Personal Loan Taxation: Are there any tax benefits on the amount borrowed?

Personal loans offer a flexible financial solution to address a wide range of personal needs. The funds can be used for diverse purposes such as home renovation, business investment, emergency medical situations, wedding expenses, and beyond. 

These loans are unsecured, meaning they do not necessitate collateral, resulting in a comparatively higher interest rate. Furthermore, personal loans typically have short repayment terms and lenient eligibility criteria, facilitating easy access. Many individuals inquire about potential tax benefits linked with personal loans.

In general, a personal loan in India typically won’t have a significant impact on your tax filing in two primary ways: 

• The loan amount is not considered taxable income. Essentially, when you take out a personal loan, you’re borrowing money that you’re obligated to repay with interest.
• Interest on personal loans usually isn’t deductible for tax purposes, unlike the interest on home loans or education loans, which may offer tax deductions. Therefore, you generally cannot decrease your taxable income by the amount of interest paid on a personal loan.

Nevertheless, there are some exceptions where you may be eligible to claim tax benefits on a personal loan:

• Using the loan amount for business: If the personal loan is utilised for business purposes and proper documentation is provided, you might qualify to deduct the interest paid on the loan from your business income.
• Home repair or renovation: When you use a personal loan for home renovation or improvement, you could potentially qualify for an interest deduction under Section 24 of the Income Tax Act. Moreover, the repayment of the loan may fall under the coverage of Section 80C, leading to a reduction in your taxable income.

Seeking advice from a tax professional is crucial to ascertain whether your particular circumstances qualify for any tax deductions associated with your personal loan. Tax laws are intricate, and regulations can be complex, making it essential for a professional to offer the most current and precise guidance tailored to your situation.

Frequently Asked Questions (FAQs)

Q. What is a personal loan?

A personal loan is an unsecured loan offered by banks, non-banking finance companies (NBFCs), or peer-to-peer (P2P) lending platforms, typically ranging from one to five years. It does not require collateral, a guarantor, or the hypothecation of any assets. The borrower has full discretion over the use of the loan. In our observation, borrowers commonly utilise personal loans for purposes such as debt consolidation, repaying high-cost debt, addressing family or medical emergencies, covering wedding expenses, funding vacations, home renovation, rental deposits, meeting business needs, purchasing specific assets, and more.

Q. What is the maximum personal loan amount I can qualify for based on my salary?

Lenders assess your eligibility for the loan amount and offer approximate estimates. Your monthly net income refers to your main income after taxes and deductions. A higher net income typically correlates with a larger eligible loan amount.

Furthermore, the Debt-to-Income Ratio (DTI) compares your monthly debt obligations, including the possible personal loan payment, to your gross monthly income. Lenders generally favour a lower DTI, usually below 36%, to ensure that you can manage the loan repayment comfortably.

A high credit score, typically above 720, signifies a positive borrowing history and consistent debt repayment. Consequently, it may result in a more substantial loan offer and potentially lower interest rates.

Having stable employment with a reputable company for at least a certain period, typically around two years, demonstrates reliability and enhances the likelihood of securing a larger loan.

Every lender establishes its standards for determining loan amounts. One common method involves using a multiplier, which involves multiplying your net monthly income by a factor typically ranging between 10 and 24 times to estimate an initial loan amount.

Q. Is it possible to apply for a personal loan online with a modest salary?

Even with a low salary, you might still be eligible to apply for a personal loan. This is because not all lenders have a specified minimum salary requirement for personal loan eligibility. However, the approved loan amount is likely to be lower, and you may also incur a higher interest rate.

Q. Can you close a personal loan before the designated term?

Certain banks enforce a lock-in period ranging from six months to a year, while others permit pre-closure even after the first EMI has been debited from your bank account. Restrictions may apply, such as being allowed to use only your funds (excluding balance transfer cheques from other banks) for pre-closure. Additionally, banks may offer pre-closure at no cost or impose a pre-closure fee, typically ranging from 2% to 5% of the amount being closed prematurely. It's advisable to seek clarification from our loan advisor or the banks regarding these factors before finalising the loan agreement.

Q. What documents do I need to submit when applying for a personal loan?

You will typically need to provide an identity proof, residence proof, your last three months' salary slips, your last six months' bank statements, and a passport-sized photograph. Additionally, banks may request further documents later, such as Form 16, an appointment letter, your company ID card, or a relieving letter from your previous employer.