Home Loan or Own Funds: A Classic Dilemma
By Joseph Samson
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Home loans having floating interest rates are generally considered to be a risky proposition in the present high interest rates regime. A borrower may or may not gain by selecting this option. Suppose, an individual decides to invest his own funds in a fixed deposit scheme, then it would be beneficial for him to avail only a fixed rate home loan, although, interest rates on even these loans are dependent on a bank's discretion. So, the possibility of increase in interest rates remains despite of choosing between fixed or floating interest rates.

To arrive at an accurate decision, the home buyer must compare the interest rates being paid on the home loan and the interest rates (or the expected earnings) earned if own funds are invested. For instance, at present even the cheapest home loan bargain will have an interest rate of 10.50%, while the highest interest rates offered on investments like fixed deposits would be 9.50%.  So, in this case, the interest on funds outflow is more as compared to the interest on funds inflow (i.e. paying 10.50% interest on home loan vs. earning 9.50% interest in FD). In such cases, when the return on income is lower than the interest rate on loan, it is a good idea to use own funds in buying a house.

On the other hand, if the percent returns earned on own funds is considerably more than paying interest on a home loan, then, an individual should go for a home loan instead of using his/her own funds. That is, suppose, the funds earn 17% annually from an investment, then, home loans interest rates being lower at 10.50%, one would benefit from availing a home loan instead.       

Another noteworthy factor would be the tax rebates that can be availed on home loans. However, one should remember that tax rebates on principle repaid amount is limited to only 1 lakh per annum as per the Income Tax Act Section 80C, and that on interest repaid amount is limited to 1.5 lakh per annum as per the Income Tax Act Section 24C. For those who have already invested in investment plans such as life insurance plans, on which they already avail the 1 lakh tax free rebate under Section 80C, rebate on only the interest component can be availed. This too, would be beneficial only in the beginning and may not matter in the later years for loans on which interest is being charged by reducing balance method.

At last, while making this decision, home buyers should remember that there is no one best solution to this dilemma. There are lots of calculations needed to be done from the point of view of income and income tax, to arrive at a suitable decision. The decision will always be case specific as any variation in any one of the four variables will alter the conclusions.

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Richelle Watford (Posted: Mar 25, 2015)
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