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Tax Treatment on A Personal Loan

Tax Treatment on A Personal Loan

  • By Saral Credit
  • September 11, 2022

Personal loans have become common for most borrowers, including quick disbursal without pledging collateral. PLs have entirely revolutionized the banking industry and have made monetary support easy and quick for everyone who qualifies for the same.

A personal loan is an unsecured loan that makes it more fascinating for borrowers. Nowadays, borrowers apply for a PL to combat their financial needs for numerous purposes, including weddings, vacations, education, or other personal tasks.

However, the biggest issue most borrowers face with a personal loan is no tax benefit. As a PL borrower, you must know that personal loans come with affordable interest rates, varying from one lender to another. However, what's more important is the tax deductions on personal loans that every borrower have to pay.

The million-dollar question is, does India's Income Tax Act provide deductions on personal loans?

When it comes to tax deductions under the IT Act, you should know about the two components of a personal loan.

  • Principal Amount: The loan amount you get from the lender as a principal amount. It is the amount that is disbursed to your bank after the PL approval.
  • Interest Paid: The interest rate varies from one lender to another. It depends upon the repayment tenure and principal amount. It is the percentage of the principal amount that you have to pay additionally.

The simplest answer to whether the income tax act allows tax deductions on a personal loan is NO.

But wait!

There are some exemptions that you get with a personal loan. Without any delay, below are the PL usage that gives you tax benefits:

Loan for Home Purchase or Renovation:

Personal loans offered to borrowers can be used to buy any land or renovate their home. In either case, you are Under the home loan; you are eligible for a deduction of up to Rs 2 lakh. However, you must note that this limit is only eligible if you currently live there. If you live in a rented property, the total interest paid on the loan can be deducted from your taxable income.

The best way to get tax deductions for a home purchase or renovation is to keep all the relevant documents required to claim the tax benefit.

Personal Loan for Business Purposes:

Another option that allows you to get the tax benefit using a Personal loan is using the amount for business purposes. The personal loan that is used against buying a business land or other properties for business purposes allows you to get tax benefits.

However, you should know that getting a personal loan for business operations won't give you any tax benefit.

Personal Loan to Buy any Asset:

Apart from residential property, borrowers take a personal loan to buy different assets, including shares, jewelry, cars, non-residential house property, and more. With these purchases, you can apply for the appropriate asset to get the tax benefit. However, taking a personal loan and investing the amount in buying these items won't provide any tax benefit. Hence, you must understand the difference and make the right selection accordingly.

In short, the end use of a personal loan decides whether you are eligible to get the exemption on your PL or not. So, you should check out the options listed above and find out whether you qualify for the tax exception option or not.

Another essential point to note is that your personal loan source can also play a significant role in getting tax benefits. The principal of your personal loan can become non-taxable, depending upon the lender/bank you have selected.

Borrowers getting a loan from a bank or NBFC, a legally approved government institution, benefit from tax deductions. Here the principal is considered a liability that becomes non-taxable.

E.g., Rohan has applied for a personal loan from PNB bank. Here the loan will be considered a liability and hence become non-taxable. However, if Rohan takes help from any friend or relative and gets the amount in his bank account, the exact amount will be considered as his income from other sources. 

What about the interest amount? The vital question resides around how you can get tax benefits on the tax amount. Well, the tax benefit on the interest amount can only be earned with the above-given three options. Rest, there isn't any option to save your tax on the interest amount.

Now you know clearly about taking a personal loan and using it for the right purposes. Below are some great tips for taking a right personal loan from the right lender/bank.

Maintain Good Credit Score: A good credit score represents your creditworthiness and gives a green signal to lenders. Any credit score above 700 is generallyconsidered good, resulting in quick loan disbursal.For more on what is a minimum cibil score for a personal loan,, click this link.

Compare Interest Rates from Different Lenders: You should never make instant decisions and start with any lender you find online. Researching and comparing the interest rates different lenders offer is always recommended.For interest rates on personal loans, click this link.

Calculate All Associated Costs: Getting a personal loan involves multiple charges that most of you might not know. Standard charges include processing fees, late payment fees, etc., that you must know before proceeding with any lender. You should also check for hidden charges that can add to your loan amount.

Apply for the Required Amount Only: You should always apply for the required amount, even if you qualify for a higher loan amount. Getting exactly what you need will maintain a fixed EMI than a higher debt with no reason.

Don’t fall Prey to False Offers: You might get spam calls claiming exciting offers with your personal loan. It's better to take time than get prey to such spam offers and deals. You should always research the lender and ensure its authenticity.

That said, you can now choose the right purpose for getting a personal loan and tax deductions. You can also consult with your tax consultant to get better insight into these aspects.