The Tax Effect on Personal Loans

In India, people often assume that borrowing money is just an added expense, but the tax effect on loan interest can actually work in your favour. While personal loans are primarily used for quick cash needs, they can also serve as effective tax-saving tools. In fact, personal loan disbursements rose 23% YoY in value during H1 FY26 and 35% YoY in Q2 FY26. Understanding the tax implications of personal loans is crucial for informed financial planning, which we discuss in this blog.

Understanding Personal Loans and Tax Basics

A personal loan is an unsecured loan, meaning you don’t need to pledge any asset as collateral. Banks and Non-Banking Financial Companies (NBFCs) disburse these loans for various purposes, from home renovation and education to business needs and vacation costs.

The principal amount received as a personal loan is not taxable income since it’s classified as a liability. However, for general consumption purposes like weddings, vacations, or gadget purchases, neither the principal repayment nor interest paid qualifies for tax deductions under the Income Tax Act, 1961.

When Personal Loans Qualify for Tax Benefits

The crucial factor is end-use. If you can demonstrate that your personal loan was used for specific tax-eligible purposes, you may claim substantial deductions.

1. Business Use 

Interest paid on personal loans used for business expansion or working capital can be claimed as a business expense under Section 37(1), with no upper limit. If you’re self-employed and borrow 5 lakh at 14% interest for equipment, the 70,000 annual interest reduces your taxable business income.

2. Property Purchase 

For house purchase or construction, you can claim up to 2,00,000 on interest for self-occupied property and up to 1,50,000 on principal under Section 80C. For home repairs, the limit is 30,000 annually. Let-out properties have no interest deduction cap.

3. Education

Interest on personal loans used for higher education for yourself, spouse, or children is deductible under Section 80E with no upper limit for up to 8 years.

Tax Effect on Loan: New vs Old Tax Regime Impact

The choice between tax regimes significantly affects personal loan benefits in 2026. Income up to 12 lakhs is tax-free in the new regime with standard deduction and rebate, but most deductions are unavailable. Let’s take a look at the detailed comparison of tax benefits between the two regimes 

to help you get an improved understanding of the impact on your ability to claim personal loan deductions and your overall tax liability:

As you evaluate these regimes, remember that smaller, short-term financial gaps don't always require a long-term tax strategy. An instant personal loan app like Loan112 can be a wise choice for these moments. Providing personal loans up to 1.2 lakh with disbursals in just 10 minutes, it offers the speed you need when you'd rather focus on your projects than on tax-regime calculations.

Additional Tax Considerations

Beyond the primary tax benefits, here are three often-overlooked tax implications that every personal loan borrower should understand:

1. GST Impact: GST at 18% on all service-related fees charged by the lender, such as the processing fees, prepayment charges and foreclosure charges.

2. Loans from Friends/Family: Under section 56(2)(x) of the Income Tax Act, any sum of money received as a gift (without consideration) from a non-relative exceeding 50,000 in a financial year is taxable as income from other sources.

3. Investment Assets: If you use a personal loan to acquire a capital asset (like a house or land), the interest paid prior to the asset being put to use can be added to the cost of acquisition under Section 48. This reduces your taxable capital gains when you eventually sell the asset.

How to Claim Personal Loan Tax Benefits

To successfully claim tax deductions on your personal loan, follow this simple approach:

1. Determine if loan usage qualifies

2. Obtain an interest certificate showing total interest paid in the financial year.

3. Verify applicable limits.

4. Choose between tax regimes

5. Subtract the eligible amount from ‘Income from House Property’ or ‘Gross Total Income’ as appropriate.

Conclusion

Personal loans in 2026 offer tax benefits only when used for specific purposes, business expansion, property purchase, or education. With the New Tax Regime as default, most personal loan deductions (except business-related) are unavailable, making regime choice essential for ensuring better tax effect on loan. Careful documentation and professional tax advice are essential for maximising benefits while ensuring compliance.