Home loan forms an important factor when considering the dream of owning a dream home. But for most, it requires the assistance of a home loan. While taking a home loan, it’s crucial to understand the finer details to make informed financial decisions. This blog delves into the key aspects of a home loan, including EMIs, interest components, and tax deductions.
Equated Monthly Installments (EMIs) – Striking a Balance:
When you avail of a home loan, you enter into an agreement to repay with interest over a specific period. The EMI, or Equated Monthly Instalment, is the fixed amount you pay every month towards the loan. It comprises both the principal amount and the interest component, but these proportions are not equal.
In the initial years of your loan tenure, a significant portion of your EMI goes towards paying the interest. While the repayment of the principal amount is relatively small. As time progresses, the balance tips, and more of your EMI starts contributing towards repaying the principal.
Understanding the Interest Amount – A Crucial Consideration:
It is essential to grasp that all loans, including home loans, are front-loaded. This means that during the early years of repayment, the lender recovers a substantial portion of the interest before recovering the principal amount. As a result, the interest paid is often significant, especially at higher interest rates.
For instance, let’s consider a scenario where you take a home loan of Rs 80 lakh at an interest rate of 8.5% for 20 years. At the end of the loan tenure, you would have paid a whopping Rs 86.62 lakh in interest on the initial loan amount of Rs 80 lakh.
The Impact of Shifting Loans and Tax Deductions:
As you progress through the loan tenure, it might be tempting to shift your loan to another financial institution offering a lower interest rate. However, it’s essential to weigh the pros and cons before making such a decision. By the later part of the loan tenure, most of the interest has already been paid, and shifting the loan could mean starting the interest payment process from scratch. It’s crucial to analyze the potential savings against the cost of initiating a new loan.
Additionally, the Indian tax regime plays a role in the decision-making process. Deducting interest payments for income tax purposes has been a beneficial practice for many borrowers. However, with the introduction of a new tax regime, this deduction might not be as advantageous if the total deductions are less than Rs 3.75 lakh in a financial year. Before making any decisions based on tax deductions, it’s advisable to consult with a financial expert.
Investment vs. Home Loan Repayment:
You must also consider the opportunity cost of a home loan. Instead of using the EMI amount to repay the loan, you might consider investing it at the same rate of interest (8.5%). If you invested the EMI amount of Rs 69,426 per month over 20 years, your maturity corpus would amount to an impressive Rs 4.18 crore. This comparison highlights the significance of making a well-thought-out decision when it comes to buying a home through EMIs.
Taking a home loan is a significant financial commitment, and understanding its various components is essential for making informed decisions. Be aware that a major portion of the EMI is front-loaded towards interest payments in the initial years. Shifting loans and tax deductions should be carefully considered to avoid unnecessary financial burdens. Moreover, it’s essential to weigh the pros and cons of investing versus repaying the loan to ensure you are on the right track to meet your financial goals.
Consider your current financial situation and long-term objectives. Make the decision of buying a house on EMI wisely. Before making any major financial decisions, it’s always prudent to seek advice from a qualified financial advisor who can guide you through the complexities of home loans and help you chart a path toward a secure and prosperous future.