The modern day consumer is in a perplexed state owning to the multiple loans he has to service for fulfilling his various needs/ wants.

So are these loans bad or bad?

Loans, probably being my ‘middle’ name, this question coming from me may surprise many as I have been advising consumers on various facets of loans for many years on a day-to-day basis. Here I would like to draw a parallel from Bollywood movie Dayawan where film ends with a question by child character – Was Dayawan (the protagonist who plays a mafia don with a heart of gold) a good person or a bad person?

So it depends on your perception.

They are good if you are able to manage and balance your loan portfolio, besides having a good repayment capacity. But it becomes a messy affair if they are not managed well or your repayment capacity takes a beating.

Ideally loans should be a means of creating assets or enhancing earning capacity. Then they are also a means to attend to unexpected emergencies. They are a “must” whatever situation you are in but the purpose of the loan plays a crucial deciding factor. The other deciding factor is the cost of the loan. The purpose of loan must also be cost effective. As you need loan to fulfill the need for more than one asset at a time, it is very important to priorities your loans.

If you are undertaking “hair cutting” course for Rs. 20 Lacs, it may not be worthwhile, as the earning capacity may not be enhanced that much. Even when the loan is for a good purpose say paying the fee for an educational course that will substantially add to the earning capacity but if the cost of the loan is too high, then it will not remain a good loan.

At the top of the hierarchy most loans taken to fund education for self or a family member would normally qualify to be a “good” loan as they create substantial earning capacity relative to their cost and are normally available at a reasonable interest cost. Tax breaks on the interest would also reduce the post tax of the loan substantially.

Second would be loan taken to fund a reasonable cost house for your own residence. Normally this asset price appreciates in value and will also act as a source of pension income or retirement through the medium of a reverse mortgage. Third would be a loan taken to buy your own reasonably priced vehicle (two-wheeler or four-wheeler). This may result in a boost in your productivity given that public transport in most cities in India is quite poor.

Then there are loans taken for consumption such as for funding or an expensive/ luxury consumer durable.

Basically there are two types of loans - Secured loans are loans such as home loan and vehicle loans. They are backed by your assets in order to minimise the risk assumed by the lender. The assets may be forfeited in case there is a failure to make the necessary payments.

Whereas unsecured loans are personal loans and credit cards, where the lender has no entitlement to any of the borrower’s assets in case borrowers fail to repay the loan. Such a loan normally carries a higher interest rate than a secured loan. Repayment plans of loans vary based on each type of loans. Home loan repayment plans can be as high as 20 years or more, whereas vehicle loans can be repaid in 3, 5 or 10 years, and the credit period for credit cards is around 50 days.

The consumerism boom fuelled by the presence of modern places of worship – Malls, has led to the phenomenal growth of plastic money. Swipe…swipe…swipe is the new mantra chanted by one and all. And the prasad of this mantra is debt…debt…and more debt. The debt on the credit card for longer duration will land you in a financial mess. The borrowing on credit card should not exceed 30 – 45 days, as interest charged is very high on such credit.

Last would be loan taken for speculative purpose such as investments in stock markets. These are strict No-No.

I would like to quote Benjamin Franklin here: “Remember, credit is real money,” which we tend to forget.

Thus it is important that you make it your personal goal to pay your credit on time as it will impact your credit rating.

So to end – remember loans can be very useful – nay – essential to improve the quality of your life and your future generations. At the same time it has the potential to destroy your life if used unwisely.

Ever wondered if you have a single source to manage, execute and account for all your personal financial planning needs like retirement planning. insurance planning, taxation planning, investment planning, loans, mortgage and cash flow management. It would make lives considerably easy cause you wont have to run behind ten different people to get a hold of all your personal finance documents and account statements. With a financial planner your financial management will be easy swift and all in one place.

The biggest advantage of a financial planner is that he will not be a salesman trying to sell products to you with the main intention of filling his pockets with the commissions of the products he sells to you. His main goal and motive is to keep you financiallly safe and secure and help you achieve your goals.

Many agents and salesmen in India pronounce themselves as a financial planner but the diffrenciating factor is that if a person is an agent or a representative of any company then he will not be in a position to give you unbiased advise as his aim will be to tell you some story and sell his companies’ products to you. To be an unbiased advisor the person must be able to provide a comparison of various available product options.

Financial planners charge fees from their clients for the advise given just like a doctor, lawyer or an architect. The advise is genuine and based on the clients needs, budget and after a detailed analysis of several available options

I had an urgent phone call from my son Akshay about his credit card payment that was due in a couple of days. More about that later. But first let me give some background.

Akshay had the good fortune (or is it misfortune) of growing up with me and the lesson drummed in his head always was that credit cards are a great convenience tool as long as you do not overspend and take care to pay 100% of your dues before the due date. In fact during his college days in Pune (I am based in Mumbai) he had an add-on card (see box for what are add-on cards) issued against my own credit card. The understanding with him always was that this credit card was to be used only for emergencies or for making expenses with my prior approval. However in practise some expenses did creep in on the add-on card (to be fair only on a few occasions), which I paid off as it was billed on my main credit card. What worried me were not the actual expenses as the fact that Akshay was beginning to fall for the allure of the so-called “painless” nature of making payments by credit cards. Being a personal finance expert it became a challenge for me to provide Akshay the experience on the whole cycle from incurring expenses on the credit card to actually paying it off. Given his profile he was not eligible for his own credit card.

It was not until he had completed his studies and had started working in Auroville (near pondicherry) that I hit on the solution. I got him a credit card from Kotak Bank secured against a fixed deposit made with them. Since the credit limit on such cards is around 80-90% of the fixed deposit amount, it is fully secure and Kotak (and other banks that issue such cards like Axis, ICICI, HSBC) is therefore able to issue it to all those who seek such cards. I made the fixed deposit on Akshay’s behalf but the card was in his name. I also made him aware of the charges and interest that he will have to pay if he delays payment even by a single day. Obviously he would have to pay for these charges from the modest stipend he was earning. I also told him about the Credit Bureau (in fact showed him my own CIBIL report) and the impact any delays in making such minor payments would have on the major education loan that he wanted to take after 1-2 years for overseas study.

What are add-on cards?

Card Issuers normally provide a facility to provide additional cards (called add-on) cards to the relatives of the credit card holder. These are issued only at the request of the main cardholder and the liability incurred on these add-on cards is that of the main cardholder. The overall credit limit remains the same and is applied on the main card and all the add-on cards put together. Normally a facility is also provided to the main card holder to restrict the credit limit on a specific add-on card so that he can control which relative is able to use how much of his credit limit. Since the payment of expenses incurred on an add-on card has to made by the main cardholder the add-on card holder does not experience the full cycle of credit card from incurring the expenses to paying off the credit card bill.

Which brings me to the reason for the phone call that Akshay had made to me. Clearly my lessons had worked. The first credit card bill was due in a few days and his card-issuing bank did not have a branch at Auroville. His stipend and the savings that he had from his summer internships were all in another bank and he was worried about how the money was going to be transferred to Kotak in time for the payment. Ultimately we worked out a solution where he withdrew cash from his salary account and deposited it in his Kotak Bank account at Chennai (yes – he actually travelled about 160 kms to Chennai specifically to deposit the cash) and then transferred the money electronically from his Kotak Bank account to his Credit card account with them. Although I could easily have found a solution by depositing the money in his credit card account in Mumbai, I let him sweat it out, as I wanted him to internalise the lesson, which he is unlikely to forget in a hurry.

And what did Akshay think was the moral of the story. In his own words “Credit Cards are like Swiss knives – extremely useful nay indispensable in an emergency – but they need to be handled with care or they can cause serious injuries”.

What a great analogy Akshay.

What do you think? I would welcome your comments as also any of your own stories on how you taught your children the value of using financial tools responsibly.

The story is about a Public Sector Undertaking (PSU) which came up with an ultimate refrigerator. With its lowest market price, standard features and much lower power consumption, it was quite a buy. The Company appointed a dealer network which was experienced in selling consumer durables of other manufacturers. Now that Company was confident of its superior product backed by good dealer network, it did not feel the need for any advertising budget and paid peanuts as compensation to its dealers. But there was no manufacturer ‘warranty’ on the refrigerator.

The refrigerator was launched and now the time had come for the Company to take stock of sales after six months. The verdict was clear. Inspite of being a superior product, it was just not taking off. The customers were not even aware of the product. The dealers also made no attempt to sell the product to the customers who walked into their showrooms as they were not making any money. In fact, few customers who had read about the product in the newspapers, came asking for it were skilfully diverted to other competing products. Reason being - the dealers made more money on such competing products even though they were not as good.

Clearly the manufacturers dogma that if you make a good product consumers will come and get it had taken a beating here.

If we substitute this analogy with the Pension Fund Regulatory and Development Authority (PFRDA) for the – the PSU refrigerator manufacturer, Banks (Point of Purchase) for the dealers, the New Pension Scheme (NPS) for the new refrigerator and lack of guaranteed returns for the absence of warranty, you have the similar result.

Let’s analyse the scenario here in detail:

The high household savings rate in India has been much touted. Perhaps this drives the thought that the savers/investors have no choice but to channel a part of their savings in this otherwise excellent long term savings scheme – the National Pension Scheme. However, most Individual savers in India prefer traditional savings instruments such as land, gold and bank fixed deposits. One thing common among these instruments is that it requires one time investment with no obligations on making a regular contribution over time. In fact even here the relatively newer products such as PPF, NSC etc. which are safe and provide good returns also needed support from individual sales agents to make sure that the operational difficulties in investing in these products is taken care of.

This kind of investments naturally favours the relatively better off people since they would have the lump-sum available to invest. The whole concept of systematically saving and investing something over time to fulfil a financial goal requires discipline and commitment.

Considering this NPS is a good scheme and no doubt gives excellent results but it still is a tough sell especially if the return is not guaranteed. As a result such products need both – wide publicity as well as reasonable incentives for the selling. Unfortunately both are lacking in the otherwise excellent pension scheme. Thus perhaps leading to an excellent product, not ready to take off. (It is not just the current tax disadvantage that this product suffers vis-à-vis other savings products that is causing such low off take). Moreover the general awareness of the product itself is quite low.

Another potential future issue is the extremely low fund management charges paid to the fund managers. To give you an idea - if the fund house is managing Rs.10,000 Crores of funds, the total payout will be Rs. 9 lacs only which is not even enough to cover the salary cost of a single executive. Obviously either the managers hope to make some money in some other manner (brokerage etc. for their sister companies perhaps) or will perhaps loose interest in the business over time. Anyway this will become a problem only at a future date when the scheme becomes popular.

We hope that after the proposed tax changes take effect in 2011, we will also see changes in the selling structures and incentives for all the stakeholders in the NPS.

We wish that this unique scheme which can be a boon for Indian investors looking for long-term disciplined savings does not meet the same fate as that of mythical PSU Refrigerator manufacturer mentioned above.

Be an Investor

Use Money in Order to Make More Money follow the “Cash Flow Quadrant”

There are four types of income generators in the world
1.    E – The Employee safe and secure job.
2.    S – The Self - Employed own their own job.
3.    B – Business owner why to do it yourself if you can hire someone to do it for you like Tata, Birla etc.
4.    I – investor who makes money with money.

AS SAID RICH V/S MIDDLE CLASS

Rich Earns    - 30% from E or S and 70% from I
Others Earns - 80% or more from E or S and 20% or less from I

Let’s resolve in 2010 to be an INVESTOR:

The Must Haves!

• “Health is wealth” Absolute Truth; when it comes to health. Remember, for yearly executive health check up. Cover your family under Regular Mediclaim / Family Floater Plans & enjoy tax benefit u/s 80D. Sec 80D allows deduction of max limit of 15000, additional limit of 15000 for coverage of dependant parents and for senior citizen the limit is 20000. Opt for LIC’s Health protection plus alongside  and enjoy tax benefit of Rs 15,000 from 2 different files. Sec 80DD allows deduction of max amt of 50,000 or Rs 1, 00,000 for treating maintenance of severe disability for dependent family members. Sec 80DDB includes deduction of medical expenditure on treatment of prescribed ailments.

• “Review Liability Portfolio “ when Too Much is Dangerous clear all your liabilities especially when we are not getting tax benefit out of it e.g. personal loan, car loan, other than business loans and education loan so that we have complete financial independence. Sec 80E includes tax relief of interest payment on education loan for higher studies of child, spouse & self.

• “Home Loan” Let You Family Inherit the House Not the Home Loan; owing a house is not just a dream but a necessity and there are several tax benefits as well. We can always opt for housing loan, as interest paid on home loan can be deducted up to 1.50 lacs, it can be doubled in case of joint borrowers. Further there is no cap on deduction of interest if the house is either let out or deemed to be let out u/s 24 as this can be worked out as a good tax planning tool at the same time it creates asset for you.

• “Life Insurance “is a plan that exalts life and defeats death; At any time human life value in society is far greater in magnitude than value of all property put together.Life insurance plans not only gives peace of mind, but also help us in securing our liabilities. Premiums paid also qualify for sec 80C & 80 CCC. The maturity proceeds are tax free u/s 10(10D)

• “Ready to retire rich ?” Chase your passion, not your pension; With stretched work hours and strenous routines, saturation level are setting in earlier for the youth today. In such a scenario, early retirement has beecome more a need than desire. Remember, the later you start for your destination, the faster you have to travel …the later you start saving for retirement, the more you have to accelerate your rate of saving You can earn tax free monthly income per month by investing monthly from today. Retirement planning assures dignified and independent life.

• Key Person Insurance ; It is an old cliché, but a true one nevertheless, that one of the most essential elements in the success of any business is the quality of people working within it. As a business owner you are a valuable asset to the company ensuring yourself can ensure your company’s future and protect the future of your business. Cost (premium) under Key man Insurance is 100% exempt from business income u/s 37(1).

• “Prepare for Education and Childs Marriage” through mutual funds. With higher apetite to take risk at younger age we can consider investing in mutual funds or unit linked policies  with respect to short term planning. Investing amounts is SIP’s can lead to better results than having lump sum in traditional bank by taking advantage of the volatility in the market.ULIP and few mutual fund schemes are eligible for deduction u/s80C.

Note;The premium can be paid upto Rs 1,00,000/-to avail deduction u/s 80C,80CCC. However the limit of 1Lac can be exhausted by paying premium under any of the said section

• “Succession planning “the key to better planning; Succession Planning combines elements of business design, ownership/management succession, wealth accumulation, retirement design, and estate planning. For further reference we have added the factor on our website www.bharatparekh.com at InstaWILL

• “New Direct Tax Code”; In this budget finance minister is planning to introduce the DTC code which is believed to more simplified and easy but lets talk abt it once it comes.

Please check if you’ve taken the benefit

• Sec 80C/80 CCC  -  Investments upto Rs 1.00 Lac in Life insurance, ULIP, NSC, tax saver - bank deposits, mutual funds, post office schemes, EPF, PPF, Prin. Payment - home loans & children’s tution fees

• Sec 24  -  Upto Rs 1.5 Lacs on home loan interest payments - For joint borrowers Rs 3.00 Lacs. For let out property, no limit on deduction of interest

• Sec 80E  -  Interest payments on education loan taken for higher studies

• Sec 80D -  Deduction upto Rs 15,000 under mediclaim/ health insurance policies. Additional Rs 15,000 for cover of dependent parents. Sr. Citizens, limit is Rs 20,000

• Sec 80 DD  -  Upto Rs 50,000 for treating  maintenance of a handicapped dependent/ Rs 1,00,000 for treating maintenance of a dependant family member with severe disability. E.g. amt deposited with LIC under Jeevan Adhar plan.

• Sec 80 DDB  -   Deduction on medical expenditure on prescribed ailments

• Sec 37(1) - Cost(premium) under Key person Insurance is 100% exempt from business income u/s 37(1)

Last but not least the “Right Choice”: choose your financial advisor with

• Service Attitude
• Thorough knowledge in his domain
• Efficient team
• Rich experience
• Strong client base.

Planning to get retired after getting rich is a dream of every person today engaged in earning a livelihood for achieving a sound financial and monetary base. Get rich retirement solutions have also gained prominence due to the fact that present day life is full of uncertainties like serious health disorders, unexpected accidents, even death that may leave family members of deceased retired person into financial crisis if he doesn’t create strong money and finance provisions for providing a happy and secure life to his family. Recently with development of Indian economy due to increase of foreign investments in Indian government as well as private sector youthful job professionals of India have seen salary increments and hikes. Along with meeting important requirements of life including basic necessities like housing, food and clothing today every youth is looking forward into the future for achieving maximum money savings and a secure financially rich retirement from his job at a very early phase. Tips given below may guide you select the best financial savings and investment plan:

• Gain control on your financial expenses:

A simple life style enhances more money savings and enables you to invest your hard saved money into a high monetary return and long term retirement investment plan. Just take control on your hi-tech cash payment transactions. Devote your attention in simple yet easy daily routine pursuits like spending with your family and friends, simple hobbies like reading, writing, walking and traveling along outskirts of your city on a small picnic this won’t cost you too much.

• Keeping your financial and retirement goals together:

Easy, early and rich retirement solutions require keeping your financial and retirement goals together. In the early years of your job you should plan your financial goals and devise ways to achieve it. Chalk out your individual as well as family expenses if your spouse is earning then you could frame a monthly family budget with combined income of yourself and your life partner. Then you should select a reliable income generating retirement plan after keeping current age human life expectancy as well as current inflation hikes.

• Make your self inclined towards more money savings:

For selecting the best, reliable and get rich retirement plan you should avoid increasing your lifestyle expenses no matter your salary is increasing constantly. Each fraction of money saved is money gained. Financial experts dealing with life insurance, mutual funds, shares & equity including income generating retirement solutions suggest to devote 25% of monthly income in savings.

• Start investing money early to double your money:

By investing money early you can double your money as after every 5-6 years rate of money returns on financial return also double. Whereas in loan plans and mortgage interest rates on money recovery increases.

• Choose a long period retirement plan:

Choose a long period retirement plan or finance investment solution prepared with correct monetary logistics. For this purpose you could consult an experienced financial consultant at periodic intervals.

• Try to create additional sources of income:

By creating additional sources of income you make your life easier from monetary point of view as it helps you to pay high amount monthly, half yearly or annual investment premiums on rich making retirement plans. For this purpose you should review your talents and explore part time job solutions that demand less investment of time daily. By following these simple tips you could enhance chances of get rich along with a secure retirement.

“Should I let my son go for an MBA overseas?”

This innocuous little question on Apnapaisa “Ask the expert” section caught my attention.

Why this question?

Which father would not want to let his son do an MBA overseas? I questioned myself.

To look answers for our ( His & Mine) questions, I decided to dig a little further to find out what was the dilemma about.

Let me share the dilemma and the solution here:

The reader Dinesh Sehgal (name changed) was in his early 50s and was working as a mid-level officer in a Public Sector Undertaking (PSU) in Delhi. He had married off his two daughters and his only son was an engineer and working with a Delhi based Software Company. The expenses incurred on bringing up his children and their education and marriage and his own modest income (Rs. 7 lacs per annum net of taxes) meant that he had no significant investments/savings. He had his own house (worth around Rs. 55 lacs) though with a home loan of Rs. 18 lacs still outstanding on it. His son wanted to do an MBA in Australia, which would cost him around Rs. 20 lacs. His son had savings of around Rs. 5 lacs and was looking for an education loan of around Rs. 15 lacs. A PSU bank had also agreed to provide this loan but required Dinesh to be a guarantor as well as to provide the house as a collateral security for the education loan. The PSU bank was prepared to take over the existing home loan as well from the existing lender.

If it was all set, then what was the problem?

Clearly Dinesh was having second thoughts. His only serious asset was the house and he was worried about loosing his house in case the son was not able to repay the loan for any reason. An unstated concern was perhaps whether his son would be responsible enough to pay of the education loan or leave him holding the can after completing the course and starting of his career. At the same time he badly wanted his son to get the additional qualifications so that he could progress in his career.

A real dilemma, this!

Even this left me perplexed, like what to advice him? As a fellow Indian I understood Dinesh’s desire to do the best for his son. At the same time as a Financial Planning professional it was clearly not advisable to expose your only financial asset to the risk in such a manner.

I must confess, I was a bit confused. After lot of discussions with our financial planning team (all of whom are much younger – with only one of them having a child aged 7 years - and hence not really in a position to empathise with Dinesh’s dilemma) I gave worked out a typical Indian style compromise solution.

My first question to Dinesh – Are you prepared to borrow money against the security of your house to lend to your son for the purpose of his higher education?

His reply was, “ If I could be reasonably sure that my son would pay it back.”

My next question - Under what circumstances did you expect your son not to repay the loan?

He mentioned the following reasons:

1) He will fail in the course – given his brilliant academic track record so far this was unlikely

2) He will fall sick or have an accident preventing him from completing the course – this is an insurable risk and should be covered by Insurance

3) He will complete the course but not be able to get a job – given his background this position at worst can only be temporary

4) He will get a job but due to other responsibilities (marriage, job overseas, etc…) neglect to repay this liability.

The last point was the real concern area. Normally, I told Dinesh, you depend on our culture and traditions to make sure that the son will pay for the father’s debts. (read the story in DNA dated November 21).

Analysing his state of mind, I advised that in your case the debt was really taken by your son himself and only guaranteed by you. A good compromise option would be to draw up a legal document between you and your son making it clear that whilst both are joint borrowers on the bank’s records, the loan has been taken for the purpose of the son and as between themselves he is fully liable to repay the loan. This document along with the normal social pressure that exists in our society should be a reasonable safeguard against the son neglecting to pay back the education loan even though being capable of paying of.

Dinesh has not got back to me on this and I am not aware whether he actually followed my advice. Could there have been a better advice in such a situation?

I invite the views of all you readers on Dinesh’s dilemma.

I was pleasantly surprised to receive a call from Raj Gupta, who has been a close friend since my CA days. But bigger surprise unfolded when he told me that he had won an argument with his wife for the first time in life,  all because of me!

He was very excited, thanked me profusely for my article in DNA. ( Refer my article on October 3 – Buy another home…)  I was even more surprised to note that my advice can make people win an argument with their wives. ( A thing that I have personally never been successful at).

Naturally my interest level in the conversation rose. I was keen to know the details. He explained that for last few months he has been arguing with his wife over buying ready made farm house-cum-plot near Karjat, approx. 100 Kms from Mumbai. His  wife has been opposing the plan, closing that it was a luxury that they could ill afford at this point of time.

And my above article extolling the virtues of buying a second home helped him in convincing his wife that it was not a luxury purchase but an investment he was making for their retirement.  Raj said, “See, even Harsh supports my view”.  Hence Raj was extremely happy with the article. 

Paradoxically I need to clear this illusion not only for Raj but for all of you who have stretched my advice a bit too far. What my article really suggests is that buying another house which is capable of being rented out.  It can be a good retirement planning tool. Moreover it should not be important that whether you would have yourself liked to stay in that house or treat it as weekend gateway. You should buy from a rental perspective. In fact buying a house in smaller towns that you have some knowledge and connection with, might be a great decision given the fast pace of growth that is likely to be experienced by smaller towns and might give good returns over a long period of 20 years.

But what Raj  was proposing is not in consonance with my suggestion, as a leisure property  could hardly be rented out on a continuous basis. Besides it is difficult to liquidate a leisure property as it cannot be sold easily thus becomes difficult to realize the value of such properties in India. Despite growing economy, FDI influx, rising urban incomes, reach of internet and many such factors, leisure property market is not very well developed in India. Moreover, there is lack of transparency at the operational level and so is the depth in such markets. Hence, getting resale value of a leisure property is very difficult, getting rental for the leisure property is even more difficult.

Let me add here that even the builders of such leisure properties have to rely on large marketing organization and marketing campaign to sell them and it is quite time and effort consuming process. This is not practical for an individual looking to sell his leisure property.

So should you never buy a leisure property? No, I am clearly not saying that, But it should not be bought, thinking it is a good investment. It should be bought from that part of your assets that are allocated to pay for luxury that most people are entitled to after achieving a certain earnings and savings status. Buying it under the mistaken notion that it is a great investment, could perhaps be a big financial mistake. In the event of any stress in your financial life, your ability to liquidate that leisure property quickly might be very difficult. But clearly all those of you who want to get away from all the distress around and connect with your families over the weekend, in a self-owned weekend gateways can positively impact your overall lifestyle and improve your earning potential. To that extent it can be considered to be well spent.

So I am not surprised that once again another wife has won the argument.

Alas! my friend Raj’s happiness was short lived. But then he, like most of us, is a good loser and gives in with grace when he knows he cannot win the argument.

Most people build a nest egg for their retirement by investing a regular sum of money into a Systematic Investment Plan (SIP) of a mutual fund or buy a pension plan from an insurance company or regularly invest in a bank recurring deposit or government backed instruments such as PPF and NSC, etc. A very few well-informed consumers are also opting for the newly launched New Pension Scheme.

But there is another very effective means to build a sizeable pension corpus - Buying another residential house for the purpose of deriving rental income as well as long-term capital appreciation.

I will illustrate this with an example.

Mr. Prabhat Varma has ability to pay a down payment of Rs. 2 lacs and can service an EMI of Rs. 6,000 every month (in other words he is able to save Rs. 6,000 per month).

This means that he can invest in a house worth Rs. 11 lacs for which he will be able to get a loan of around Rs. 9 lacs. The EMI for this 20-year loan at 9% is around Rs. 8,100 per month, which Mr. Varma will easily be able to pay from the rental income (estimated at around Rs. 3,000 per month), clubbed  with the existing savings of Rs. 6,000 per month. The tax deduction on the home loan (for rental properties the tax deduction will continue even under the new Direct Tax code) and any potential increase in rent in later years is just an icing on the cake.

Even if we assume a rather conservative 10% p.a. capital appreciation the property will be worth Rs. 74 lacs at the end of 20 years. Thus the easy availability of home loans even for residential property bought for the express purpose of renting it out effectively turns this investment into a SIP into real estate. 

While Mr. Varma crystallises his plan for another house purchase, he should keep few of these things in mind:  

1)      This is not about the house that you are staying in, the house in question here is  purely for investment purpose. 

2)      An investment horizon of at least 10 years is needed for this to be effective,  so if you are planning to retire by 60, and then this is not for you if you are already above 50 years of age.

3)      This is much riskier than a bank fixed deposit (the expected returns obviously are higher to compensate for the higher risks) and so if your risk appetite is low then this investment is not for you

4)      A meaningful Real estate investment will require much larger initial investments as also much larger continuing investments. Also the flexibility to miss an regular investment instalment is not available since the continuing investment is by way of loan repayment.

5)      It is not important that whether you would have yourself liked to stay in that house or not. You should buy from a rental perspective. In fact buying a house in smaller towns that you have some knowledge and connection with, might be a great decision given the fast pace of growth that is likely to be experienced by smaller towns and might give good returns over a long period of 20 years.

6)      Investment in real estate is a relatively high maintenance investment in terms of dealing with societies, finding and dealing with tenants, etc.

7)      Though state and local laws are fast changing tenancy laws in some states and property taxes in some cities make renting out a property a non-viable option. So avoid investment in such areas.

So this investment proposition is ideal for the likes of Mr. Varma who like saving regularly in traditional assets such as real estate.

How about you? Are you like Mr. Varma?

The Direct Tax Code (DTC) is a major evolutionary step in direct tax history of the country , which is all set to change the entire financial landscape of India. As it spells major change, it will require fairly in-depth study before all its implications can be understood and assimilated. On the face of it, DTC may have added cheer to the lives of Indian tax payers due to some of its moves, but it looks like a dampener for Indian realty industry.

Moreover, it is likely to undergo many changes and corrections before it is finally enacted. Hence commenting on the DTC is a minefield.

With these qualifications let us see analyze some aspects that will apparently impact the property market:

Firstly there is a significant change in the way Income from House Property is calculated under the DTC most of which are adverse from the point of view of residential property investments.

1) Tax on every property – The Current Tax provisions provide for paying tax in respect of every property (except one self occupied property) whether let out or not, based on “Contractual rent” and where that is not available then based on “Reasonable Rent” (a phrase coined by me). There is also a provision for a vacancy allowance in case of property that has previously been let out at any time. Under the DTC Bill the tax is payable on all properties (except one non let out property) on the basis of higher of “Contractual Rent” or “Presumptive Rent”. The provision for vacancy allowance has also been deleted. The real killer here is “Presumptive Rent” which is assumed at 6% of the “rateable value” fixed by the local authorities. In most cases now the local authorities have moved to a market value based rateable value. It is a very rare residential property that gets anywhere close to 6% of the market value (normally they get around 4 % of the market value) as rent nowadays. Possibly the presumptive rate has been kept at a middle value of 6% considering that commercial properties can be rented out at around 8% of market value. Of course this simplicity works against residential property ownership.

Since the income is higher of “contractual rent” or “presumptive rent” the end result will be taking completely non-existent income as “income”. Thus whether or not a tenant is available for the premises, it forces the owner to pay tax on “income” that he may never get as in case when he is unable to find tenants for his property.

Without the protection of the vacancy allowance that is available under the current tax laws this single change will drive investors out of the market. Some may argue that not having “investors” (as distinct from buyers who buy for their own use) may not necessarily be a bad thing but I am not one of them.

2) The wordings for not applying this income clause to one non let-out property (equivalent to self-occupied property under the current provisions) are a little unclear and if left unchanged can jeopardize even this small relief.

3) For let out properties the standard deduction has been reduced from 30% to 20% of gross rent.

4) Deduction is available on all properties for local taxes and service tax to the extent paid.

5) There is no deduction for interest for the non let out property (broadly self-occupied under current provisions) where the income is taken as “nil” unlike the current provision where this is available up to Rs. 1,50,000/-.

6) There is no provision for deduction on the principal payment of the loan taken to buy a home.

7) As far as commercial property is concerned it is now clear that renting out of property in whatever guise (whether as a business center etc.) will now be taxable as “Income from House Property” and not as Business Income or Income from Other sources. The impact is that no deduction for any other expenses will be allowed except local taxes, service tax and interest on loan (and off course the standard deduction of 20%).

The good thing is that calculations for jointly owned properties has been made absolutely clear as also treatment of interest payable for loans taken to re-pay the original home loan (transfer of loan from one lender to another).

All in all the real killer here is the presumptive rent. Clearly this is a stiff annual Wealth Tax on owning a residential house property in the guise of creating an objective benchmark for the rental potential of a residential house property. With the changes in Capital gains tax as well as the current rental laws, which discriminate against the landlords, and the stiff service tax on rentals, owning residential property except one for self-occupation will be fairly “taxing” thing.

Clearly the government is not in favour of you owning more than one property and if you do, you will have to be prepared to pay tax through your nose. These provisions, if enacted, are likely to have a very large impact on the residential property market. Firstly residential properties purchased for investment purposes or ownership of second properties is likely to go down significantly. Secondly tax driven decision making to purchase own residence also is likely to significantly reduce.

Still these are l early days so let us see what actually gets enacted as law.

Till then you move on with your decisions of home buying!