Should you invest your money or use it to prepay home loan?

Source: The Economic Times

If you have an outstanding home loan, and happen to have just received an annual bonus or any other lump sum payment, should you use it to prepay your loan? Or, should you invest it to meet some other goals? Assess the following conditions to arrive at the right decision.

The first variable to be considered is psyche: some people may not be comfortable with a large housing loan and to reduce their stress they may want to get rid of the loan burden at the earliest. For them, settling the question of how to use their bonus is simple: just pay off the loan. Gaurav Mashruwala, Sebi-registered investment adviser, categorically states: "You should pay off the home loan at the earliest. Several unfortunate happenings— job loss, death of the earning member, serious illness, etc—can cause trouble during the 10-15 year loan period. Treat it as a mind game and not a numbers game."

Tax benefit is the next variable. If a home loan does not seem like the sword of Damocles hanging over your head, it makes sense to continue with the regular EMI schedule. This is because of the tax benefits that a home loan offers. The principal component of the EMI is treated as investment under Section 80C. The interest component is also deducted from your taxable income under Section 24. The annual deduction in respect of the interest component of a housing loan, for a self occupied house, is limited to Rs 2 lakh per annum.

You won't be able to claim deduction on interest paid above Rs 2 lakh. So, if your annual interest outgo is higher than Rs 2 lakh, it makes sense to prepay the loan, and save on future interest payment. For example, the annual interest on a Rs 70 lakh outstanding loan, at 9.5%, comes out to be Rs 6.65 lakh. After taking into account the Rs 2 lakh deduction under Section 24C, the interest component will fall to Rs 4.65 lakh, and bring down the effective cost of interest from 9.5% to 8.64%, even for the people in the 30% tax bracket.

You can, however, optimise the tax benefits if the loan has been taken jointly, say, with your spouse. "If joint holders share the EMIs, both can claim Rs 2 lakh each in interest deduction," says Harsh Roongta, Sebi-registered investment adviser. In case of joint holders, there is no need to prepay if the outstanding amount is less than Rs 40 lakh.

There is no cap on deduction in lieu of interest paid on home loan, if the property is not self-occupied. "Since there is no cap for interest on loan against second or rented out homes, there is no need to prepay it," says Naveen Kukreja, CEO and Co-founder, Paisa Bazaar. Bear in mind, by prepaying your loan, you may also forego future tax benefits. For instance, if by prepayment, you bring down your outstanding loan amount to Rs 20 lakh, your annual interest outgo for subsequent years may fall below Rs 2 lakh. Thus, you won't be able to avail of the entire tax-deductible limit and, in such a scenario; prepayment may not be a good strategy. Also, building an emergency fund, if you don't have one, should take a priority over prepaying the housing loan: "Make sure that you have a contingency fund in place before opt for prepaying your home loan," says Roongta.

The third key variable is returns from investment of the lump sum at hand. As a thumb rule, you should go for investment, instead of prepayment, only when the post-tax return from the investment is likely to be higher than the effective cost of the housing loan. For investors in the 30% tax bracket, and whose outstanding home loan balance is less than Rs 20 lakh, the effective cost of loan is only 6.65%. Since there are several risk-free, tax-free debt options such as PPF, Sukanya Samruddhi Yojana and listed tax-free bonds , which offer higher annualised return than this, it makes sense to invest in them.

All the debt products mentioned above are long-duration products. If your risk taking ability is higher and time horizon is longer, you can consider investing in equities , which can generate better returns "It's sensible for long-term investors (five year-plus holding period) to go for equities, provided they are savvy and understand the risks involved there," says Kukreja.

There are some home loan products that provide an overdraft facility of sorts and help you maintain liquidity. All you have to do is to park the surplus money in these products and not bother with whether it's a prepayment or not. It's like prepayment with the option of taking out that money, in case you need it in future for personal use or for investment purpose. The strategy of maintaining the housing loan interest close to Rs 2 lakh per annum can also be managed by these special loan products. And even if you are going to invest, the SIPs can go from this account.

"I park my bonus and do SIPs in equity from the loan account," says Kukreja. Most banks charge more for these special loan products. "Though the stack rate differential is more, you can bring it down by bargaining with the banks," he adds.

Six things about home loan tax incentives you didn't know

Source: The Economic Times

2016 is looking to be one of the best years for home buyers. More tax benefits, rate cuts on loans, stagnant property prices, and new launches in the 'affordable' segment with freebies and attractive payment schemes. Many of you will be looking to take advantage of these benefits and buy a house. While hunting for a house at the right price, you'll be haggling with the bank to cut a loan deal too. Even if you get a discount on both, your tax bill can burn a hole unless you know the rules well. Here goes a list of six lesser known and often-missed tax benefits on home loans.

1.      You can claim tax benefit on interest paid even if you missed an EMI. Unlike the deduction on property taxes or principal repayment of home loan, which are available on 'paid' basis, the deduction on interest is available on accrual basis. Meaning, even if you have missed a few EMIs during a financial year, you would still be eligible to claim deduction on the interest part of the EMI for the entire year. "Section 24 clearly mentions the words "paid or payable" in respect of interest payment on housing loan. Hence, it can be claimed as a deduction so long as the interest liability is there," says Kuldip Kumar, partner tax, PwC India. However, retain the documents showing the deduction so that you can substantiate if questioned by tax authorities. The principal repayment deduction under Section 80C, however, is available only on actual repayments.

2.      Processing fee is tax deductible. Most taxpayers are unaware that charges related to their loan qualify for tax deduction. As per law, these charges are considered as interest and therefore deduction on the same can be claimed."Under the Income Tax Act, Section 2 (28a) defines the term interest as 'interest payable in any manner in respect of any money borrowed or debt incurred (including a deposit, claim or other similar right or obligation)'. This includes any service fee or other charge in respect of the loan amount," says Kumar. Moreover, there is a tribunal judgement which held that processing fee is linked to services rendered by the bank in relation to loan granted and is thus covered under service fee. Therefore, it is eligible for deduction under Section 24 against income from house property .Other charges also come under this category but penal charges do not.

3.      Principal repayment tax benefit is reversed if you sell before 5 years. You score negative tax points if you sell a house within five years from the date of purchase, or, five years from the date of taking the home loan." As per rules, any deduction claimed under Section 80C in respect to principal repayment of housing loan, would get reversed and added to your annual taxable income in the year in which the property is sold and you will be taxed at current rates," says Archit Gupta, CEO, ClearTax.in. Thankfully, the loan amortisation tables are such that the repayment schedule is interest heavy and the tax-reversal rule only apply to Section 80C.

4.      Loan from relatives and friends is eligible for tax deduction. You can claim a deduction under Section 24 for interest repayment on loans taken from anyone provided the purpose of the loan is purchase or construction of a property. You can also claim deduction for money borrowed from individuals for reconstruction and repairs of property. It does not have to be from a bank." "For tax purposes, the loan is not relevant, the usage is. The taxpayer should be able to satisfy the assessing officer how the loan has been utilised for constructing or purchasing a house property and completion of construction was within five years and other conditions are met," says Gupta. Remember, the lender must also file an income-tax return reporting the interest income and paying tax on it. "The interest charged should be reasonable and a legal certificate of interest should be provided by the lender along with name, address and PAN," says Gupta. This rule, however, is only applicable for principal repayment. You will lose all tax benefits for principal repayment if you do not borrow from a scheduled bank or employer. The additional benefit of Rs 50,000 under Section 80EE is also not available.

5.      You may not be eligible for tax break even if you are just a co-borrower. You cannot claim a tax break on a home loan even if you may be the one who is paying the EMI. For one, if your parents own a property for which you are paying the EMIs, you can't claim breaks unless you co-own the property. "You have to be both an owner and a borrower to claim benefits. If either of the titles is missing you are not eligible," says Gupta. Even if you own a property with your spouse, you can't claim deductions if your name's not on the loan book as a co-borrower.

6.      You can claim pre-construction period interest for up to 5 years. You know you can start claiming your home loan benefits once the construction is complete and you receive possession. So, what happens to the installments you made during the construction or before you got the keys to the house? As per rules, you cannot claim principal repayment but interest paid during the period can be accrued and claimed post-possession. "The law provides a deferred deduction on the interest payable during pre-construction period. The deduction on such interest is available equally over a period of 5 years starting from the year of possession," says Vaibhav Sankla, director, H&R

Personal loan — do your homework first

Source: The Hindu Businessline.

Evaluate the options available before you zero-in on any specific lender. This is because the eligibility criteria, interest rates, fee and other charges vary widely across banks.

Ajith has been working in an IT company for the last three years. His sister’s wedding is coming up in two months, he also wants to purchase some consumer durables for his house and vacation abroad during the Dussera holidays. For sure, he earns a fat salary and has some savings. Should he use these up to fund these expenses?
Not necessary. He can take a personal loan, offered by almost every bank on every street corner. Such a loan is typically available for a five-year period and getting one is hassle-free as it involves minimum paperwork and no security, guarantor or collateral. What more, most banks take less than 72 hours for the approval! True, the process is so simple that some banks offer this service at your doorstep. But to be on the winning side, you need to do your homework before you zero-in on any specific lender. This is because the eligibility criteria, interest rates, fee and other charges vary widely across banks.

Eligibility Banks offer personal loans under two broad categories — salaried and self-employed individuals/professionals. For a salaried individual, the age limit for availing a loan is broadly 21 years-60 (at the time of maturity) and for the self- employed, it is 25-65 years. Although these limits broadly remain the same across all banks, the cut-off level of income for being eligible for a personal loan and the maximum loan available differ. For example, HDFC Bank sets the minimum net annual income at Rs 84,000 for the salaried while at ICICI Bank it is Rs 96,000. At CitiBank, it is Rs 1,20,000. Others, such as Punjab National Bank, have different eligibility levels for customers in metros, urban and non-urban centres. For professionals such as doctors and techies, Canara Bank has special schemes — Doctor’s Choice and CanTech.
The loan amount too varies. For instance, Standard Chartered offers up to Rs 30 lakh for the salaried and Rs 15 lakh for the self-employed. At PNB, the minimum loan is Rs 24,000 for an urban centre while the maximum is 12 times the net monthly income subject to a ceiling of Rs 10 lakh.Hence, to get the best deal, visit the Web sites of all banks. Look at what is on offer. Some banks offer ‘relationship discounts’ i.e. if you already have an existing relationship with a bank, you may be able to get better rates, discounts on fee and charges, etc. Some offer a personal accident/health insurance cover at a nominal premium alongside.
Also, make use of online eligibility and EMI calculators. Some banks have these calculators on their Web sites too. If your income is not sufficient to fetch the loan you want or if you feel the EMI is at a higher-than-comfortable level, consider taking a joint loan with your spouse. That will enhance your eligibility and divide the EMI burden as well. Interest, fees and other charges.

Rate of Intarest
A key criterion to choose a lender would be the rate of interest and rates for personal loans differ based on your profile. The rate is based on banks’ perception of your risk profile, which, in turn, depends on your occupation, salary/income, credit history, place of residence and personal profile. Banks charge anywhere between 12 and 25 per cent interest on personal loans and so, negotiating rates is desirable.

Compare ratesAjith gets a loan at 12 per cent while his friend Suman gets one at 15 per cent interest. Isn’t Ajith lucky to have obtained a lower rate? Yes, if these two rates are comparable. More often than not, they are not. This is because, the basis of computation of interest may differ. Some banks may quote a flat rate of interest while others may quote a rate calculated on quarterly, monthly or a daily reducing balance. Let’s assume Ajith borrows Rs 2 lakh at 12 per cent flat rate for three years. The total interest would be Rs 72,000. The EMIs will be 2,72,000/36 = Rs 7,555 .55. At the end of every month, he would have repaid a part of the principal through the EMI, but would still continue to pay interest on the repaid amount (as interest is charged on the entire loan amount). In this case, the effective interest cost works out to be much higher than the said 12 per cent.
It is always better to get a loan with interest charged on reducing balance. But here too, the effective cost will vary depending on whether it is annual, quarterly, monthly or daily reducing balance. A monthly reducing balance might suit you as it times well with your EMI payments but it is always better to work out the effective cost of different options before choosing one.

Other Charges
Besides, you also need to check on the other charges, such as processing fee, documentation fee, pre-payment penalties and switching charges as they add to the cost of the loan. Further, a few administrative costs — charges for duplicate statement, charges for rescheduling, — may not be disclosed upfront may surprise you later on unless you figure that out early enough.
If you have done your homework, you could take the upper hand in the negotiations and obtain the loan at competitive rates.

DocumentsOnce you have chosen the lender based on the above criteria, documentation requirements are quite simple. You need to give proof of your identity — voter ID/PAN card/driving licence/passport; proof of address, bank statements, Form 16 and salary slips of the past few months as may be required. If you are self-employed, you will have to produce a certified balance-sheet and Profit and Loss account of the past two/three years along with other mandatory documents, such as partnership deed, in addition.

All that you wanted to know about sub-prime crisis

Source: The Hindu BusinessLine.

Chennai, Aug. 18 Sub-prime is prime news. “Indian markets catch sub-prime chill,” declares Forbes. Sub-prime ills are not hitting the markets closer home, assures SEBI. Meanwhile, WNS, India’s second-largest BPO, has suffered hit due to the sub-prime crisis. “Sub-prime lender NovaStar firing 37 per cent of staff,” reports USA Today. “Next wave in sub-prime mess could be fraud charges,” cautions International Herald Tribune. Scotsman talks about “Merrill Lynch’s painful lesson in sub-prime,” and Houston Chronicle says: “EU to examine credit rating agencies.”

If, like many, you are clueless about sub-prime, this is just the right time to know the basics. So, here is Dr Sunil Rongala, Group Economist, Murugappa Group, answering a few elementary questions on the subject posed to him by Business Line.

First, what is sub-prime?

When banks lend money to people, they broadly classify them into prime and sub-prime debtors, where the former are people who are considered creditworthy and the latter, less so.

Normally banks don’t lend to those who are not creditworthy, do they?

While it will be prudent not to lend to anyone other than the creditworthy, banks do lend to sub-prime debtors. However, since these debtors are considered less creditworthy for reasons such as low income, banks usually lend to them at higher rates of interest.

Sub-prime borrowers pay a risk premium, may we say?

Yes. And in some cases, risks were high: loans were given to NINJA borrowers (that is, No Income, Job or Assets). This is the genesis of the ‘sub-prime crisis’ that is playing itself out currently on global markets.

How is sub-prime crisis defined?

Firstly, one must understand that though the word ‘sub-prime crisis’ is being used as a generic term, it actually refers to a credit problem among sub-prime borrowers (they account for 8 per cent of total mortgages in the US) in the residential market in the US. Like borrowers anywhere in the world, the interest paid on residential mortgages in the US is linked to the central bank’s benchmark and in this case, the US Federal Reserve’s Fed Funds Rates.

Can we trace back the problem to find out when things began to turn messy?

Between 2004 and 2006, because of incipient inflation in the US economy, the Federal Reserve or Fed increased its Fed Funds rate (the overnight rate at which banks lend to each other) from 1 per cent all that way to 5.25 per cent and the discount rate (the rate at which the Fed lends to banks) from 2 to 6.25 per cent. Because of this, holders of residential mortgages too saw their payments on their house loans rise. This rise in rates was a disaster in the making for the banks that gave loans to subprime borrowers. (However, the Fed, in an unusual move, decreased the discount rate by 50 basis points to 5.75 per cent on August 17 to increase liquidity in markets.)

Defaults would have increased when interest rates, and therefore the repayments, rose?

True, because the first issue with subprime borrowers is that they are likely to be low-income people. When faced with higher mortgage payments, they fell behind on their payments and in cases, some also became delinquent and banks started repossessing houses.

The banks would have sold the repossessed houses to recover the dues?

In the normal course, yes. However, because of higher interest rates, people became more cautious in borrowing to buy houses and there was a general slowdown in demand in the housing market, causing these banks to hold assets that people weren’t just willing to buy.

Did no one see the crisis coming?

The so-called sub-prime crisis started unfolding when people started defaulting on their housing mortgages. Initially, it was thought that the problem was only limited to a few lenders and people didn’t give it much thought. A testimonial to the fact that people didn’t give it much thought is best highlighted when one looks at the level of the Dow Jones Industrial Index. The news of the sub-prime defaults was highlighted earlier in the year itself but the Dow actually closed at its highest level ever of 14,000 on July 19. Then things started unravelling.

The lenders take the hit when borrowers default, but we find the crisis spreading far and wide. How so?

That is because mortgages held by banks are typically bundled and sold to other institutions. These institutions will then slice these mortgages into residential mortgage backed securities (RMBS) or in other words, securities that are backed by collateral; the collateral here being the mortgages held by sub-prime borrowers.

And then?

These RMBS are then rated by rating institutions such as Moody’s and Standard & Poor’s based on various parameters…

Which is why the wrath has now turned on the rating agencies?

That’s right. These RMBS are then divided further and sold as collateralised debt obligations or CDOs to various investors; and investors will buy these CDOs based on their appetite for debt.

Risky appetite?

Obviously. The people who hold the riskiest debt also get paid the highest when times are good, and get hit first when times are bad.

When did the issue surface?

The CDO issue first arose in June when a Bear Stearns hedge fund borrowed money from Merrill Lynch and gave their CDOs as collateral. Merrill Lynch decided to sell the collateral but soon realised that there was something wrong when they were unable to sell because their sale was driving down prices.

‘Painful lesson in sub-prime’, as the media reports?

And a costly one, too. Soon the market realised that there was a serious issue with the CDOs that went just beyond the Bear Stearns debacle. Essentially since these CDOs are part of RMBS, people realised that there was little or no solid collateral backing the RMBS because of the defaults by sub-prime borrowers.

An ‘asset’ that turned out to be hollow?

Exactly. And then two issues arose. One, no one knew how much of these CDOs banks and financial institutions were holding; and two, banks and financial institutions didn’t know how much their CDOs were worth because the market for the CDOs had practically collapsed. Because of this, the markets started punishing the banks that held these CDOs and that is cause behind the volatility that one is currently seeing in global equity markets. It also emerged that there were more lenders caught in this sub-prime mess than was initially thought…

Do we know how many are affected by the problem on hand?

As of now, it has been estimated that 127 lenders have been caught in this. On August 15, the shares of Countrywide, the largest mortgage lender in the US, fell by 13 per cent after they issued warning about the potential hit on their balance sheet. One of the biggest concerns of this debacle is that instruments that were rated at AA have now started defaulting.

Have the rating agencies woken up?

Jolted from slumber, one may say. Rating agencies have now started to downgrade all RMBS backed by sub-prime mortgages and that will force banks to sell them because of capital norms and this will only cause a further plunge in prices.

Now, what are the lessons from the crisis?

This sub-prime mess raises two very important issues. One, the way banks lend money willy-nilly to people without properly checking their credentials; and two, the absolutely pathetic rating process used by the rating agencies. While both are hazardous to the system, the latter raises issues of moral hazard because the rating agencies profited massively from rating these RMBS.

Can we say that the worst is safely behind us?

Doubtful. It looks very likely that we are merely at the tip of the proverbial iceberg as far as the sub-prime crisis is concerned and that there is much more below the surface.

Around The World On Borrowed Money

Source: The Economic Times.

Planning an exotic vacation with your family, but falling short of funds? Don't worry - a travel loan can solve your problems. While all banks offer personal loans (which you may use for travel purposes), few banks offer loans meant specifically to meet your tour expenses for domestic and overseas travel. Also, several tour operators have tie-ups with banks, which extend loans for a specific tour package. So, you can either plan your own holiday and approach a bank directly for a travel loan, or you can book a holiday package with a tour operator and then make use of the EMI facility. However, you need to find out which of these two options is more cost-efficient and suited to your needs.

Loan Amount
Certain public sector banks offer specific loans to meet travel expenses like cost of ticket, hotel stay, visa, airport tax, purchase of Basic Travel Quota, etc. For example, SBI provides an 'Easy Travel Loan', while Bank of Baroda (BoB) offers 'Baroda Desh Videsh Yatra Loan'. If you opt for an SBI travel loan, the minimum loan amount is Rs 24,000, while the maximum is 12 times the net monthly income for salaried individuals and pensioners, and one year's net annual income for selfemployed professionals. If you opt for a BoB loan, the minimum loan amount is Rs 25,000, while the maximum is Rs 2 lakh (for domestic travel) and Rs 10 lakh (for overseas travel).

On the other hand, if you book a holiday package with a tour operator, you can get your entire trip financed by a bank (maximum loan amount varies from Rs 2-3 lakh). For example, SOTC of the Kuoni Travel group has a tie-up with Kotak Mahindra Bank while Cox & Kings has tied up with Citibank, and Raj Travels has a tie-up with State Bank of Patiala to finance their respective tour packages. ICICI Bank funds packages offered by Travel Mart and SOTC, with the same terms and conditions as personal loans.

Interest Rate & Tenure
If you directly approach a bank for a travel loan, it generally works out cheaper than opting for EMI facility offered by tour operators, since interest rate is usually lower for the former. SBI currently offers an interest rate of 15.25% p.a. on a daily reducing balance while BoB offers 15% p.a. Meanwhile, interest rate for an SOTC package varies between 14% and 16% p.a. (interest rate is lower for lesser tenure) while Cox & Kings offers 16.5% p.a. on a reducing basis. While SBI offers a long repayment period of up to 48 months, BoB has a maximum of 36 months. Similarly, SOTC allows you to pay in 12/24/36 EMIs while Cox & Kings offers greater flexibility with 6/12/18/24/30/36 EMIs. In case you decide to prepay your loan, SBI and BoB don't levy any prepayment penalty. However, SOTC and Cox & Kings do levy a prepayment penalty, which is around 4% of the outstanding loan amount.

Other Charges
Taking a travel loan directly from a bank has its disadvantages in terms of processing/documentation charges and margin amount. While SBI levies a processing charge of 1% of the loan amount, BoB charges 1.5% of the loan amount. In addition, BoB levies documentation charges of Rs 100-200. Moreover, for loan above Rs 50,000, 10% of the amount is charged as margin money, and third-party guarantee or collateral security is also required. On the other hand, if you opt for EMI facility offered by tour operators, no processing/documentation charges are levied and no margin money or security is required. But tour operators levy booking charges of Rs 15,000-20 ,000 per person.
Eligibility & Documents
If you approach a bank for a loan, you need to fulfil several eligibility criteria. You'll be eligible for a loan if you're an employee of state/central government , PSU/public limited company, reputed institution or MNC with minimum 1-2 years of service; or self-employed professional or businessman with minimum two years stable business. The documents required include latest salary slip and Form 16 (for salaried individuals) or I-T returns for last two financial years (for self-employed individuals); copy of ticket; copy of invoice containing ticket fees & insurance charges; copy of passport and visa (for overseas travellers).

The eligibility criteria and documents required are much less if you opt for EMI package offered by tour operators. Anyone with a minimum net income of around Rs 15,000 per month and having a good credit history can opt for such packages, says an SOTC official . After booking a tour package, you have to submit your salary statements and identity/address proof to the tour operator, which sends these documents to the bank for approval of loan.

Weigh Your Options
So, are you better off by approaching a bank directly for a travel loan, or should you opt for EMI offered by tour operators? The former option may work out cheaper in terms of interest rate and absence of prepayment penalty, but it may be more time-consuming and cumbersome due to the huge amount of paperwork involved. On the other hand, Sunil Gupta, COO, SOTC & Kuoni Holidays, feels the benefit of approaching a tour operator is that "they need far less documents, loans are pre-approved up to an amount and enjoy fast-track sanctions."

Implications Of Cancellation
In case the tour operator cancels the tour for some reason, an alternative tour date will be set. If you agree to go on that date, nothing will change in terms of the loan and EMI. But, if you don't agree to go on that date, the tour operator will refund the entire amount, including the initial Rs 15,000 or Rs 20,000 booking charges. In case the customer decides to cancel the tour due to personal reasons, when the loan has already been activated, it cannot be cancelled. The customer will have to forgo the initial booking charges plus he will have to pay all the EMIs on a regular basis, even if he doesn't opt for the tour package. In effect, the customer will have to bear the entire tour expenses, without having gone on the tour at all!! But, tour operators claim that in certain special cases , if they are convinced that the reason for tour cancellation is genuine (example, tragedy in the family etc), they may allow loan cancellation, but initial booking charges will still have to be foregone.

Don't prepay loan just to keep your EMIs constant

Source: The economic Times.
Home loan borrowers have more reasons to worry. As a consequence of the recent hike in the cash reserve ratio (CRR), banks have yet again hiked the home loan rates. Higher rates are not only increasing the cost of home acquisition, higher EMIs are also putting tremendous pressure on monthly budgets. In such a scenario, the loan taker has three main options - pre-pay a part/whole of the loan, switch to a fixed-rate loan, or opt for an increase in tenure. We explore each of these three options.

Prepayment of loan
The fundamental question is whether it is wise to prepay even at this time. "You can prepay the loan provided you have investments profits from equity or additional surplus after meeting all commitments," says a certified financial planner and a chartered wealth manager Kartik Jhaveri. Industry experts say that a borrower should not prepay the loan with the only intention of keeping the EMI constant. Usually, with the incremental income , borrowers can absorb the rise in EMIs. What a borrower should calculate is the optimum EMI he can service with a possible rise in the salary. Says UTI Bank's head-retail assets, Sujan Sinha, "Every borrower is comfortable with a certain amount of deduction. So, a borrower can partly prepay the outstanding loan amount such that the interest and the principal outgo remain unchanged."

When should you prepay the loan? - This decision can be tricky too. While prepaying principal reduces the liability and the cumulative interest one will pay, it can also reduce the ability to take full advantage of the tax benefits on home loan interest. So, if you want to control your overall absolute cost of acquisition, prepayment in the initial stages can be fine as maximum interest is chargeable then. However, if it is advantageous to claim full tax benefits, it may be better to stick around till the later stages of the loan. That is the time when interest component in an EMI is low and principal is the dominant component. "Let's assume you have borrowed Rs 30 lakh for 15 years. The total pay out for the first year aggregates to over Rs 4 lakh, principal accounts for almost Rs 76,000 of this outgo. In the last quarter of the loan (after 10 years), the outstanding principal is over Rs 16 lakh. Now, if you partly/wholly prepay the loan you stand to gain from better tax benefits as interest outgoes are substantially lesser in this cycle of the loan" says VP UTI Bank retail assets VP Sujan Sinha.

How do you finance your prepayment? - If you get some bonus or are sitting on surplus cash, you can partly prepay the loan. This would help you keep the EMI and the tenure of the loan constant. You can avail of an overdraft facility against NSC, LIC policy or shares to offset the increase in EMIs/tenure. However, it does not make sense for a borrower to break into his liquidity to prepay the loan. For example , a borrower can invest the same amount in a tax saver fixed deposit to earn a higher return. A borrower should calculate internal rate of returns and calculate other options before arriving at a decision.

Conditions for part prepayment - You can partly prepay your home loan only under certain conditions . For instance, HDFC allows to prepay only twice a year, provided your amount is at least three times the EMI. SBI is slightly stringent. It doesn't allow you to prepay more than 50% in the first five years. If you intend prepaying your loan, then it would make sense to go for a floating rate as most banks or financial institutions do not charge prepayment charges for floating rate loans. Fixed loans, however, normally carry prepayment charges of 2%.

Fixed vs floating
Industry experts recommend floating rate for new customers. "A floating rate product comes at a rate of 11-12 %. However, a true fixed product, which is not linked to money market conditions (MMC), comes at nothing less than 13-14 %. Now, if you borrow a home loan at a floating rate of 11%, it will take at least a year or two for a floating rate to increase. In these two years, a borrower will save a considerable amount by riding on the lower end of the interest rate cycle," explains Apnaloan CEO Harsh Roongta.

Should the existing floating customers switch to fixed product? - It does not make any financial sense for borrowers to switch from floating rates to fixed rates or vice versa. Industry experts estimate the average growth of income of salaried employees at 20% in 2006-07 . In the same period, the EMIs grew by almost 25%. The difference is reasonable and borrowers can cope with the rise in EMIs. If you want to convert to fixed rate then you have to pay 1.75% as conversion charges on the principal outstanding amount (charges are for ICICI Bank and HDFC). Nationalised banks charge up to 2%.

Increase EMI or tenure
Whenever a bank/HFC increases the interest rate, a borrower witnesses a hike in either the EMIs or tenure. If you stick to EMI, a half a percentage point increase in borrowing rates could increase your tenure by 25 months. Which one is a better option? - "If you can adjust your monthly budget, bear the increase in EMIs. Try not to increase the tenure of the loan as it would increase the overall cost of the house," adds Mr Roongta. However, if you choose to increase the tenure to keep the EMI constant, banks can do so only up to a point. Beyond that, if the interest rate continues to rise, the EMI becomes insufficient to cover the loan (interest and principal) and banks are forced to increase the amount of EMI as well.

WHAT NEXT?

1. If you get some bonus or are sitting on surplus cash, you can partly prepay the loan.
2. A borrower should calculate internal rate of returns and calculate other options before arriving at a decision.
3. Most banks or financial institutions do not charge prepayment charges for floating rate loans.
4. Try not to increase the tenure of loan as it would increase the overall cost of the house.

All About car financing.......

Source: The Economic Times

Arun Seth, a salaried employee is about to purchase a car of Rs 350,000 under a margin money scheme. He has to pay margin money of Rs 35,000 and pay an EMI of Rs 10,000 for the next three years. He is also expected to incur monthly car running costs of around Rs 5,000. Arun would meet the margin money, EMI and car running costs from his take home pay. Is this the right step?

What should Arun do to optimise his tax benefits? There are broadly two types of conventional auto financing schemes which are typically chosen by buyers - margin money scheme and finance lease. Another variant of a lease is an operating lease, which perhaps is the most beneficial for a salaried employee. However, it is the employer who has to enter into this lease arrangement and not the employee. All the above three Car Financing mechanism are explained below in detail:

1. Margin money scheme: Typically, under the margin money scheme, the ownership of the car lies with the buyer but the car is hypothecated with the financier as security. The financier finances up to 90% of the cost of the car and the buyer has to pay the balance amount as down payment. The financed amount is repaid in equated monthly installments (EMI) during the tenure of the loan, which generally ranges from three to seven years.
2. Finance lease: Under the scheme, the ownership of the car lies with the financier. The car is leased out to the customer for a specified tenure and the customer pays monthly lease rentals for use of the car. At the end of the lease term, the customer has the right to purchase the car at an agreed residual value. The scheme is so structured that the monthly lease rentals together with the residual value equal the cost of the car and the interest calculated thereon for the lease term at a certain rate. A finance lease is preferred by individuals who do not have enough funds to pay the upfront down payment. The interest rates charged are dependent on various factors like the economic profile of the customer and his credit rating. In certain cases, finance companies and banks also have tie-ups with car manufacturers and offer competitive rates on specific car models.
3. Operating lease: Under operating lease, the car is merely provided on rent to the customer against monthly hire charges. Running costs like repairs, insurance, etc., may be borne by either the leasing company or the customer and the monthly hire charges reflect the same. At the end of the lease term, the car is repossessed by the leasing company. Operating leases are not offered by banks and are generally offered by non-banking financial companies and leasing companies to corporate employers.

Tax planning for salaried employees

Unlike self-employed individuals who can claim the interest payments and car depreciation as a deduction and lower their tax bill, salaried employees do not enjoy any tax benefits under conventional auto financing options. Ideally, Arun should approach his employer who should then get into an operating lease arrangement with the finance company. This car can then be provided to Arun for official and personal use.

Process through which it is done

Here, as against the employee entering into a conventional financing arrangement with the financier, the corporate employer enters into an operating lease in respect of the car with the leasing company and provides the car to its employee, who then uses it for both official and personal purposes. On the tax front, the corporate employer incurs a Fringe Benefit Tax (FBT) cost. Thus, there is no tax liability on the benefit provided: - usage of the car, in the hands of the employee. It is essential that the lease is in the nature of an operating lease since the FBT provisions apply only in respect of operating lease payments. The lease rentals would be paid directly by the corporate employer ti the leasing company and the employee's take home pay would be lower to that extent. The running costs of the car upto a certain limit could be reimbursed by the employer on production of necessary evidence. As mentioned above, at the end of the lease term, the leasing company would repossess the car. The employee could if required, enter into a separate arrangement with the leasing company to purchase the car at an agreed residual value.

The tax advantage: How it works

The tax planning opportunity is presented by certain provisions of newly introduced FBT regime which seeks to tax certain fringe benifits provided by employer to their employees at the hand of employer. Under the FBT provisions, rent payable for an operating lease of a motor car is liable to FBT. The value of fringe benefit provided to the employee is laid down at 20% of the lease rentals. The employer is required to pay FBT @ 33.66% of such value (the effective FBT rate working out to be 6.73%). Reimbursements of car running costs like fuel, maintenence, driver's salary, etc., are also liable to FBT at an effective rate of 6.73% of such reimbursements. Once an employer has paid FBT on ceratin benefits provided to employees, such benefits are not taxed as perquisites in the hand of the employees. The above provisions present a useful tool to leverage the lower FBT rates and reduce the overall tax costs suffered by employees.

In Arun's case, his employes would be liable for an annual FBT in respect of the lease rentals and the reimbursements of the car running expenses. His annual taxable salary would be lower to the extent of the lease rentals and reimbursements, resulting in substaintial tax savings. However, even though the car is used by him, he would not have to pay any tax on the benefits (perquistes) available to him. Further, at the end of lease period, if the car is sold by the leassing company to the employee after having reposed the car, the perquisite rule would not be triggered since the transferror is not the employer and accordingly, the employee would not be taxed on such transfer. On the other hand, in the absence of an operating lease arrangement by the employer, he would have to pay income tax on the lease rentals and car running costs, which would be a taxable perquisite.

Other Factors

However, before implementing the above option, one should also consider other factors like registration cost (since the car would require a corporate registration which costs substantially more than an individual registration- the car would be registered in the name of leasing company) and the residual value at which car is sold to the employee at the end of the lease period. An informed desicion after considering the above factors, could enable the employee to reduce his yearly tax bill in an efficiant manner.

Does borrowing spell panic for you?

Source: The Economic Times.

Debt is no longer a dirty four letter word. It is the privilege of spending money you don’t have. Today, every financial institution is pushing consumer loans, home loans, car loans and credit cards aggressively. With the variety of loan products on offer, you can get easily swayed into taking on a loan. Borrowing has its own advantages, provided you know how to manage debt smartly. Let’s look at three real-life situations - being heavily in debt, not in debt but contemplating taking a large loan, and being averse to debt, and ways to emerge as a winner in each of these situations!

Being heavily in debt

Have you immersed yourself into too many loans? Juggling between a car loan, home loan and credit card bills? How will you know if you have slipped into a debt trap? Here are a few warning signs which will tell you if you have reached the ‘danger zone’ in your borrowings:

1. You have little or no savings left You simply pay the ‘minimum amount due’ on your credit card bills
2. A major portion of your monthly income goes towards paying off your debts
3. You borrow from other sources to pay your current dues
4. Your cheques have bounced a few times in the recent past

These are tell-tale signs that indicate how deeply you are stuck in debt. In such a scenario, the sooner you tighten your belt, the easier it will be to successfully shed the burden of debt. All you need is to get disciplined and follow a plan. Here’s how:

1. Prioritise your borrowings: If you are servicing many loans, the ones that should be cleared off first are the high interest rate loans and those with no tax benefits. Personal loans and credit cards fall into this category. Also, if you have taken a loan against any assets such as equity or house property, then this one too should be a priority, since if you are unable to repay on time, the financer can take hold of your assets. The loans that you can service over a period of time include home loans and education loans since these offer tax benefits and carry lower interest rates.
2. Take a low cost loan to pay off your high cost debts: If your existing loan comes with high interest costs, such as credit cards, you can consider taking a fresh low interest rate loan to settle high cost debts. For instance, taking a personal loan to repay your card outstandings makes sense since credit cards attract steeper interest rates than personal loans.
3. Dig into your own resources: If you are neck-deep in debt, you can encash your existing investments to pay off your loans. Investments bearing lower rates of return, such as fixed deposits, savings account balances, etc., can be withdrawn to clear off your dues. However, if your investments are earning good returns and repayments won’t be possible in a short time, it is best to leave these funds alone. If it’s a temporary bad patch, you could look at borrowing from friends and family to tide you over loan troubles, rather than touch your assets.
4. Curb your spending: One of the best ways to come out of the debt trap is to live moderately and prudently, cut down on unnecessary expenses, build up your savings and channelise your existing funds into repaying your high cost loans. Even if it entails living a frugal lifestyle for a while, do it.

Not in debt but contemplating taking a large loan

While borrowing comes with its own set of benefits, you need to consider the following factors before you take on a loan:

1. Borrow for a need, not a want: Before you take on debt, you need to understand it first. One kind of debt is the debt you incur to fund an expense, which can be called consumption debt, for instance, taking on a personal loan to buy some consumer durable. The second is investment debt, where you take a loan to build an asset, for example, taking a home loan. There are situations where you could avoid using credit, such as making impulsive purchases, meeting luxury expenses, etc.
2. Get the loan amount correct: Most financial experts suggest a maximum borrowing of up to 40-50 per cent of your total net monthly income. For instance, you should not take a home loan where the EMI exceeds 40-50 per cent of your net salary. Realistically speaking, how much credit you can afford solely depends on your own personal situation as well. If your current job is not very secure, the amount of credit should be less than this 40 per cent margin. Conversely , if your source of income is reliable and you have ample savings that are earning good returns, you may take more credit.
3. How much can you repay?: When you are repaying a loan, your monthly cash flow position changes. Knowing your repayment capacity before borrowing is important so that you can afford to pay your loan and continue to enjoy your current standard of living.

Being averse to debt

Avoiding debt altogether can actually prove unwise at times, since the power of credit is tremendous. Credit helps you achieve tangible aspirations and lets you build assets much earlier in life. Therefore, sometimes it makes sense to borrow. In fact, generally, major necessities such as buying a home or providing for education, merit borrowings. As a rule of thumb, if you are averse to the idea of debt, you may avoid borrowing for frivolous purposes like a vacation, apparel, dining out at expensive restaurants, speculating and gambling, etc. Sometimes borrowing is a close call. Items like furniture, appliances and certain home improvements fall into this category. It’s preferable not to borrow for such goods, but you may be able to justify the interest expense if you’re buying items that you’ll keep for 5-10 years or more.

Pull up your socks and act now

Sound financial advice doesn’t change much from year to year. Bad money management decisions, however, seem to mutate and flourish with each passing season. Managing your debt is in your hands. With just a week or two into the New Year, it isn’t too late to make that New Year resolution to get debt savvy!

How much does your loan cost?

Source: The Economic Times.

The very idea of buying a house is an exciting one. It is an undeniable fact that investing in real estate is a prudent financial decision. When your dream house nears reality, it is an exhilarating experience. People spend much time selecting a property, working with carpenters, plumbers, furnishing and interiors. But how many of us really spend time selecting a lender and analysing expenses? Most deals are finalised with the first lender you meet, who agrees to sanction you the required loan amount. It is only much later that home loan borrower complains of increasing rates, additional costs and penalties.

Many still believe that cost of a loan is simply the equated monthly installment (EMI) towards the loan amount. But in reality, any loan comes with a plethora of other expenses and penalties. This is a caution for those people who decide on a Housing Finance Company (HFC) based on the advertised interest rates and other freebies on offer. There are numerous other charges and hidden costs that must be compared when comparing the cost of borrowing.

The first cash or cheque that you must hand over is in the form of an application fee. Lenders charge this fee when you file in an application for a loan. This is a very small fraction charged by the HFC and is usually non refundable.

Processing (Fee) your application for a loan involves, verifying your documents, analysing credit worthiness, doing a check on your credit history and verifying property documents. There is a team of legal experts, finance experts and administrative staff doing all this work. This cost is passed on to the prospective borrowers by most lenders. While many lenders advertise as 'zero processing fee', this expense could be billed to the applicant under some other title.

Application and processing fees are sometimes refunded and at other times not. Find this out before you proceed. Some banks also charge legal fees, technical fees, charges for stamp duty and registration of the mortgage deed. There are a host of other charges that are passed on to the customers which includes increase in the effective rates of interest due to the annual reducing balance method, pre payment charges, delayed payment charges, duplicate statement request, bounced cheques and so on.

Prepayment penalty is yet another core issue that prospective borrowers need to make clear from their lenders. It is comes to a huge 2 percent that translates into big money. Most people try to clear the debts on their homes first, if they receive huge money from some other source. There is always a desire to rid the house off the dangling loan as house carries more of an emotional value. Since banks would lose interest money on loans, they levy a penalty if a borrower tries to repay the loan ahead of schedule. This is known as a pre payment penalty.

This may come as a rude shock for fixed rate borrowers who are already paying huge money when compared to their floating rate counterparts. Most borrowers lock themselves in fixed rates with the hope that there will be no hike in their rates. The recent hike in their rates is real surprise for many customers. Be aware that even in a fixed rate agreement, the force majeure clause empowers the lending institution to increase the rate, if the market situation demands.

So, it is not only your monthly principal and interest component of your loan, but also all these additional costs and fine prints. Further, you will have to make arrangements to pay property tax, registration fees, association fees, maintenance deposits, woodwork, furnishing and moving expenses.

Step-up option for young borrowers

Source: The Economic Times.

The repayment of housing loans is through equated monthly instalments (EMIs). Some banks provide a step-up EMI facility to borrowers. The step-up EMI facility intends to reduce the repayment burden in the initial years and helps in increasing the loan eligibility of the borrower. The facility helps young borrowers, who intend to borrow early but at the same time do not have high incomes and cannot afford higher EMIs in the initial years. However, over time, as their income increases, they can afford to pay higher EMIs. It is to be noted that in this process, the borrower takes on a higher interest rate risk if the loan is based on a floating rate of interest. A rise in rates would mean that a portion of the interest would remain unrealised and added to the borrower's principal.

Since a large part of the initial instalments go towards interest payment, the borrower can avail of tax benefits for a longer period. Interest on the loan involves a cost. However, tax benefits tend to reduce the cost of the borrowing. This way the borrower can deploy his savings in other investments schemes which offer a better rate of return. Under this facility, the EMI portion is recovered in parts. During the first few years, a lower EMI is to be paid by the borrower. During the latter part of the loan tenure, EMIs are stepped up i.e. increased. This way the burden of repayment in the initial years is reduced on the borrower. The principal repayment under the step-up loan may start immediately, thereby reducing interest rate risk on the customer. In other cases, the EMIs for the first few years are just enough to cover the current interest rate. The process of step-up can be in different phases. In some cases, two phases are offered - one at a lower rate and the other at a higher rate. In other cases the step-up can be a gradual process. It can be done yearly or every five years, or some other time period. Some banks also offer the step-up facility with fixed interest rates, but the rate of interest on such loans is higher than the floating rates. The step-up facility involves a lower outgo in the initial periods. Borrowers who are likely to earn more in future can avail this facility to get higher loans and adjust their cash flows over a period of time. The borrowers need to keep in mind the fact that in the step-up facility, the interest rate risk exposure is quite high. In the initial years, the interest component is more and the principal component is less, lower EMIs in the initial year would mean that lower principal is being repaid. This deferral of principal to the later part of the loan tenure will increase the interest cost of the loan. This may turn out to be very costly in case of floating rate loans because in case the interest rates increase, the higher interest would have to be paid on a higher outstanding principal loan amount. In case of a rise in interest rates, the difference is recovered by way of higher EMIs towards the end of the loan tenure.

What's Your Pick?

Source: The Economic Times

So you are all set to buy your dream home? May be you are already arranging for the down payment and preparing to make that biggest and, perhaps, the best investment of your life. While taking a home loan, the normal tendency is to stretch the loan tenure to the maximum. Some banks actually offer loans with a 25-year tenure to reduce your EMI (equated monthly instalments) payments. With rising property prices, this strategy is becoming quite popular for property buyers. But is it prudent to go for such a long-tenured loan?

While it is true that you can pay only as much as you can afford, the key question is to what extent should you extend the tenure. Though you reduce your EMI payments by extending the loan tenure, you also end up increasing the interest payments. So, what is the optimal tenure that you should go for - 15 years, 20 years or 25 years? Our number-crunching finds that it is prudent to not extend loan tenures beyond 15 years.

First let's decode the EMI and find out how its components affect you. EMI comprises two parts - principal and interest. So, every time you pay an EMI, some of it goes towards paying the loan amount (and reduces it), while the balance goes towards paying interest for the loan. At the beginning of the tenure, the interest component of the EMI is the highest and as you pay EMIs, the principal amount that you have to return gets reduced. Consequently , the interest on this remaining loan also keeps reducing. Since for you the outflow (EMI) is the same, you do not understand the impact, but as you proceed, the principal repayment gets faster and the interest component of the EMI reduces.

If you take a one-year loan of Rs 1,000 loan at an interest rate of 12%, your EMI comes to Rs 89 (see table 'Home On The Range'). But if you look closely at the components, you'll find that in the first month, you will pay Rs 10 as interest and Rs 79 as principal. So, in the following month, your loan outstanding reduces to Rs 921. In the subsequent EMI, you pay Rs 9.2 as interest and Rs 80 as principal. Thus, by the end of the tenure, Rs 88 of the EMI go towards repaying the principal and the interest payment hardly amounts to anything.

The faster you reduce the principal outstanding, the better it is, as you will be paying lesser interest. Let's see what will be the repayments for a Rs 1,00,000-loan for different time periods (15, 20 and 25 years), assuming an annual interest rate of 10% (see table 'What's The Difference'). As you can see, the interest component varies significantly over the three time frames. For a 15-year loan, the EMI works out to Rs 1,075 for a loan amount of Rs 1 lakh. Instead of 15 years, if you go for a 20-year loan, you will end up paying Rs 38,176 more in interest, compared to a 15-year loan. In the process, you also reduce your EMI per lakh by Rs 110. For a Rs 30-lakh loan, it means reducing your EMI by Rs 3,300.

For a 25-year loan you Rs 41,005 more in interest, compared to a 20-year loan for a Rs 1-lakh loan and a staggering Rs 79,181 (38,176+41,005) more in interest compared to a 15-year loan. So, you reduce your EMI compared to a 15-year loan - Rs 56 per lakh. For a Rs-30 lakh loan, it means reducing the EMI by Rs 1,680. So, while you saved Rs 3,300 on your Rs 30-lakh loan by moving from a tenure of 15 years to 20 years, you saved only Rs 1,680 by moving from 20 years to 25 years.