Tax debate: Does a housing loan amount to savings?

The recent budget proposal on individual income-tax has attracted a lot of discussion. The predominant question is — will the budgetary push to make the New Tax Regime more attractive with fewer slabs and higher income caps impact household savings? There is a hesitation in moving from the Old Tax Regime to the new one, since the latter does not allow any deductions. Does the New Tax Regime de-incentivise a home loan?

Union Finance Secretary TV Somanathan recently said the home loan is not a savings instrument from the macroeconomic aspect, that the tax sops given for it are merely a push to make people buy houses. Former Finance Minister P Chidambaram responded to this, asking Somanathan to re-examine his theory on housing loans. “The payment of interest and the instalments of the loan are indeed an expenditure, but it is expenditure which is converted into an asset, which is a saving,” he said.

Which of them is right? Let us analyse the statements.

What are savings?

‘Savings’ refers to the money that you have left over after you subtract your consumer spending from your disposable income over a given period. Savings, therefore, represents a net surplus of funds for an individual or household after all expenses and obligations have been paid.

Savings are kept in the form of cash or cash equivalents (such as bank deposits), which are exposed to no risk of loss but also come with correspondingly minimal returns. Savings can be grown through investing, which requires that the money be put at risk, however.

How do banks lend?

Before a bank gives out a housing loan, it needs lendable resources, which come out of deposits mobilised by it. The deposits are of savers who park their money with the bank.

When a bank extends a housing loan, it uses savers’ money and an asset (house property) in the name of the borrower is created. In the books of the borrower, the property becomes an asset with the corresponding liability of a bank loan. Hence, with the savings of the various depositors of the bank (which takes place before the loan is disbursed), an asset for the borrower is created.

So the sequence is: savings by individuals, investment as deposits, lendable resources of banks, home loans to eligible persons and creation of housing property as an asset for the borrower.

Repayment is not equivalent to saving

When the borrower starts repaying the loan, again, the lendable resources of the bank go up to the extent of recovery. This does not increase its deposit base. It simply reduces its loans portfolio, which enables it to re-lend.

For the borrower, repayment is not saving. At the most we can say that he makes repayment out of saving. It is simply a reduction of liability and improvement in net worth, with the asset as a constant (appreciation not taken into account here).

Though the repayment of loan improves the lendable resources of banks, it does not increase the deposit base and hence cannot be termed as a saving of the community. It is simply recycling of funds already saved and mobilised by banks.

What this means for the borrower

If housing loan repayment is to be treated as a saving, then it is applicable for any other loan repayment also, which will show the futility of such an argument.

While the home loan does not amount to a saving for the borrower, it does lead to the creation of tangible property whose value may appreciate over time. If the house is going to be self-occupied, that is all the more reason to go for a home loan, with or without the incentive of tax deduction.

(The writer is a retired banker. The views expressed here are his own, and do not constitute investment advice.)