I know this may sound sacrilegious, but the housing loan (mortgage) interest deduction is the most over-rated tax strategy in existence. I constantly hear happy “homeowners“ boasting about how much money they “saved“ with their mortgage interest deduction. Asking your boss to reduce your salary would perhaps have the same effect.  

If you are in the 30% tax bracket each Rupee you pay interest on is only going to save you 30 paise. That means you are still spending 70 paise to save 30 paise. My family believes that I choose to become a CA over IIT because I am weak in mathematics. Even to my dumb head, this sounds like bad mathematics, correct?

This is actually the classic difference between a deduction and an expense write-off. Can you convince a businessman that an expense is good, just because it can be claimed as deduction? I doubt it.

The other question that I ask in all my classes “Is a car an asset?“  Thanks to `Rich Dad Poor Dad`; many people having read that, say no. Then I ask them “Is a house an asset?“ In spite of reading “Rich Dad Poor Dad“, people are still confused.

And you`re so happy with this so-called tax break you aren`t thinking clearly about what is really happening. In the first few years of a mortgage the majority of your payment goes toward paying your interest on the loan, not the principal. And homeowners think that`s fine; it means a bigger tax deduction. But if you can bring some logic to this you would realize you`re not building up any equity because of your payments.

You may be building up equity yes, but that is because real estate prices are going up.

The question has to be asked, what happens if they ever start to go down. But let`s just look at why the mortgage companies really have you pay the majority of the interest up front.

First, the stats show that homeowners tend to buy a second house in six or seven years. So that means when you go to sell you`ve only paid interest on your mortgage; you haven`t really paid down any of your principal which means that the lender has been getting interest on almost all of the money they originally lent you which in the long run helps them make more money but at your expense. At this stage the nice middle class homeowner go back to the lender, pay off the loan and take a fresh loan, and the interest payment cycle continues.

Thank God for my shareholding in India`s biggest mortgage company! They surely got their maths correct, and so did I!

Let me come to my favorite topic of compound interest. Why do people feel happy about real estate?

I think it is simple mental heuristics. People do not understand the importance of the compounding formula (Future value = present value * (1+ r) ^ n).

That is why they come up with “My father bought a house in Santa Cruz (an up market suburb of Mumbai) for Rs 30,000, now it is worth Rs 30,00,000. We see it as a great 100 bagger! Great.“

However if you see that the purchase was made in the year 1964 and do an IRR it comes to “only“ 11% p.a. If you factor in the interest cost, maintenance, and society charges, it does not sound too great, does it? This was over a period when inflation was hovering between 9 and 19% in India, and when for many years cost of funds was in excess of 12%.

Also this person was earning a princely sum of Rs 900 in 1964 – which meant he was paying 33 times his monthly salary for a house. However at a CTC of Rs 18L p.a. I am paying only 20 month`s salary. Thus the house, expressed in terms of inflation adjusted return may not be worth it.

Now while I know most people need a mortgage in order to purchase a home, there will come a time in your life when it will make sense to get rid of your mortgage. So I don`t want you to just keep paying a mortgage under the guise that it is your only tax write-off.

Very few seriously rich people have a mortgage. They simply write a cheque. Its simple guys, “its better to receive interest rather than pay interest“.

Did you know that only since the Second World War the mass psychology changed from “use value“ to “ownership value“. Earlier, people like my Grand dad (decision circa 1919) was happy to rent 2 houses in Central Mumbai location and pay a rent for the rest of his life. One more thing I cannot understand is how come we treat different assets differently?

Do you think you and your husband will do a 2nd job to support a Porshce, or a Mercedes? Sounds irrational, correct?

Do you say “Invested in a car?“ Well, I have not heard that ever. How come you cannot invest in steel but can invest in steel and cement?

It beats me.

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  1. Amazing article ..

    Can you give more idea about this shift of change in mental attitude from “use-valu” to “ownership-value” ? Any good book or resources on this ?

    I think there exists a very minute class of people who understand what you say , but they still buy house for other reasons like “Now I am married, so better settle at one place, and not roam around in rented place” , more than financial logic , their emotional logic plays with them .

    As you say I agree that one can buy a simple house just for living , but then the intention should not be to make money out of it , it should just be to be at a place stably .


  2. Sir, what I didn’t understand is that If I am paying 1 lakh per year as Interest (assume at 10% interest) and if am getting saving tax on it there by getting 30% or 30k back., does this mean I am paying only 70k as interest i.e 7% interest on loan. Plz correct me where I am wrong.

  3. The existing rate of home loan is around 11% and after a 30% tax deduction, the effective interest rates come out to 7.7%

    However, the real estate prices in the last 4 years havent even grown by 5 %. So home loan borrowers have paid more than what they’ve received and are incurring a loss.

    All these rumours of tax saving through investment in property are being spread by builders and home loan companies as they only swt to gain through this investment and not the buyer….

  4. & the rent saved living in our own homes???.

    Atlease in bnglr at present on a house costing 50lac , ppl are getting around 2.5 lac as yearly rental, i.e around 5% as rent. If we deduct this one towards the intrest we paid we are paying almost nil intrest to bank.

    The maintainance, charges etc are same whether you stay in rented or own one.

    P.S: I didn’t own and can’t afford one at this time, My mind doesn’t understand whether to go for home loan or not when the above calculations are made

  5. @Praveen: I did an exhaustive calculation of renting vs buying for Bangalore; I was eying at a property around Rs. 60 lacs; and I appreciated the house at 6% for 30 years (btw.. that is the realistic gains you can expect in 30 years in real estate, 2003-2007 was just an anomaly. You have to consider prices didn’t move from 1988 to 2002) and rent increasing 10%. Considered 50% downpayment, tax benefits and everything else, society charges, maintenance, etc. Still renting turned out to be the cheaper option. Only downside about renting is that you may have to shift your place periodically, but that is just 2 days of pain in 2-5 yrs. Hence renting galore!!! I would save nearly 2 crores.. retirement amount for many, just by renting…

  6. Hi Subra, I am not convinced with what you wrote here. My colleague bought a 2BHK flat in Viman Nagar, Pune in 2005 for 13Lakhs. Now he sold it for 65Lakhs. Which FD can give such return?

    Another colleague of mine bought 2BHK in Kalyani Nagar, Pune for 15Lakhs in 2004. He now sold at 85Lakhs. Which other investment would have given such returns other than REAL ESTATE?

  7. Mr VK,
    There is a well known equity mutual fund namely “Franklin India Prima Fund”.

    Had your friend invested 15L on 1st Jan 2004 in this fund and stayed put, he would have earned 1,17,72,140/- as of yesterday, Friday the 15th May 2015

    You friend made a nominal loss of 32 Lakhs 🙂

    You still want to question this view?

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