Factors To Be Considered Before Taking A Home Loan : Monthly Expenses, Income Tax Benefits, Down Payment And Prepayments

Rajeev is a 28-year-old salaried professional, earning a net monthly salary of Rs 55,000. He stays in a house at a rent of Rs 10,000 per month. But recently Rajeev has decided to buy a house for himself and found his dream house which is worth Rs 41 lakh. However, he is not sure whether the pricey home is within his budget. He has a ready cash of Rs 6 lakh for down payment. So, what is the loan amount for which Rajeev is eligible? Let us find out with the help of following steps:

Rajeev's Monthly Income and Expenses

Let us take a look at Rajeev's total income and expenses in a month.

• After deducting total expenses from the income, Rajeev has around Rs 38,000 left with him.
• Banks use Instalment to Income ratio, also known as Debt Servicing ratio, to decide the loan amount for an individual. The ratio is usually in the range of 35 per cent to 65 per cent, depending upon the individual's credit history.
• Since Rajeev's other expenses are monthly household expenses, they will not be recorded. But banks will know about the auto loan through CIBIL report and they will factor the amount while calculating Rajeev's loan eligibility.
• Provided the credit history of Rajeev is clean, a bank can consider 60 per cent of Instalment to Income ratio for him, hence, the maximum allowable EMI would be Rs 31,800.{60% of (Rs 60,000 – Rs 7,000 = Rs 53,000) i.e. Rs 31,800}.
• Apart from the EMI, Rajeev needs to pay home maintenance charges, insurance and municipal taxes on a monthly basis, a total expense of Rs 5,000 per month.
• Moreover, the net income in the first year will increase to Rs 60,548 per month on account of tax benefits arising out of the principal and interest payments. For a detailed salary analysis post home loan, please click on Salary Analysis.

Tax Benefits on Home Loan Payments

• Presently, Rajeev's gross salary is Rs 8.12 lakh per annum while his take home comes to Rs 55,000 per month after deducting all taxes as shown in Table 1.
• However, under Sec 24(b) of the Income Tax Act, interest paid on a home loan is tax deductible up to Rs 1,50,000 while principal paid up to Rs 1,00,000 is tax deductible under Sec 80C. Hence, Rajeev's monthly inflow would increase significantly, almost by Rs 5,500 per month. (Refer Table 2)

Calculating the Maximum Loan Amount

With an EMI of Rs 31,800, the different tenure and interest rate options available to Rajeev are as given in Table 3.

Initial/Down Payments

• Rajeev has stashed aside Rs 6 lakh for down payment.
• These days, most banks/financial institutions provide loans only up to 80-85 per cent of the property value. So, Rajeev will need 10-15 per cent of the purchase price of the house (i.e., Rs 41 lakh) or around Rs 5-6 lakh as down payment.
• Apart from this, Rajeev will also need some amount towards brokerage, home shifting, furnishings, etc., which may amount to Rs 1-2 lakh. So, Rajeev may require a total of Rs 7 lakh in hand.

What Are the Risks Involved?

• Economic uncertainty
  Economic slowdown has hit the world hard. Moreover, the recession has worsened the situation, putting many jobs in danger. Keeping these things in mind, Rajeev needs to build a contingency fund to finance his liabilities for three months before he could find another job, in case he loses his job.
• Increase in interest rates
  Interest rate on Rajeev's loan is fixed at 9 per cent and the loan is linked to his present income. Hence if there is a sudden increase in the rate it would directly affect Rajeev's finances. But he can squeeze through by paying the increased EMI from the difference amount he would get from the tax benefits.
• Decrease in salary
  Economic uncertainties and downturn can force companies to trim their input costs including employees' salary. Rajeev could face the same situation.
• Unforeseen events
  Unforeseen events such as sudden death or permanent disability can create problems in repayment of loan. Rajeev should consider buying home loan insurance so that his family members do not have to worry about their finances if something untoward happens.

Prepayment Always Helps

Prepaying the loan will be a wise decision for Rajeev. In a part prepayment, the tenure will drop which in turn will reduce the EMI for Rajeev. In case of a total prepayment, even after paying a penalty of 2 per cent Rajeev would be able to save some money. Considering a 5 per cent annual increase in his salary, the auto loan of Rs 7,000 to continue for 7 years, EMI remaining constant for the complete tenure and expenses increasing at a rate of 8 per cent, Rajeev's total savings accumulate to Rs 26.82 lakh at a moderate rate of 6 per cent. Click here for details Cash Accumulated

So, Rajeev can consider prepaying the remaining principal from the accumulated savings of Rs 26.82 lakh. This move will help him save Rs 12.93 lakh in interest in the next 10 years. Check the table given below:

Finalising the Deal

• Rajeev would get a loan of Rs 35 lakh on a Rs 41-lakh property, and has no problem in paying the down payment of Rs 6 lakh.
• At the current interest rate of 9 per cent, Rajeev can afford to take a loan of Rs 35 lakh for tenure of 20 years. His EMI will be stipulated to Rs 31,800.
• Rajeev needs to arrange another Rs 1 lakh from additional resources for expenses towards brokerage, home shifting, etc., or else he can negotiate with his bank for raising his loan amount to Rs 36 lakh.