Know why you should not take loan against PPF account

Late in December, the government made some tweaks to the Public Provident Fund (PPF). One of those changes was regards to the interest rate charged on loans take against PPF accounts. According to the changes made in the scheme, any loan taken from or after December 12, 2019 will be charged at the rate of one percent per annum instead of two percent earlier.

At one percent, the interest rate on such a loan is much cheaper than any other type of loan. However, experts advise against taking a loan against one's PPF account.

Reason number one is that fact that you will lose out on the tax exempt interest amount that you earn on your PPF. Alok Agrawal, Partner, Deloitte India says, "Interest rate charged on the loan taken from the PPF account is charged at the rate of one percent per annum. However, while taking a loan against PPF account, the individual also loses out on the tax-exempted interest. This is because no interest is paid on the PPF account (to the extent of the amount of loan taken) till the time principal amount plus interest is repaid. The balance amount in the PPF account will continue to earn interest. This makes the effective interest rate charged on loan from PPF account at the rate of prevailing PPF interest rate plus one percent."

The PPF is a favourite among savers due to its tax benefits. PPF enjoys an exempt-exempt-exempt (EEE) status, i.e., your money is exempt from taxes at the time of investment, accumulation and withdrawal. Raj Khosla, Founder and Managing Director, says, "PPF account is used for wealth creation in the long term and offers guaranteed, tax-free returns. The lower interest rate on loan against PPF does look appealing. However, one must remember that during the loan period, the account does not earn any interest until the time loan is repaid, therefore impacting tax-free returns of the account holder."

Another reason to take a loan against PPF is that due to the amount that you can borrow and the criteria on which you can borrow.

As per the scheme rules, an individual can take a loan after the expiry of one year from the end of the year in which account was opened but before the expiry of five years from the end of the year in which the account was opened. In layman terms, this means that loan is available from the third year of opening of account till the sixth year of opening of account.

The amount of loan that a person can avail cannot exceed 25 percent of the amount that was available in the account at the end of the second year immediately preceding the year in which the loan is applied for. This can be explained with an example. Suppose you opened your PPF account in July 2018-19. Therefore, loan facility will start from the third year of the opening of account i.e. 2020-21 and will continue till the sixth year (2023-24) of opening of the PPF account.

Let us say you decide to take a loan in the fifth year. The amount of loan you will be eligible for will be calculated on the basis of 25 per cent of the amount available in account two years prior to the year in which loan is being applied.

As you have applied for the loan in 2022-23, the amount of loan you are eligible is 25 per cent of the closing balance in 2020-21, i.e., Rs 1,31,230. This is a small amount. Remember, a PPF accountholder can take loan only between the third and the sixth financial year.

"Loan on PPF account can be availed for relatively smaller amounts and for shorter tenures. However, a home loan and/or a loan against property is a much better option for larger amounts and for longer periods of time," explains Khosla.

Once this period is over, the PPF accountholder cannot avail a loan from the account. However, an individual can withdraw money subject to certain conditions. Along with the tax benefits, the PPF comes with the advantage of compounding of returns. Taking a loan, will have a negative impact on compounding of tax-free interest received and consequently on your corpus.

Vikas Gupta, CEO & Chief Investment Strategist, OmniScience Capital says, "The loan against the PPF account is offered at one percent per annum. However, the effective rate on such a loan becomes the prevailing interest rate on PPF account plus one as no interest is paid on the amount of loan taken. The interest rate charged on loan from the PPF account is cheaper than the interest rate charged on a personal loan. However, it is advisable that one should avoid taking a loan from the PPF account. This is because the loan facility from the PPF account is offered in the early years which negatively affect the compounding benefit you get on the tax-free interest paid to you. Losing out on the compounding benefits will negatively affect the amount you are saving for your retirement corpus or any other money goals. The loan from PPF account should be treated as last resort once one has exhausted all the available areas to take the loan."

News Source: Economic Times, Url:

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