Is Home Loan Right Choice for Saving Tax?

I had a very interesting discussion on one of the question by a reader earlier this month. The question was –

My gross salary is approximate 12L and my net take home is roughly ~78,000 Rs per month. I think I am paying lot of tax and want to know ways to save tax. Can I save tax with a home loan?

I am sure this is one of the questions for many salaried individuals because there are very little options to save tax.

When we look at home loan, we feel it can save till income is roughly 6L per annum. 2.5L as tax free option, up to 1.5L as saving on principal paid under 80C and up to 2L on the interest paid. So let us analyze the complete scenario for salaried individual and answer the question to see if home loan can actually save any tax and by home much.

1. Home Loan and 80C Tax Saving Options

This is the primary attraction point for home loans. If you take a home loan, the principal amount you pay back each year will become part of your 80C investment and so you don’t need to be doing other tax saving investments.

Really looks a great choice.

The reality is lot different that that. With a take home salary of ~78,000 there is a big chunk of it going into provident fund. Your contribution towards provident fund is part of the 80C limit of 1.5L and so the tax you will save on your home loan will not be the full amount of 1.5L but only the fraction left after your provident fund deductions.

I assume around 50% of your 80C limit is already used by your provident fund contribution. Just get your salary slip out and see what is the your contribution towards provident fund. If it is more than 75,000 per year, you will save very little in tax from home loan under 80C.

Note that 80C limit was 1L in the previous year and if you were not able to make up to those 1L limit earlier only from provident fund I assume you have not opted for an elongated policies where you have to keep investing for years. If you have opted for such policies, you have used maximum portion of your 80C limit anyway.

So once you deduct the already invested amounts, the rest amount up to 1.5L is what you will save under 80C, which I don’t think will be significantly high.

2. Home Loan Interest up to 2 Lakh is Tax Free

There is second benefit of saving tax on interest paid to banks up to 2L per year. Looks really good when you want a home loan but then just for the sake of saving tax, a home loan means you are paying 2L or 100% as interest to the bank to save a tax of ~60,000 (taxed at 30%). Not a very good idea.

Conclusion

My view is, home loan is not a good idea just for the sake of saving tax but if you need a home loan for a living or an investment, you can go for it. I have shared my views on when a rented house can save you more tax than home loan here

So does it mean it is not a good idea to be going for home loan?

I would say it is one of the best options if you can use the interest being paid. Otherwise it is not worth looking at home loan as an option only to save tax. The option I see it is to opt for a home loan when you would go for other type of loans like education or personal loans.