Why It’s Not Such a Good Idea to Take a Loan from Your Employer Even if It’s Interest Free?

by Vinaya HS on July 1, 2008

in Finance

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I have made this mistake once before and thought I’d share my experiences. Here’s why I believe you should not opt for a loan from your employer:

  • Any loan from your employer ties you to your job. You can’t come out until the loan amount has been cleared in full. You might argue that you can always ask your new employer to bear the loan. But where does that take you? From one chain to the next? Plus, I’m not sure if any employer today would be willing to bear existing loans.

  • It’s psychologically debilitating to see your take home salary cut by the EMI (Equated Monthly Installment) amount on the loan even before it’s credited into your salary account. I used to end up getting frustrated when this continued to happen each month, but they served as a good reminder of my mistake and actually motivated me to get out of the situation.

  • There’s a hidden cost. Though you do not actually pay any direct interest on the loan amount, the notional interest surfaces as a perquisite in your income tax calculations and adds directly to your taxable income. I didn’t know this fact until I saw my income tax calculations; it was already too late.

With some fanatic fiscal steps, I managed to come out of this situation sooner than I thought it would take. I know I will NEVER repeat this mistake again. Once was good enough a lesson for me.

What do you think? Do you have an experience to share?




Thanks for reading this article. I'd love to hear your opinion. Please use the comments section below to share your thoughts. I frequently write new articles that also cover several other aspects of personal finance including credit cards, financial goals, health insurance, income tax, life insurance, mutual funds, retirement planning, and much more. You can Subscribe through Email and receive new articles directly in your Inbox or you can Subscribe through the RSS Feed and receive new articles in your feed reader.

{ 17 comments… read them below or add one }

Anoop July 1, 2008 at 3:49 PM

On the contrary, it aint gonna be a bad idea if ur company sponsors u for an MBA and retakes u back @ managerial positions, that way you dont have to indulge in the process of job hunt, you get a position boost and a higher pay hike as well, dont forget you still have to pay EMI’s if you are not borrowing loans from your employer as you still have to borrow loans from any local or international banks,unless & until you are son/daughter of vijay mallya or lakshmi mittal who can finance ur education without loans, the end result may be the same in both cases, as in the former it may add some value to the position in your company..

Anoop July 1, 2008 at 3:52 PM

@ your last point, you still have to pay income tax even if you are paying loans, but the tax paid will be much lesser, but the rest goes to loans asusual. I bel only way u can avoid tax in India is through real estate business..
It wont be a good idea though to borrow loans for education from your employer, if you don’t want to rejoin them or just waiting to get away from them for ever..

raj October 16, 2008 at 4:11 PM

hi
can u explain explain exactly what does ur last point mean?
its quite confusing ….

Vinaya HS October 17, 2008 at 9:20 AM

Raj,

Suppose you take a loan of Rs 60,000 for one year from your employer. Your employer will deduct Rs 60,000/12 months = Rs 5,000 per month from your salary. The amount you have paid back to your employer at the end of one year is Rs 60,000, which means that you have paid zero interest. In effect, it’s a free loan.

Now, no loan in this world comes for free.

Therefore, a component called “notional interest” is added to your taxable income under a section called perquisites. Notional interest is the interest that you would have paid had you taken a loan from a commercial bank.

For simplicity, let us assume a notional rate of interest at 10% (simple interest). An amount = Rs 60,000 * 10% = Rs 6,000 gets added to your taxable income as a perquisite. You therefore have to pay tax on this “notional interest” component of Rs 6,000.

Hope this clears your confusion.

raj October 17, 2008 at 7:56 PM

hi
thks for this, its quite clear now
but since it gets added to the taxable income,
u ll only pay tax on Rs. 6000 (say 600 @10% or 1200@20% depends on ur income)
which would be much lesser than the interest u pay
if u have taken the loan frm any commercial bank. right?
if i m wrong please clearify me
thks again.

Vinaya HS October 20, 2008 at 10:41 AM

That’s correct.

ani December 13, 2008 at 11:26 AM

Hi raj u have taken simple interst to calculate notioanal intrest.what the kind of intrest banks actually going to calculate.also what is the actaul difference netween the tax paid and intrest paid to a bank would have been.suppose take the example raj has given above.

ani December 13, 2008 at 11:27 AM

Hi Vinay u have taken simple interst to calculate notioanal intrest.what the kind of intrest banks actually going to calculate.also what is the actaul difference netween the tax paid and intrest paid to a bank would have been.suppose take the example raj has given above.

Anonymous December 31, 2008 at 6:29 PM
Anonymous January 19, 2009 at 10:15 PM

“With some fanatic fiscal steps, I managed to come out of this situation sooner than I thought it would take”
How did you manage to?

Anonymous March 16, 2009 at 11:49 PM

Hi ,
My gross income is around 3Lacs p.a. and I pay Rs. 6K per month as rent . However, my company divides the complete income into Basic + FBP (fringe benefit pay)..there is no component in the salary as HRA. So the TDS is cut on the 6K which I pay as rent too. Can I claim that from IT deptt. at the time of filing ITR ?

raj August 14, 2009 at 6:46 PM

Dear Sir,

The emi calculator want to do in Perquisite rate 15.50 % amt 60000 for 24mnths.

Please specify this.

Thanks

Yogender Mohan December 21, 2009 at 10:51 AM

I do not agree with this notional interest causing any upset to the tax calculations. If you are adding interest as perquisite then it will be shown as payment also. You never got it as perk. Interest income notional can be set aside by interest payment notional. Again interest payment on housing loan is deducted directly from the Gross Income. It will land you at the base figure without any burden of tax.

Yogender Mohan Ambardar

joji February 20, 2010 at 12:40 PM

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Mr. G.D.Mishra March 4, 2010 at 3:22 PM

I have taken free interest loan from my employer amounting to Rs. 3 lacs for housing purpose in the month of July,2009 & Rs. 10000 P.M. is being deducting form my salary. Pls. let us know the status of Tax applicable or not.

Yogender Mohan Ambardar March 15, 2010 at 4:56 PM

Since no interest is involved in this case hence no deduction for this component shall be allowed. However 10000 p.m. subject to a maximum of one lakh shall be considered for rebate of tax under 80 C.

Dhiraj Sheti November 21, 2010 at 10:56 AM

My wife has take about 10 lacs of interest free loan from her employer, with no time frame for repayment. Her salary is 3.0 lacs per annum.

Can you please inform me the income tax computations for this?

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