A loan, when managed well, is the biggest realiser of our dreams. And when it comes to a life goal as significant as buying a home, a home loan is a tool that benefits countless people. However, there are many among us who have funds to buy a home without requiring help of a loan. They often face a dilemma: should they exhaust their savings to purchase a property and avoid debt or take a loan instead? There's no "one-size-fits-all" answer to this.
That said, lack of funds is not the only reason why people take a home loan. This financing facility comes with a number of benefits to lure aspiring homeowners. A home loan is one of the cheapest borrowing tools which comes with a low rate of interest. Unlike other loans, there's zero prepayment penalty on home loans with floating interest rates. So, there are definitely some advantages in taking the loan route.
Tax benefits under a home loan
A home loan is possibly the biggest tax-saving instrument, thanks to a number of tax deductions available under Sections 24, 80C and 80EEA of the Income Tax Act. Together, an eligible home loan borrower can claim a total tax deduction of up to Rs 5 lakh ( Rs 1.5 lakh on principal repayments under Section 80C plus Rs 2 lakh on loan interest component under Section 24 plus Rs 1.5 lakh on loan interest component under Section 80EEA if he meets the eligibility criteria) which can help him reduce his tax liability by Rs 1.5 lakh if he falls under the 30% income tax bracket.
Opportunity to grow your fund
Even if you are capable of buying a home using your own fund, you may still want to avail a home loan facility to save on taxes. You can thus invest your funds to earn an attractive return. For example, the current interest rates on floating rate home loans range between 7.9% to 8.3% per annum depending on your credit score, loan amount and tenure. These record-low rates are currently being offered after RBI's directive to lenders to link retail loan rates to an external benchmark like the repo rate.
So, on a home loan at 8% interest rate, let us suppose the total interest amount on your home loan is Rs 3.5 lakh in a year and you are able to exhaust the entire deduction available under Section 24 and Section 80EEA. This means, if you fall in the 30% tax bracket, you will be able to save on tax up to Rs 1.05 lakh. So, the effective cost of borrowing on your home loan would only be 5.6% p.a. You can safely earn 7.5%-10% p.a. by investing own funds in various instruments. As such, you can earn a higher return on your own fund and pay a lower effective interest on your home loan, depending on how much tax you can save and the ROI prospect.
When you face a liquidity crunch and are forced to take a financing facility like a personal loan or a collateralised loan, it may cost you much more in interest compared to your home loan interest amount. So, why use your own funds and live in a liquidity crunch to buy a home? Your funds will protect you against life's uncertainties and help meet other important financial goals.
Due diligence of property by bank
Banks exercise strict due diligence before financing a project, something that reduces your risk to a great level. They verify the project-related documents, its title and legal clearances before approving a loan on it. So, when you take a home loan from the bank that has already approved the project, it becomes safer than an unapproved project.
When to buy a home using own funds
There's no single answer to the "own funds vs. home loan" dilemma. Using your own fund to buy a home could be a good step when you are absolutely assured that it won't impact your other important financial goals and you'd be left with enough liquidity even after making the payment. Doing so could be a viable option even for those who would feel uncomfortable in handling long-term debt.