Budget 2025 has made the New Tax regime more attractive, but we know that the new tax regime comes with certain restrictions. You do not get tax deduction for investments under Section 80C, specific expenses (health insurance under Section 80D, house rent/HRA) and loan repayments (home loan and education loan).
Hence, as a taxpayer, you need to analyze the pros and cons. It is a simple mathematical exercise. You just need to calculate the taxes under both regimes and decide accordingly. There are various online calculators available for the same.
Since we usually write about loans and credit cards, in this post, we will focus on how this shift towards the new tax regimes affects how you think about loan repayments.
Certain Loans Come with Tax Benefits
- Home Loan: Under the old tax regime, for a self-occupied property, you get tax benefit on interest payment of up to Rs 2 lacs. For up to Rs 1.5 lacs for principal repayment under Section 80C. Under the new tax regime, you get no such tax benefit.
- Education loan: Under the old regime, you get tax benefits for the interest paid (without any cap) under Section 80E. No such tax benefit if you opt for the new tax regime.
Note: For let-out properties, the new tax regime also offers tax benefit on interest payment (not on principal repayment). However, even for let-out properties, old regime offers better tax benefit than the new regime. I have covered this topic in great detail in a previous post.
With the new tax regime becoming more and more attractive over the past few years, the scale has already tilted towards the new regime. Though the old regime can still come out on top in certain cases (especially around surcharge boundaries), most taxpayers will likely be better off in the new regime.
New Tax Regime Will Change How You Think About Loan Prepayments
The tax benefits on loan repayment used to reduce the net cost of the loan. Now, if you file your ITR under the new regime, you won’t get such tax benefits. Does that change how you think about loan prepayments?
It does. How?
Your education loan is at 10%. If you are in the 30% tax bracket and file your returns under the old regime, your effective cost of loan would be 7% due to the tax benefit. Now, if you have some excess funds, you have a choice between prepaying the loan or picking up an investment where you can earn a better return.
The threshold to beat shall be 7% (post-tax cost of loan). Hence, if you can find a product that earns (or can potentially earn you) more than 7% on a post-tax basis, you will consider making that investment.
Under the new tax regime, the same threshold jumps to 10%. Hence, you must find a product that can offer you 10% on a post-tax basis. If you can’t, you are better off prepaying the education loan.
The same applies to home loans as well. If your home loan is for a self-occupied property, then the pre-tax cost of loan is the post-tax cost of loan under the new tax regime. The loan at 9% p.a. will cost you exactly the same on a post-tax basis. Hence, 9% will be the return threshold to beat under the new regime and not say, 6.5-7% p.a. (as under the old regime).
Clearly, as an investor, you have a more difficult job at hand. You can’t keep your excess money lazily invested in bank FDs at 7% while you pay 9-10% on your loan.
Loan Repayment Is More than Just Tax Workings
Not everyone goes through this complex analysis. Many just don’t like to be indebted. They want to bring down debt, irrespective of its post-tax cost. To such borrowers, all this analysis is meaningless and there is nothing wrong with that. Everyone is wired differently. Some want to optimize to the last penny while others just want peace of mind.
If I had to make a similar choice, I would prefer that the loan comes down to more manageable (or psychologically comfortable) levels before I get into such dilemma.