Mar 4, 2013

Fretting over the FinMin's brain-farts

I recently bought a house, and as is usual in such situations, the loan has seriously cut my disposable income. So I was hoping for some help from PC when he presented the Union Budget last week, and was even encouraged when I heard something was being offered for new home loan borrowers. When I heard the details of what he was offering, though, I was very disappointed. Let's dig into why.

The FM has announced an additional exemption of Rs 1 lakh for home loans under Rs 25L, if it is the first time the borrower is availing such a loan, and if the property value does not exceed 40L. Now, if you live in Bangalore, NCR, Chandigarh or any major city - you'd know that's not enough to buy a decent 1,000-ft 2bhk flat in areas that are commercially developed AT ALL (or even safe). So, middle & upper income families in big cities cannot benefit from this.

Some argue in defense of this - they say the govt is only helping those who really need it. But I don't agree because this is a classic example of govt. attempting wealth re-distribution, which is a fundamentally flawed idea that has never worked well anywhere in the world. It doesn't work because it is unfair and unnatural - it demotivates those who produce wealth, and those who receive the benefits neither appreciate their worth, nor have any incentive to work harder.

Now, I'm all in favor of higher tax rates for the rich and govt. support for the poor, but that support should be provided in terms of infrastructure, employment, education, healthcare etc. Those are basic needs. Home ownership is not. That becomes wealth redistribution.

Closer examination of the proposal reveals its true nature - it's an election freebie thrown at a vote-bank, and made to sound bigger than it really is. Let me explain.

1. Most people stretch their budgets when buying a home. It's the sensible thing to do. So we can assume that anyone taking a 25L loan can't really afford a bigger loan (in other words, a better house).

2. Banks typically give loans based on household income. Some rules of thumb - EMI in thousands is numerically almost equal to loan amount in lakhs. Banks assume that you can set aside 50-60% of your monthly gross salary for EMIs. So, a 25L loan means the borrower has an income up to 6lpa (with assumption 1).

3. If only one member of the family is earning, they can still avail deductions of at least 4.5L on their income (2L basic + 1L 80c + 1.5L for int. on home loans already available to all). If they avail exemptions for any allowances (HRA, LTA, food, conveyance etc.) or other exemptions like medical insurance premium, donations to charity etc., this figure (deductions) goes up. If two members are earning, this figure goes up much further. The point is, if your household income is less than 5L, you already pay no tax and will gain nothing. Even if it is higher, but you've planned your taxes well, you'll still gain nothing.

This means the new tax proposal really only benefits some households with incomes in the 5-6 lpa range. At 5 lpa, you can just save a few rupees. Beyond 6lpa, you'll probably take a bigger loan and not qualify. Within this narrow range, you can save up to Rs 9,700 per year, or ~808 per month, if you take a loan for 25L on April 1. Note that this is an upper limit. The majority of beneficiaries would save less than this.

I don't think the benefit is very size-able for the target income group, but I could be wrong about that. Even if it is, why is the govt. being so selective in offering it, and with so many strings attached? I feel the govt. simply doesn't have the funds to be magnanimous, which I can understand. But this looks like a charade aimed at an electoral constituency that is becoming increasingly alienated from the current govt. These people protest about corruption, about scams, about women's safety and many of them admire regional leaders like Modi. So the govt. throws a little carrot at them. Typical Congress politics, and I hate it.

While on the subject of home loans and taxes, I have a few more bones to pick.

Tax exemption on interest paid on home loans is capped at Rs 1.5L. This means if you are paying a rent exceeding Rs 15k a month and using up all your 80C exemptions, your tax liability will almost certainly go up if you buy a similar house and start living in it. This is because you will no longer be able to claim tax exemption for HRA. Nearly all governments globally claim their policy is to encourage home ownership, but our current income tax regime acts as a barrier.

You can legitimately work around this by registering the property in your parents' name(s) and paying them rent, as long as they aren't living in the same house. This will allow you to claim HRA and also your part of the interest paid on the home loan. Moreover, if your parents are also repaying a part of the loan on the house, the interest they repay is fully tax exempt with no limit (I think) and the rental income is also tax exempt if it is lower than their EMI. So between both parties, you can save a lot.

The above arrangement is perfectly legal, although in my opinion it is unnecessarily convoluted. Worse is that it encourages bogus transactions. People pay inflated rents to their parents to evade tax, and then take the money back in cash form. It becomes black money. A lot of people may not want to do this, but the cost of being completely honest is unreasonably high.

Things would be so much simpler if the limits on home loan repayment were relaxed or abolished. Not only would this obviate the need for complex or bogus contracts, under-valuation of sales, over-statement of rents etc., the tax benefits will significantly accelerate demand for properly-accounted home loans among the upper-middle class, which is way better than having the market operate with a lot of black money. The govt is also nearly certain to gain with higher tax collections.

Now, while I'm no expert on policy or the country's financials, I'm fairly sure the scenario I've described above would be a win-win for all. Why doesn't the govt. just do this, then? I suspect the real reason is that our political establishment and decision-makers are themselves the biggest stakeholders in the property black market!

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