What Are the Benefits of Taking Out a Home Loan ?

A home loan provides benefits like tax savings, liquidity, and growth opportunities for those with sufficient funds to buy a house.

A well-managed loan is a powerful tool for achieving life goals, such as buying a home. However, many individuals have the funds to buy a home without a loan, but often face the dilemma of whether to use their savings to avoid debt or take a loan. There is no one-size-fits-all answer to this issue.

Home loans are not just for lack of funds; they offer numerous benefits to aspiring homeowners, including low interest rates, low prepayment penalties, and the option of floating interest rates. These financing options make home loans attractive to those seeking to purchase a home.

A home loan is a significant tax-saving tool due to tax deductions under Sections 24, 80C, and 80EEA of the Income Tax Act. Eligible home loan borrowers can claim a total tax deduction of up to Rs 5 lakh, which can reduce their tax liability by Rs 1.5 lakh if they fall under the 30% income tax bracket.

Opportunity to grow your fund

Buying a home using your own funds can save on taxes, but a home loan can be a more attractive investment option. Current interest rates on floating rate home loans range from 7.9% to 8.3% per annum, depending on your credit score, loan amount, and tenure. These record-low rates are offered after the RBI’s directive to link retail loan rates to external benchmarks. What Are the Benefits of Taking Out a Home Loan ?

If you have an 8% interest rate home loan with a total interest of Rs 3.5 lakh per year, you can save up to Rs 1.05 lakh on tax if you fall in the 30% tax bracket. The effective cost of borrowing is only 5.6% per annum. However, you can earn 7.5%-10% per annum by investing your own funds in various instruments, resulting in a higher return on your investment and lower effective interest on your home loan.

Liquidity benefit

During a liquidity crunch, using personal or collateralized loans may cost more in interest than a home loan. Therefore, it’s better to use your own funds to buy a home, as it protects against uncertainties and helps meet other financial goals, avoiding the need for a home loan.

Banks are required to conduct due diligence on property

Banks conduct thorough due diligence before financing a project, ensuring the project’s documents, title, and legal clearances are verified. This process reduces risk significantly, making home loans from banks that have already approved the project safer than unapproved ones.

The “own funds vs. home loan” dilemma has no single answer. Using your own funds for home purchases may be beneficial if it doesn’t impact other financial goals and leaves enough liquidity post-payment. This option is suitable for those uncomfortable with long-term debt management.

Below are the advantages of availing of a home loan

• Tax benefits under home loan: A home loan is a significant tax-saving tool due to tax deductions under Sections 24, 80C, and 80EEA of the Income Tax Act. Eligible home loan borrowers can claim a total tax deduction of up to Rs 5 lakh, which can reduce their tax liability by Rs 1.5 lakh if they fall under the 30% income tax bracket.

• Balance transfer facility: Home loans allow you to transfer your loan to a different lender if they offer a lower interest rate.

• Facilitate buying your dream house: Many people find buying a house a significant accomplishment, but owning the property is not feasible, making home loans, which can be repaid in monthly installments, an alternative option.

•  Saves you from paying rent: Metro cities’ higher rent prices strain monthly budgets, making it better to pay EMIs and own a house.

• Sense of accomplishment: House ownership is the largest purchase in most people’s lives, and owning a house brings a sense of accomplishment. Home loans help those unable to afford a house in one go, making it the largest component of their portfolio investment.

• Low-interest rate : Buying a home is a long-term decision over a 10-year period, and interest rates may fluctuate. Falling rates can provide benefits, such as allowing prepayment of loans and ownership of the home, and can occur during various interest rate cycles.

Requirements of first-time homebuyers

Mortgage approval depends on various factors, including income, down payment cash, and a credit score above a certain threshold. Lenders typically require proof of sufficient income for monthly mortgage payments, sufficient cash for a down payment, and a specific lender.

A first-time homebuyer is someone who meets specific criteria, such as not being in their 20s, to be approved for certain types of loans, according to the U.S. Department of Housing and Urban Development. This broader definition applies to individuals who are not already in their 20s.

Common Types of Mortgages

Conventional Loans

Conventional loans are mortgages not insured or guaranteed by the federal government and can be more challenging to qualify for than government-backed loans. They require a larger down payment, higher credit score, and lower debt-to-income ratio. Conforming loans comply with guidelines set by Fannie Mae and Freddie Mac, which buy loans from lenders and package them as securities on the secondary market.

In 2024, the maximum conforming loan limit for a conventional mortgage is $766,550, with higher limits in high-cost areas. Jumbo loans, made above this amount, carry slightly higher interest rates and involve more risk, making them less attractive to the secondary market.

Nonconforming loans are underwritten by portfolio lenders, who set their own guidelines, and due to regulations, they cannot be sold on the secondary market.

Federal Housing Administration Loans

The Federal Housing Administration (FHA), part of HUD, offers mortgage loan programs for Americans, with lower down payment requirements and easier qualifying. The FHA guarantees loans made by approved private lenders, reducing lender risk. This makes FHA loans easier to qualify for.

FHA loans are suitable for first-time homebuyers due to their less stringent credit requirements and the ability to make a down payment as low as 3.5% or 10%. However, these loans have limits, such as a single-family home loan limit of $498,257 to $1,149,825 in 2024.