Home loan vs HRA: Which offers higher tax savings?

This is how you can avail of tax benefits under HRA and home loan for the purpose of tax saving.

Home loan vs HRA Which offers higher tax savings

House rent or home loan makes up a significant chunk of a person’s outgoing expenses. The question that often arises is: can employees undertake the responsibility of honouring a home loan and paying rent expenses at the same time? The short answer is yes. But before going into the details, let us understand the definition of these concepts under Indian law. 

What is house rent allowance?

House rent allowance (HRA) is a component of your income taxed under the head of salary. It is provided to salaried individuals to meet the requirement of renting a living space. It is calculated based on the basic salary of an employee and can be claimed under the following conditions:

The computation of income tax under Section 10(13) is as follows:

  • The HRA received
  • 50% of the basic salary in metro cities and 40% of basic salary in non-metro cities
  • The rent paid minus 10% of salary

The lowest of the three will be considered for deduction under Section 10(13) of the Income Tax Act. To understand this better, let us consider an example. 

Mr Om is employed in Ahmedabad, where he lives in a rented property. His basic salary is Rs 30,000 per month. He receives an HRA of Rs 15,000 per month. He pays a monthly rent of Rs 10,000

  • HRA: At Rs 15,000 per month, Mr Om receives an HRA of Rs 1,80,000 for the entire year. 
  • Since he lives in a non-metro, the computation is 40% of his basic salary. His annual basic salary is Rs 3,60,000, so 40% of this amounts to Rs 1,44,000 
  • The rent he pays for the entire year is Rs 10,000 x 12 = Rs 1,20,000. Ten percent of his annual basic salary is 10% (30,000 x 12) = Rs 36,000. So, the rent paid minus 10% of basic (1,20,000 – 36,000) = Rs 84,000.

In this example, the third component (Rs 84,000) is the lowest figure and will therefore be considered for income tax exemption. 

Related: What you must know about HRA to ensure it is not rejected

Home loan 

Individuals who wish to apply for a loan to purchase or construct a home can claim tax exemption under the law. Under certain circumstances, you can claim both, provided certain conditions are fulfilled. Let us study the benefits that can be availed of by the taxpayer under the following circumstances: 

Rented accommodation in the city of employment

In some cases, it is likely that the owner of the house might choose to live in a rented house despite having their own home in the city of employment. Can an employee claim tax benefits on HRA and house loan? Yes, as a house owner you can claim both under relevant sections of the law. 

However, you are not permitted to claim HRA benefits under the following circumstances:

  • You own the property jointly and pay rent to the co-owners of the house
  • You lived in a rented accommodation owned by your employer and pay rent to help the employer recover the rent  

Rented house in the city of employment and home in a different city

In some cases, a person who has decided to opt for a loan might reside in another town/country for employment. In this case, the employee can claim a maximum of Rs 2 lakh a year as exemption. However, if the taxpayer resides in a city other than their hometown, they can claim an exemption under this section.  

For instance, Mr Om has decided to move to Kochi for employment. He pays a rent of Rs 12,000 per month towards rent and is entitled to an HRA of Rs 20,000 per month. His basic salary is Rs 50,000 per month. He has decided to purchase a house in his hometown (Ahmedabad) where his family resides. He repays the interest in addition to the home loan. 

  • HRA receivable on Mr Om’s salary = Rs 20,000. 
  • 40% of his basic salary = Rs 20,000. 
  • Rent paid minus 10% of basic (Rs 12,000 – Rs 5000) = Rs 7000 

Rs 7000 is the amount that Mr Om can claim as an exemption under the relevant sections of the IT Act. The remaining amount is eligible for taxation under HRA. 

This is how the interest on home loan will be computed: Mr Om’s family lives in the home and hence the rent earned from the property is nil. A set-off of up to Rs 2 lakh is allowed on the interest on the home.

Related: Buying a home in your hometown or in a big city: What makes financial sense?

Staying with family and paying them rent

Can an employee living with family and paying them rent claim HRA benefits? Yes, they can. An employee can pay rent to his family, provided the home is owned by his parent(s), and claim HRA benefits. This amount paid towards rent is taxable under the parent’s income. For employees thinking of paying rent to their spouses, this arrangement may be viewed as an attempt to avoid tax and may be disallowed.

For example, Mr Om lives in his city of employment. He earns a salary of Rs 40,000 and pays rent to his parents who own the house. He is entitled to an HRA of Rs 16,000 and pays a rent of Rs 12,000.

  • HRA on Mr Om’s salary = Rs 16,000
  • Rent paid minus 10% of basic = 12000 - 4000 Rs 8000

Therefore, Mr Om can claim an exemption on Rs 8000.

Related: Looking for a home loan? Here’s what you need to know

Last words

This example is for those who live in areas across non-metros where the average home rent would range between Rs 10,000 and Rs 15,000. Over the tenure of claiming HRA on the rent paid or across the tenure of a home loan, factors such as the rate of interest, tax slabs, etc. may undergo a significant change. However, if one is planning to purchase a house, it makes sense to secure a home loan.

Therefore there is no single answer to which option is the best. Consider the number of years you intend to live on rent, the tenure of your home loan, and the rate of interest, before choosing an option that best suits your requirements. Home equity loan or ‘second mortgage’ demystified.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas. 

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