Loan against Property (LAP) and Home Loan: What’s the Difference?

When Sunanda, a 52-year-old widowed school teacher, learned of her daughter Rachna’s confirmed admission with a partial scholarship to her dream college in the US, she was beyond happy. At the same time, she felt torn with anxiety over how to secure the remaining financial support for Rachna besides the scholarship at such short notice. Her only option seemed to get a loan against property, her ancestral home. But is that a home loan? Is she even eligible for the loan from the bank? What sort of questions should she prepare to apply for a loan against property?

Like Sunanda, many of us facing similar struggles over raising money on short notice for various personal, business or other reasons, start thinking of getting a loan against your home or other property. Before you go ahead to apply for the loan, it’s important to get a clear idea about the differences between a loan against property and a home loan. Let’s help you with that.

By Definitions

Home Loans enable you to purchase or construct a new home for residential purposes only. At the point of loan approval from the bank or housing finance authorities, the property in question is still not in your possession.

However, as per the Transfer of Property Act, registration of the transfer of any immovable property is compulsory for any lender to disburse a home loan. Therefore the home loan provider may insist on property registration or a tripartite agreement, although rarely, between the lender, customer, and the developer where they may seek an indemnity.

On the other hand, Loan Against Property (LAP) requires you to keep an existing property (that you already own) as security to the lender in exchange of an agreed sum of money as a loan. Also, the use of this loaned money is not restricted by any cause. You can utilise the amount for a variety of purposes, including but not limited to business expansion, financing a wedding, foreign education, vacations etc.

Difference in Structure

Security: A home loan is either disbursed in full or can be distributed in a limited number of pay-outs as per the agreed contract between the borrower and the lender authorities. However, there’s no immediate threat to your existing properties in case of defaulting on the loan. It’s the new property, to be purchased or constructed by using the loan amount, that’s pledged with the lender as security.

The LAP is disbursed only after validating security in the form of an existing property that you own. It can be disbursed as a lump-sum, or a line of credit may be established with draft limitations as agreed upon by you and the lender.

Margin: Whether it’s a home loan or LAP, the lenders never agree to disburse with the entire amount of the asset’s value, as protection from market fluctuations. The amount of money left as this gap is called a margin in a loan. The RBI and the National Housing Bank regulate the margin for home loans approved by banks and housing finance companies respectively. Depending on various financial and demographic factors, the home loan margins tend to be within 10%-25% of the total asset value. You’re supposed to come up with this margin money by yourself in purchasing the new property.

A loan against property is not covered under priority sector lending and generally have a margin of 25%-40% of the property value.

The Rate of Interest: The rates of interest for any loans vary depending on a number of economic and socio-political factors. However, as a general trend, the interest on home loans ranges between 8.5%-9% across lending institutions.

The LAPs tend to fetch a higher interest for the lender – generally between 11%-15%, depending on similar factors as the home loans.

The Difference in Tax Implications

You can enjoy two-fold tax benefits on home loans under current income tax laws. The principal repayment up to 1.50 Lakhs can be deducted from your taxable income under Section 80C. Also, the interest paid on the loan gets exempted under Section 24(b).

However, if the borrower has mortgaged his house in order to avail loan against property, there is no exemption.

In case of loan against property, the principal repayments are never exempted from tax and there are only two possible scenarios eligible for tax benefits on the interest:

1. If you utilise the borrowed sum for business purposes, then you can claim tax exemption against the interest paid for the loan and the additional fees and charges incurred while processing loan. This falls under Section 37(1) and should be treated as business expenditure.
2. If you are a salaried person and utilise the loan amount to purchase a residential property, then the interest amount can be tax exempt under Section 24(b).

If you need to take a loan, research all the relevant details in advance to avoid any unwelcome surprises in the future. This, along with the points we have discussed above will help you make an informed decision ahead.