Is Taking a Home Loan for the Long Term Worth It?
When considering a home loan, one of the most crucial questions to ask is whether taking out such a loan for an extended period is wise. While many argue that long-term loans can help manage monthly payments, there are significant drawbacks to consider, particularly concerning the amount of interest paid and potential tax savings.
Implications of Long-Term Home Loans
Usually, taking a home loan for a prolonged period means paying significantly more in interest than the original property value. This is because, over time, the interest compounds, and the total amount paid towards the loan more than doubles the initial cost. For instance, on a home loan of Rs. 10 million with a 15-year term at a 7% interest rate, the total interest paid would be approximately Rs. 6 million, making the total cost of the property Rs. 16 million. This is equivalent to 60% of the original property value.
Myth of Tax Exemption
It's often claimed that taking out a home loan can provide tax benefits. However, this claim is based on a misconception. Taking a home loan to save tax doesn't make financial sense when you consider the overall cost. For example, under Section 80E of the Income Tax Act, you can claim an interest deduction of up to Rs. 1.5 lakh, but the interest rate is typically around 7-8%, and with an annual loan of Rs. 10 million, the interest would amount to around Rs. 0.7-0.8 million. To save Rs. 5, 20, or 30,000 in tax, you would have to pay about Rs. 100,000 more in interest. This does not make a significant financial difference, and the interest savings are negligible compared to the total cost of the loan.
Investment vs. Loan Reduction
Instead of extending the term of a home loan to reduce monthly payments, it is wiser to focus on closing the loan as soon as possible. This approach allows you to save more interest and use the same amount of money to invest in other tax-saving options, such as the Equity Linked Savings Scheme (ELSS), Public Provident Fund (PPF), or other retirement plans. For instance, if you invest the same amount you would pay in interest annually into ELSS, which historically yields returns of around 12%, you could build a substantial retirement corpus over time.
Tax Benefits and Loan Tenure
For income tax assessees, taking a home loan for a maximum 30-year tenure is a sound financial decision. During this period, declining interest rates and tax benefits like Section 80C for principal repayments and Section 80E for interest can make the loan effectively interest-free. Over a longer period, the effect of interest rate declines means that the effective interest rate charged on your loan decreases significantly, making the loan cost-effective. Additionally, the interest on home loans is deductible under Section 24 of the Income Tax Act, providing further financial relief.
However, it's crucial to strike a balance between affordability and long-term financial health. While a 30-year loan might seem attractive, it's important to ensure that you can comfortably shoulder the monthly instalments and have a buffer for unexpected expenses.
In conclusion, while taking a home loan for the long term might seem like a good idea, it is more beneficial to prioritize shorter loan terms and use excess funds to invest in tax-saving instruments. This approach not only reduces the total cost of the loan but also enhances your financial well-being in the long run.