dividend by market value of the home) is in the region of 2-3%.

Even after deducting a notional rent, the interest component tends to be massive during the initial years and helps people with two or more homes, claim huge tax deductions.

This “deduction” has been used over the years by well-paid corporate employees to bring down their taxable income. Further, individuals who use this deduction benefit on two fronts—tax deduction as well as capital appreciation. Even if, the capital appreciation is not huge, such individuals are happy in claiming just the deduction than actually making money from an increase in price. Hence, they may not sell the flat, even in a scenario where prices may be falling.

While offering a tax deduction on a self-occupied property makes some sense, there is no logic to offering a tax deduction on a home, one is not living in. This “deduction” needs to be plugged immediately as it encourages speculation.

Jaitley could have done the cause of the prospective home buyer even more good by plugging in this loophole. But sadly that did not happen.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column was originally published on Firstpost on March 1, 2016