Posts Tagged housing

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


Comments (9)