Home loan tax deduction is/maybe no more

One of the best things that I like about the proposed new direct taxes code in India is the lack of home loan tax benefits. Without much delay, let us start cracking with the advantages of doing away with such stupid laws.

The following points, when taken together, prove that home loan tax breaks do no good to the country, or its common people. If anyone was served by such laws, it was the builders and the bankers. Let me demonstrate how.

1. Lower tax rates compensate for lack of home loan tax breaks. It is as if everyone is getting more than the full benefit of home loan tax break, without taking a home loan.

2. Leverage: Home loan tax breaks encourage taking home loan even if you can save (partially or fully) for buying the house. Or if buying a house is more trouble than it is worth for you because of the mobile nature of your job, so you prefer renting. Encouragement of loan taking leads to over-leveraged consumer behaviour, similar to the US sub-prime mortgage trouble. Read up on the dangers of over leveraging here and here. Since home loans are very long term loans, there is the added risk of interest rates rising a lot which can even double your EMI and thus break your back.

3. Lower housing prices: Removing tax breaks for home loans would bring down housing prices. It is the simple concept of demand and supply. Today, people select a house based on the (EMI – tax break) they can afford. When tax break is no more, they will select a house based on the EMI they can afford. This brings down the demand price. The lack of tax break will mainly affect the margins of builders. As we know, builders are no cuddly teddy bears who cannot take care of themselves. Between the white, black and all colors of money they earn, they can better take care of themselves than any of their buyers or employees.

This point is complicated, read carefully. The absolute amount of money in the hands of consumers is higher because of lower tax rates so real estate prices may not come down in absolute terms. But relative affordability of houses as compared to, say, cars/stocks/clothes/food/travel will increase because there is no tax deduction just for paying interest on a home loan.

Initially the builders will try to maintain the high margins by delaying projects and reducing the quality of buildings. So the buyers will have to remain cautious in buying newly built houses for a while and check the quality thoroughly before buying. But we need to do that anyway. See a video by a Unitech customer here.

Upto a few weeks ago, I had assumed that the Government will never be able to defy the powerful builders’ lobby and such tax breaks will remain forever as evils of Indian democracy. But my faith in Indian democracy has been restored to a small extent. The Government has at least proposed to do away with tax breaks for home loan. Well done ministers / babus / everyone involved. I think hon. Finance Minister Pranab Mukherjee should not get all the credit for this, as hon. former Finance Minister P. Chidambaram and team had started work on this code and it might be his legacy.

Dangers of this proposal:

1. The biggest danger is, of course, of the Government surrendering against the real estate lobby and re-introducing the stupid home loan tax deduction.

2. Since the builders have cash to burn and the power to wait out, people who want to buy a house in next few years might not get the full benefit of lower house prices. Hence they might have to make do with lower quality house than if they waited a few years for house prices to react to this news. Eventually, of course, no one can beat demand and supply.

3. Of course, the price of your house may be less now for the same reason: the buyer of your house will not get any tax break for taking a home loan to buy it. But I guess it is a very small price to pay for more affordable housing for everyone, including your future self and your kids.

Related post: Risk Analysis of investment: Real Estate vs Equity

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9 Comments »

  1. I’m so glad I found this site…Keep up the good work

  2. Hey good stuff…keep up the good work! 🙂 I read a lot of blogs on a daily basis and for the most part, people lack substance but, I just wanted to make a quick comment to say I’m glad I found your blog. Thanks,)

    A definite great read.. <a href="http://wiki.hudson-ci.org/display/~bill-bartmann&quot;

    -Bill-Bartmann

  3. Do loan modification companies really help you save your home from foreclosure or just take your money and leave you high and dry? Anybody have any experience with a loan modification company at all?…Thanks,

  4. Yes. Similar laws were brought in USA in 1986 and housing markets slipped there. Affordable housing is only possible if this rule is implemented. Speculation and Bubble in Housing market would be curbed.

    Good analysis.

  5. Vaibhav Saha said

    Kudos to you for giving such a vivid view of the implications of the Direct Tax Code 2011! And hearty congratulations to the Ministry of Finance for finally endeavouring to rationalise the personal tax structure in India. Many of these initiatives were long overdue and will be welcomed by common man. But a few of these, especially the withdrawal of tax exemption on interest on home loans will be misunderstood for some time before people grasp the real intention behind it.

    With economic prosperity, we also got our share of accepting some over-blown western myths like the ever-expanding worth of real estate. Though housing needs in India are far from fulfilled, we need to beware that the fulfilment does not end up commoditising the housing sector, which is of vast socio-economic importance.

    Given that half of our population still strives for daily existence, the basic necessities like Food and Shelter should be kept away from the trading designs. We have been relatively fortunate that we have had only a limited impact of such commoditisation, as the housing prices came crashing down and food prices spiralled upwards across the country in the past few months. And it is a lesson fast learnt by the government despite the obvious pressure from the strong construction lobbies.

    Prudence at the systemic level is the moral of the story!

  6. sureshkumar said

    Fine This give me an very good idea behind this tax code system.

  7. Tarun said

    Sir wat about the persons who have already taken home loan dear? pls elaborate…..

  8. rahul said

    I apprecaite your reasons for removing tax benefit from home loan. however it would be better if exemptions are allowed for self occupied property. So that, people will be able to buy homes for self ocupation, but wont be able to do it just for investment i.e. buying second or third home and taking tax break.

    • businesspandit said

      If you maintain that exemptions should be allowed for self occupied property, you do not appreciate my reasons for removing tax benefit from home loan.

      No one is preventing anyone from buying homes for self occupation even if there is no tax exemption. High property prices is not a concern if you see the point about how removing tax exemptions helps in lowering property prices.

      Why don’t you argue that tax exemptions for second and third homes lowers house rent for poor souls?

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