Taking a home loan vs. Using own funds

By abithadeepak | June 15, 2012


She discussed the idea with her close friend Ashwath, who suggested she put the inheritance in a fixed deposit and get a home loan, as she could avail tax benefits for her income. Suchitra decided to mull over this and do her research on the subject.

Suchitra had always been waiting for a golden opportunity to buy her dream home and had started saving pretty early for this, `to be treasured moment’ in her life. She meant to take a home loan, when she had saved enough funds for her down payment. One morning, out of the blue, she got a call from the law firm of her grand aunt who had recently passed away in the ripe old age of 90.

The lawyer called to say that her grand aunt had left behind, quite a sizable sum of money for her. Suchitra knew she had always been one of her grand aunt’s favourites but was deeply touched by her gesture, which came as a grand surprise.

It so happened that around the same time she had spotted this quaint looking pretty house by the beach and had immediately fallen in love with it. She wanted to use the inheritance from her grand aunt to buy the house and even thought up a name in memory of her good old grand aunt.

She discussed the idea with her close friend Ashwath, who suggested she put the inheritance in a fixed deposit and get a home loan, as she could avail tax benefits for her income. Suchitra decided to mull over this and do her research on the subject.

These were her thoughts after her research and some mulling over:

“Floating rates are always a big risk in such a fluctuating money market. It may or may not work in my favour. If I am opting to put my inheritance in a fixed deposit scheme then it would make sense to opt only for a fixed interest loan rate, but then even fixed interest rates are dependent on the Bank’s discretion, so the risk of an escalating interest rate remains irrespective of the loan rate I opt for.

In spite of that, a best home loan bargain I can lay my hands on currently will have an interest rate of around 11.5% while the best interest rate I can get from a fixed deposit in the current market conditions is about 9-10%. So, already it is obvious that in terms of interest my money outflow is higher compared to the inflow ( i.e. 11.5% home loan interest spent vs. 10% FD interest gained).

The only good thing about the deal would be the tax rebates I can avail on my home loan. However, come to think of it I can only avail so much in one financial year. That is my principal repaid is capped at 1 L under Section 80C and my interest repaid is capped at 1.5L under Section 24C. I already have a ELSS mutual funds plan and a few other options lined up for the next couple of years and a life insurance plan as well, for which I utilize the 1L tax free component under Section 80C. This leaves me only the interest component, which would prove useful initially but will not matter in the later years in a reducing balance loan.

I am in no hurry to put in a lump sum as a fixed deposit right away. In such a scenario, I think it’s wise to pool in the money that would have gone to repay EMIs into a fixed deposit scheme. Also makes sense to cancel on my ELSS scheme next year, which is currently not in great shape anyway and replace that with a tax saver fixed deposit schemes. This will help me get a good interest rate and convert my inheritance funds into a fixed asset that can appreciate in value in a very short term, given the steady development in real estate, despite the correction that will eventually fall in place.”

When Ashwath heard what she had to say, he decided to make some changes to his own plans as well!

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14 thoughts on “Taking a home loan vs. Using own funds

  1. Personal Loan

    Very interesting study. It's helpful to see what other people find out and see how it can impact me.

    Reply
    1. Anonymous

      What is missed out here is on the best FD rate of 10%, post tax -you will end up with 7 to 8%, so paying of the home loan is in almost
      cases better than parking your funds in debt/money market instruments. If you are prepared for taking more risks, equities can obtain higher returns.

      Reply
      1. Pradeep

        I think in current scenario it is best to utilze your money in real estate which is growing at a minimum rate of 15% per year. At this rate you will double the money in less than 7 years. If you have excess money, it is wise to invest in a property.

        Reply
  2. Rakesh Tripathi

    I'd tend to think that the best thing to do should be to retire high-cost debt of Home Loans with the surplus funds which generally tends to fetch a lower post-tax
    return than the interest outflow that you'd end up paying on account of the home loan.

    Reply
  3. Credit Card

    I was thinking of buying a house or just get a house loan but because of your article, it makes me change my mind.

    Reply
  4. Anonymous

    I think in current scenario it is best to utilze your money in real estate which is growing at a minimum rate of 15% per year. At this rate you will double the money in less than 7 years. If you have excess money, it is wise to invest in a property.

    Reply
  5. sankar

    Hi,
    I got confused with last para. Finally is it better to repay(/partial payments) against loan than putting the surplus money in fixed deposit or better to deposit the money than repaying loan partially to avail tax benefits? Pls clarify.

    Reply

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