16 September, 2010

Responsible access to credit

There has been a sea change in the perception with regards to taking loans, these days. The market has opened up significantly in the last two decades. Home loans have been around for long. It is a secure loan and attracts the lowest interest. Vehicle loan too is a secure loan and is available at comparatively low rates. Many times, the car manufacturer themselves subsidise the loan, to sweeten the deal. The delinquency in the home segment is lower than vehicle segment due to the Indian consumers’ penchant for treating the home as a sacred investment and hence would not jeopardize that.

But, personal loan and credit card loans are different. They are both unsecured loans. What’s more, these days personal loans are available without collateral or guarantors and minimum documentation. With rising consumerism and aspirations, personal loans and credit card spends are increasingly the poison of choice. Add to that, cut throat competition, which pushes the lenders to dive deep into the city’s unseen folds and source customers. The cream has long gone. What is left now are the riskier ones who have now become “eligible” for loans. Apparently, people earning as low as Rs.3000/-pm, can now get a personal loan. By it’s very nature, people who have to take recourse to personal loans may not be financially very sound. Add to that the fact that there are no guarantors or collateral and the fact that the loans are being sourced increasingly from the lower middleclass to lower than that. Also, now recovery agents have been restrained and banks have to go through the legal redressal mechanisms, which is notoriously slow. The upshot – rising defaults.
Credit card debt is similar. It is very easy to get carried away by the plastic sliver in one’s hands. Since, one does not count out the money and just need to swipe, one does not realize the outgo. When it comes to payment, many times, there isn’t enough money to settle the outstanding in one shot. Hence, people go on revolving credit. That works for some time, till more goods have been bought and the revolving credit payable every month itself is a huge figure. Then defaults happen. Credit cards are also easy to come by. Customers are serenaded with offers of lifetime free credit cards and sugary sweet offers. Even here, the penetration has gone all the way down to those who may not be eligible for a credit card in the first place.

By stretching themselves and defaulting on loans, customers are doing untold damage to their credit worthiness – for everything is being captured today and is being reported in one’s credit history. Defaults damage one’s credibility, making loans in future difficult to get and/ or high cost. This could bar them from any access to capital, should they require it, anytime in future.

The previous generation can teach us a thing or two here… living within one’s means is something that today’s senior citizen’s vouch by. No holidays on EMI, fancy white goods on easy loans for them. While enjoying the good things in life, we all need to watch out and make sure we don’t cross the line. Once we are on the other side, we are damaged goods… forever condemned by these institutions who will not extend their line of credit. If that sounds like Armageddon, it is!

Published in The Economic Times of 16/09/2010

Are you buying a property to save taxes ?

Saving tax is a pet preoccupation with our citizenry. Sometimes it borders on the ridiculous. People will go to any extent to save taxes. While saving taxes is a legitimate exercise, one needs to evaluate whether it makes sense to make certain investments, primarily to save tax.
Investments by definition is something that needs to give a reasonable return, after taxes. Also, investments have other aspects which need to be considered like tenure, liquidity, risk potential, returns, suitability for meeting goal requirements etc. Tax efficiency is but one such aspect.
Due to the rapid property value rise in the past five years, many have assumed that it will continue it’s upward rise, uninterrupted. It won’t. Also, it will not be able to rise at a compounded 20%, like it has risen in the past few years. It’s most likely to settle at a sedate single digit long-term growth rate of maybe 7-8%. Massive increases in property prices have stalled the markets and transactions have come down. It has to come down, pause a bit for income to catch up and move. So, in light of this, we need to evaluate whether investing in a property for primarily saving taxes is a great idea.
Property is bought for residential use and as an investment. If it is for use as one’s home, then tax considerations recede into the background… for one will anyway go in for it, for personal consumption. Tax concessions over and above that, is icing on the cake. Let us examine what are the tax concessions for a self occupied property.
For a self-occupied property ( where the whole or part is not let out & no benefit is derived from it ), the maximum interest permissible to be set off would be Rs.1.5 Lakhs. This is subject to the condition that the capital is borrowed on or after April 1, 1999. The deduction is Rs.30,000/- pa for capital borrowed towards acquiring home property before April 1, 1999. Also, the acquisition / construction should be completed within 3 years from the end of the Financial Year in which capital was borrowed. The loan agency needs to certify in respect of the interest payable against the loan taken for acquisition of house property. So, in case a person is taking a loan of Rs.50 Lakhs and the interest in the first year comes to Rs.5 Lakhs, he could avail a deduction of only Rs.1.5 Lakhs. The tax saved at the highest bracket is Rs.46,350/- assuming that the borrower is in the highest tax slab. Hence, if tax saving is the preeminent consideration, it is going to be met, only to a small extent. In this situation, an EMI of in the region of Rs.50,000/-pm would also be added on and has to be carried on for years – maybe two decades!
Again people have the view that it is still a good idea as an asset gets created. Most again have the view that when one starts paying an EMI, the surplus cash that one has gets used up and the chances of frittering away any surpluses comes down. While this is true, it also creates a long-term liability. This creates a problem in case of any income disruption. Especially in a situation when the loan taken requires two people to work ( which today, is mostly the case ), it snatches away the possibility of one person stopping work. If the husband and wife are working, and they have a small child at home, both of them have to continue working even if the lady wants to stay back to take care of the child. This is being played out across the country today.
Also, people are very mobile and their careers can take them to various cities or even abroad, over time. If they have invested in one city say Mumbai and they get transferred to say Delhi, they will have to put the house in Mumbai on rent and rent out another in Delhi. This again is happening in a lot many cases, in view of the increased mobility and churn. This beats the very purpose of buying the home in the first place. Also, the argument that in future the homes will become so costly as to be unaffordable is also untenable. As it is, even today the prices in many suburban areas is unaffordable for most middle class households. Assuming a long-term increase of 7-8% in property, it can clearly be bought at a later point when one has dropped anchor. Till such time, it may be a good idea to stay in rented properties, which typically are available at reasonable prices ( typically the annual rental is about 3-4% of the value of the property ). This gives one the flexibility and freedom to pursue opportunities unhindered.
In summary, buying a residential property for residential purposes makes sense if,
1. One is clear that this is the city in which they want to settle.
2. They are getting the property at a fair value.
3. They are clear that they can shoulder the responsibility of repaying the loans for an extended period of time.

Published in Business Standard on 12/09/2010

06 September, 2010

How do I save tax when I sell a property

Property investments have gained currency these days. In the past five years or so, property values have shot through the roof. There are many who are hence investing in property these days.
Property is sold either to buy another property – probably a bigger residence or a better locality or both. It may also be to simply book a profit, when the valuations have become attractive.
Vikram was doing the latter. He was getting transferred out on Mumbai, to his hometown – Delhi. He had bought his residential property in a Mumbai suburb, about 6 years back. Now, he is interested in selling it as he plans to settle down in Delhi and he even has a buyer for it. He is seriously considering that, but wanted to know a bit about the tax matters surrounding sale of property. He wanted to know his options.
When a property is sold and the profits are retained, taxes have to be paid. In property transactions, normal income tax does not apply; capital gains taxes apply. For properties sold after 3 years of acquisition, Longterm Capital Gains ( LTCG ) applies. Short term capital gains apply for properties sold less than 36 months after it is bought. Short term capital gains are at the applicable tax rates for an individual. Longterm capital gains are 20% after applying the cost inflation index. Cost inflation index is applied to compensate for the effect of inflation, over time.
He has the option of paying the tax computed after indexation @ 20% and invest in a good instrument and earn good returns. If he invests in Equity Mutual Fund Schemes for instance, he will be able to get good double digit, tax free returns. This is a good option too, as one need not invest in low-yielding propositions, for the sake of saving tax or be forced to invest in another property. But then many people want to save taxes at all costs.
If Vikram does not want to pay tax, he also can invest the gains in Capital Gain bonds ( under Sec 54EC ). These bonds are issued by entities like Rural Electrification Corporation ( REC ), National Housing Boad ( NHB) etc. There is a six month window in which to purchase these bonds. Currently, they yield about 6% and have a lockin period of 3 years. The problem in this case is that though Vikram would be able to save tax by investing in these bonds, he is also potentially losing, as the interest rate on these bonds are low. The income from these bonds are however taxable. Also, the maximum one can invest in a capital gain bond is Rs.50 Lakhs for a Financial year. However, if the transaction has happened after 1st October of the year, then the window flows to the next financial year too allowing one to invest upto Rs.1 Crore.
Vikram has another way of saving tax too. He can buy another property for the value of capital gains. This comes under Section 54 of IT Act. When buying such a property, it can be bought one year prior to the sale or within two years after the sale. In case of construction of property, the time allowed is three years from the date of sale. The capital gains need to be deposited in a Capital Gains Depost Account before the date for filing returns. Any unutlised amount of this capital gain after the stipulated period, will be charged to income tax in the “previous year” at the end of the three year period. So, part utilization is possible too.
Vikram also wants to know if he can sell in Mumbai and buy in Delhi. It is permitted to buy anywhere in the country. There is a bit of ambiguity on whether one can invest the proceeds on one residential property or more than one. From a strict reading of the clauses, it is safe to assume that the proceeds need to be invested in a single residential property.
Now Vikram’s friend Gaurav has another problem. He has sold a commercial property and would like to save on Capital Gains tax. This is possible too under Section 54F of the IT Act. This is applicable for Capital assets, other than a residential property.
There is one major difference as compared to the sale of residential property and the capital gains treatment there on. Here, Gaurav will have to invest the entire proceeds from the sale into a residential property. The time frames for investment remain the same as in the case of sale of residential property. This however will work if he does not own more than one residential house on the date of transfer of the original asset, excluding the one he would purchase to save capital gains tax.
It is now upto Vikram to make up his mind whether he wants to buy a property or pay the tax and invest elsewhere. He has his options open now.

Published in Business Standard on 5/9/2010

Crossed 45 and Panicking...

For many, realization dawns that they need to do something fast to secure their future when they cross 45. What can they do? Read on…
It was when Vatsal comfortably reclined in his easy-chair that it hit him… he was somehow feeling uneasy. When he thought about it, he understood why. The easy-chair brought back memories of his uncle back in his home town, who was having money problems. His uncle was a pensioner – but it was not enough. He was somehow managing with it.
Vatsal was acutely aware of his situation. He has not been a great saver till this point. At 47, it occurred to him that the time is running out. His situation is in stark relief, compared to the position of many of his friends and colleagues. His only asset is his home and some savings in FD, MF, Equity etc., all amounting to about Rs.7.5 Lakhs. His PF accumulation is showing about Rs.11 Lakhs. His only liability is a home loan of Rs.3 Lakhs.
In his case, he has had a load of responsibilities… he had to support his parents, brothers, sisters as his father had retired, even when his children were still studying. That has not given him too much of a chance to save. But Vatsal is determined not to follow his uncle’s footsteps. He does not want to spend his retirement years in penury.
There are many like Vatsal who are on the wrong side of 40 and are panicking now, when they realize that they are but a decade away from retirement and the bank balance is more like a worn out mattress than a feather bed. What do they focus on?
Cover your bases – The first thing to do is to ensure that the family is covered medically… for this is one thing that can make a pauper out of even the well -endowed. A medical insurance cover of at least Rs.5 Lakhs for adults and Rs.3 Lakhs for dependant children is a good idea. Critical illness cover, Hospital cash etc. are good to have bells & whistles.
Is the family security ensured? A family has a lifestyle and future expectations based on a certain amount of income coming in, every month. If suddenly that were to stop, it puts a huge pressure on them. Their cherished goals, suddenly become impossible to meet… reason why, a person needs to take adequate insurance. But how much ? A ball park figure would be about 7 -8 times gross income for someone about 45 years. Add to that any liabilities and subtract insurances already there.
Drive away the retirement blues - Am I sufficiently funded for Retirement is a question that keeps the 45+ awake at night. Suddenly, this has become a looming concern for them. There is a way to estimate and act on this. Project what the expenses will be ( say Rs.6 Lakhs )in the first year of retirement. Multiply that by 12. That ( Rs.72 Lakhs ) should be the corpus at retirement. Now add a 25% buffer for inflation. The corpus needed becomes Rs.90 Lakhs. Assuming that retirement benefits will amount to Rs.20 Lakhs, another Rs.70 Lakhs need to be found. Suppose 13 years of earning life is left, Rs.25,700/- needs to be saved every month to retirement ( this can be done in a spreadsheet or using one of the calculators freely available these days ). So, you can estimate how much is needed for the golden years.
What about other goals ? There may be other goals like Children’s education. In Vatsal’s case, he has a son studying in 1st year Engineering. He needs to fund for the next three years. Estimate is about Rs.4 Lakhs for these three years. He can easily meet this from his savings and surpluses in these years. But if the amounts are huge, the recourse would be to take a loan, draw from PF, save up every month to meet the goal…
Liquidity position – It is a good idea to have atleast three months expenses as liquidity. A portion of this, say 2 months expenses can be in the bank and the rest can be in a ultra short term funds ( to earn a little more ). This can be brought down, if one has access to overdraft, which some banks offer. A good idea would also be opting for sweep in deposits, which bear a higher interest than Savings account. Here money becomes accessible on demand and earns, till that point.
It would be a good idea to provide for any lumpsum payments one has to make – like Insurance premium payments, fees for education, travel etc. According to the time the money is required, it can be invested in debt funds, FDs or other instruments.
Investments – It is important to choose the right places to invest, especially if one has not done too much savings till that point. The good news is that, the last few years can make all the difference in one’s savings for – loans get over in this stage, income is high, expenses related to education comes to an end in this period and lifestyle related expenses moderate. Hence, in the last decade or so, the savings that one can do will be much more than what one has done till that point.
Typically, it is good to invest about 50% of the surplus in Equity / Equity oriented assets. Land / property investments can also be a good idea – but due diligence needs to be done here before investing as all properties do not appreciate to the same extent. Investing in Gold is a hot topic today. Do it to the extent of 5-10 % of the portfolio. In case of debt instruments like FD, bonds, NSC etc., calculate the net return after taxes and decide the place to invest. PPF may be a good idea as it gives 8% tax free returns… could be a good vehicle to plan one’s retirement. So would be the NPS, for funding one’s retirement.
Vatsal was happy that there is a roadmap, a plan which he could follow. He was happier that he would be able to achieve his goals, if he followed this rather simple path. With a decade or more to retirement, things can still be made to work. And that should give solace to the 45 somethings.

Published in Business Standard on 25/8/2010