Mortgage Advice: CAIIB Retail banking (Module E), Unit 3

Mortgage Advice: CAIIB Retail banking (Module E), Unit 3

Dear Bankers,
We all know that CAIIB exams are conducted by the Indian Institute of Banking and Finance (IIBF).  CAIIB is said to be one of the difficult courses to be cleared for the bankers. But we assure you that with the help of our “CAIIB study material”, you will definitely clear the CAIIB exam.
CAIIB exams are conducted twice in a year. Candidates should have completed JAIIB before appearing for CAIIB Exam. Here, we will provide detailed notes of every unit of the CAIIB Exam on the latest pattern of IIBF.
So, here we are providing “Unit 3: Mortgage Advice of “Module E: Additional Reading Material On Home Loans” from “Optional Paper: Retail Banking”.

The Article is CAIIB Unit 3: Mortgage Advice

Economic and Regulatory Context For Giving Mortgage Advice

In India, mortgage advice profession is carried out without any regulations. There is no entry barrier and no code of conduct or ethics are stipulated by any regulation. Any person can enter the profession and can provide advice and do business. There are regulations in US, UK and other countries regulating the mortgage advice services. It would be worthwhile to look at some of the legal provisions in US to understand the position prevailing in these counties and to feel the need of such regulations in India.

Development of “Home Information Packs”

This concept is being introduced in UK from 1st August 2007. An attempt has been made to explain in brief the concept and its utility. It is not at all applicable in India. However, the study of this concept and understanding its usefulness may be advisable. This may also pave the way for introducing the same in the country on a limited basis in a gradual manner.

What is Information Pack?

  • The Home Information Pack contains important information that buyers and sellers need to know. Home Information Packs including Energy Performance Certificates will be implemented on a phased basis from 1st August 2007 in UK. From then, on Packs will be required for the sale of four bedroom properties and larger, with smaller properties being phased in as soon as sufficient energy assessors are fully qualified.

Time Value of Money-Interest and Annuities

The Rule of 72

This rule allows you to determine the number of years before your money doubles whether in debt or investment. Here is how to do it.

Divide the number 72 by percentage rate you are paying on your debt (on earning on your investment.

For Illustration: Suppose, you borrowed Rs. 1,000 at 6% interest. 72 divided by 6 is 12. That makes 12 the number of years it would take for your debt to double to Rs. 2,000, if you did not make any payment. Similarly, a saving account with Rs. 500 deposited in it earning 4% interest. 72 divided by 4 is 18. It will take, 18 years for your Rs. 500 to double to Rs. 1,000 if you don’t make or with any deposit.

Future Value of Money

For finding out future value (FV), we must use compounding formula which is given below:

FV = PV(1 +r)n

Where PV means present value, 1 means one rupee, r means rate of interest and n means period or term

Example:

If Rs. 1,00,000 is invested for a period of 6 years at interest at 11% p.a. find the maturity sum i.e., future value

Future value = PV × future value factor

FV = 1,00,000 x 1.87 = 1,87,000

Solving problem through MS EXCEL program

The in-built function of FV in excel is –

FV (RATE, NPER, PV, TYPE)

FV = Future value, RATE = rate of interest, NPER = Total number of periods, PV – present value. PMT and TYPE are included to handle annuities (a series of payments equally spaced over a period of time). TYPE is for indicating whether the cash flow occurs at the beginning (1) or at the end (0) of the period.

In order to do calculation with EXCEL go to Insert, go function, click financial function.

Calculating the Future Value of an Ordinary Annuity

If you know how much you can invest per period for a certain time period, the future value of an ordinary annuity formula is useful for finding out how much you would have in the future by investing at your given interest rate. If you are making payments on a loan, the future value is useful for determining the total cost of the loan. In order to calculate the future value of the annuity, we have to calculate the future value of each cash flow.

F = A

Where, F = future value of an annuity

A = annuity

I = interest rate

n= term

Calculating the Future Value of an Annuity Due

Since each payment in the series is made one period sooner, we need to discount the formula one period back. A slight modification to the FV-of-an-ordinary-annuity formula accounts for payments occurring at the beginning of each period.

Notice that when payments are made at the beginning of the period, each amount is held for longer time at the end of the period. For Illustration, if the Rs. 1,000 was invested on January 1st rather than December 31st of each year, the last payment before we value our investment at the end of five years (on December 31st) would have been made a year prior (January 1st) rather than the same day on which it is valued. The future value of annuity formula would then read:

= Rs. 5801.91

The same value can be calculated by using annuity table.

Future value of annuity = Annuity x CV factor

Compound value factor for annuity (CVA) of Re. 1 at different rates of interest are given below for information. Assume rupee to be invested at the end of the year.

Year 7% 8% 9% 10% 11% 12%
1

2

3

4

5

6

1.00

2.070

3.215

4.440

5.751

7.153

1.00

2.080

3.246

4.506

5.867

7.336

1.00

2.090

3.278

4.573

5.985

7.523

1.00

2.100

3.310

4.641

6.105

7.716

1.00

2.110

3.342

4.710

6.228

7.913

1.00

2.120

3.374

4.779

6.353

8.115

 

Example:

If Ms. Abhinav is paying home loan instalment at Rs. 12,000 per year for a period of 6 years how much she paid till the end of the loan period (What is the future value of an annuity of Rs. 10,000 p.a. at 11% for a period of 6 years)

Solution:

By using the annuity table above, find CVA factor for 6 years at 11% and multiply by Rs. 10,000 CVA for 6 years @ 11% = 7.913

Annuity = Rs. 10,000

So Future value of annuity = 7.913 x 10,000 = Rs. 79,130

Present Value

Present value is nothing but the reverse of future value. For finding out present value (PV), we must use counting formula which is given below:

PV = FV + (1 +r)^n

Where PV means present value, 1 means one rupee, r means rate of interest and n means period or term and FV means future value.

CAPITAL GAINS

Any profit or gain from transfer of a capital asset is chargeable to tax under the head “capital gains”. Capital asset means any property whether movable or immovable, tangible or intangible. Transfer, in relation to capital asset, includes sale, exchange of the asset.

The following assets are, however, excluded from the definition of capital assets:

i)Stock-in-trade, stores, raw material,

ii)Personal effects (excluding Jewellery, archaeological collections, drawings, paintings, sculptures, etc.);

iii)Agricultural land in India, not being a land situated;

  • Within jurisdiction of municipality, notified area committee, town area committee, cantonment board and which has a population of not less than 10,000;
  • Within range of following distance measured aerially from the local limits of any municipality or cantonment board:
  • Not being more than 2 KMs, if population of such area is more than 10,000 but not exceeding 1 lakh;
  • Not being more than 6 KMs, if population of such area is more than 1 lakh but not exceeding 10 lakh; or
  • Not being more than 8 KMs, if population of such area is more than 10 lakh.

Bonds/securities under certain schemes, as announced by Government.

For the purpose of income tax Law “Transfer”, in relation to a capital asset, includes:

  • Sale, exchange or relinquishment of the asset;
  • Extinguishment of any rights in relation to a capital asset;
  • Compulsory acquisition of an asset;
  • Conversion of capital asset into stock-in-trade;
  • Maturity or redemption of a zero-coupon bond;
  • Allowing possession of immovable properties to the buyer in part performance of the contract;
  • Any transaction property which has the effect of transferring an (or enabling the enjoyment of) immovable property or
  • Disposing of or parting with an asset or any interest therein or creating any interest in any asset in any manner whatsoever.

Types of Capital Assets Shon-term capital assets

  • Long-term capital assets
  • Short Term Capital Assets

Short Term Capital Assets

  • Short term capital asset means a capital asset held for less than 36 months immediately prior to the date of transfer. However, in following cases, asset held for less than 12 months is treated as short term capital asset. However, in respect of certain assets like shares (equity or preference) which are listed in a recognised stock exchange in India, units of equity oriented mutual funds, listed securities like debentures and Government securities, Units of UTI and Zero Coupon Bond, the period of holding to be considered is 12 months instead of 36 months.
  • In case of unlisted shares in a company, the period of holding to be considered is 24 months instead of 36 months.
  • With effect from Assessment Year 2018-19, the period of holding of immovable property (being land or building or both), shall be considered to be 24 months instead of 36 months.

Short Term Capital Gain (STCG):

Short Term Capital Gain on property is considered as a gain from selling a property which was held by an assessee for not more than 36 months.

Long Term Capital Assets

Long term capital asset means a capital asset held for more than 36 months immediately prior to the date of transfer. However, in respect of certain assets like shares (equity or preference) which are listed in a recognised stock exchange in India, units of equity oriented mutual funds, listed securities like debentures and Government securities, Units of UTI and Zero Coupon Bonds, the period of holding to be considered is 12 month instead of 36 months.

  • In case of unlisted shares in a company, the period of holding to be considered is 24 months instead of 36 months.
  • With effect from Assessment Year 2018-19, the period of holding of immovable property (being land or building or both), shall be considered to be 24 months instead of 36 months.

Long Term Capital Gain (LTCG)

Gain arising on transfer of long-term capital asset is termed as long-term capital gain.

Method of Computation of Short-term and Long-term Gain

Computation of short-term Cap. Gain Computation of Long-term Cap. Gain
1. Find out full value of consideration

2. Deduct the following:

a. Expenditure of transfer

b. Cost of acquisition

c. Cost of improvement

3. From the sum so arrived at deduct the exemptions provided by sections 54B, 54D

4. The balancing amount is short term capital gain

1. Find out full value of consideration

2. Deduct the following:

a. Expenditure of transfer

b. Indexed cost of acquisition

c. Indexed cost of improvement

3. From the sum so arrived at deduct the exemptions provided by sections 54, 54B, 54D, 54EC, 54F

4. The balancing amount is long term capital gain

 

 Cost Inflation Index

Indexation is a process by which the cost of acquisition is adjusted against the inflationary rise in the value of the asset. For this purpose, Central Government has notified cost inflation index. The benefit of indexation is available only to long-term capital assets. For computation of indexed cost of acquisition following factors are to be considered:

  • Year of acquisition/improvement
  • Year of transfer
  • Cost inflation index of the year of acquisition/improvement
  • Cost inflation index of the year of transfer

Capital Gains: When and to What Extent Exempt from Tax

Section in IT Act Gain eligible for claiming exemption Asset in which the capital gain is to be re-invested to claim exemption
section 54 Long-term capital gain arising on transfer of residential house property. Gain to be re-invested in purchase or construction of one residential house property in India.
section 54B

 

Long-term or short-term capital gain arising on transfer of agricultural land.

 

Gain to be re-invested in purchase of agricultural land.
Section 54EC Long-term capital gain arising on transfer of any capital asset. Gain to be re-invested in bonds issued by National Highway Authority of India or by the Rural Electrification Corporation Limited. The investment should be made within a period of 6 months from the date of transfer of capital asset and bonds should not be redeemed before 3 years. This benefit cannot be availed in respect of short-term capital gain. The Maximum amount which qualifies for investment will be Rs. 50,00,000. Thus, the deduction under section 54EC cannot be claimed for more than Rs. 50,00,000.
Section 54EE

 

 

 

Long-term capital gain arising on transfer of any capital asset.  Gain to be re-invested in units of specified fund, as may be notified by Govt. to finance start-ups.
section 54F

 

Long-term capital gain arising on transfer of any capital asset other than residential house property. Net sale consideration to be re-invested in purchase or construction of one residential house property in India.
section 54D Gain arising on transfer of land or building forming part of industrial undertaking which is compulsorily acquired by Government and was used for industrial purpose for a period of 2 years prior to its acquisition. Gain to be re-invested to acquire land or building for industrial purpose.
section 54G Gain arising on transfer of land, building, plant or machinery in order to shift an industrial undertaking from urban area to rural area Gain to be re-invested to acquire land, building, plant or machinery in order to shift the industrial undertaking from an urban area to a rural area
section 54GA Gain arising on transfer of land, building, plant or machinery in order to shift an industrial undertaking from urban area to any Special Economic Zone Gain to be re-invested to acquire land, building. plant or machinery in order to shift the industrial undertaking from urban area to any Special Economic Zone.
Section 54GB Long-term capital gain arising on transfer of residential property (a house or a plot of land). The transfer should take place during 1st April, 2012 and 31st March 2017. However, in case of investment in “eligible start-up”, sunset limit of 31st March 2017 is extended to 31st March 2019. The net sale consideration should be utilised for subscription in equity shares of an “eligible company: W.e.f. April 1, 2017, eligible start-up is also included in definition of eligible company

 

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