In the last eight months, the RBI has cut policy rates (repo/reverse repo) by almost 150 basis points. But this is not all – interest rates are expected to fall further in the coming months.
As a country’s economy graduates from that of an under developed one to a matured one, interest rates are bound to fall. Sample this. According to data compiled by the RBI, the minimum lending rate at which commercial banks lend (including SBI) stood at 19 per cent in 1991-92. This has more than halved to 7.5-8 per cent by 2010-11. India’s nominal GDP which was $293 bn in 1991-92, is estimated to be around $2.4 trillion in 2015-16. With the economy expected to sustain healthy growth over the next few years, one can expect rates to only fall furthermore. If you are in the higher income bracket falling rate cycle is good for you, because a lower interest rate regime can help you save more. Here’s how.
With the RBI expected to progressively cut policy rates, banks will follow suit and lower their interest rate on loans. You can thus look forward to cheaper housing and other loans. This is a win-win because buying a second home in a falling rate cycle can help you save big money on the interest outgo besides availing tax benefit on the interest paid. Though lower interest rate, means lower tax benefit, it is still good for you because the actual saving on interest outgo is far higher than the tax break on your interest. Consider the example below.
If you plan to avail home loan of say Rs 60 lakh to buy a Rs 80 lakh worth property, at the current interest rate of say 10.5 per cent and assuming loan tenure of 15 years, you may end up paying Rs 59.4 lakh as interest over the loan period. You are paying twice the principal amount to close the loan.
Longer the loan tenure, higher is the interest outgo. Keeping the loan amount and interest rate constant, if you increase the tenure to 20 years, the interest outflow alone for the Rs 60 lakh loan works out to Rs 83.7 lakh. But the tax saving if you are in the upper end of the tax bracket will be 30% of the total interest outgo. That is, on a 20 year tenure loan the maximum that you can save on tax is Rs 25.11 lakh.
Now assuming that the interest rates gradually come down, and your effective interest rate reduces from 10.5 per cent to say 7.5 per cent, the interest paid is Rs 56 lakhs, a saving of Rs 27 lakh, plus any tax saving you can avail on this. So this is higher than the Rs 25.11 lakh that you will save on the tax outgo.
The property can also give you rental income. If your property is in a prime location, you can expect to receive a good sum as rental income. You will have to disclose the rental income for tax purpose and can claim tax exemption on the entire interest component of your equated monthly instalment.
Of course, given that rental yields today are at abysmally low levels, long term asset price appreciation and tax saving may be the main motivation to invest in real estate. A property typically appreciates over time, unless it was bought in a high during a bubble. And buying it on a loan would increase your return. For example, say a home priced at Rs 50 lakh appreciates by 5% a year for 3 years. If you only put in 20% as down payment, then your gain is 5 times. How so? The appreciation after three years will be Rs 7.9 lakh. If you only put in say Rs 10 lakh as down payment and even if you paid Rs 5 lakh as interest and principal, your return is upwards of 50%.