5 reasons to consider investing in debt funds now!   Nov 01, 2014


Buying a dream home is one of the financial goals, which we all endeavour during the earning phase of our economic life cycle. But with property prices having gone off the roof, especially in a metro such as Mumbai, this primary need has become a distant dream. You see, even in extended suburbs prices have skyrocketed making it difficult, especially for those looking out for a house to live in. Now while many may say that with capital appreciation, I’ll stand to benefit in the long run; let’s us take you through the present situation.

According to Mumbai-based real estate research firm LiasesForas, there are 52,000 2BHK flats lying unsold in Mumbai city and 1.47 lakh in the Mumbai Metropolitan Region (MMR) – up from 45,000 unsold ones in the city and 1.30 lakh in the MMR last year. The reason for pile up in inventory is:

  • The unaffordable rise in property prices;
  • An elevated interest rate regime making it difficult to avail a home loans;
  • Slow rise in household income (due to flagging economic growth);
  • The exuberant phase of the Indian equity market encouraging many to invest in equities
So, there is clear cut indication of supply outstripping demand. In such times the potential of capital appreciation is capped. In recent past, although developers doled out discount offers during Diwali (to offload their inventory), it has failed to revive the property market and make it affordable. At present there property prices have stagnated.

You see, despite such a scenario while many of you may be thinking of buying a house to move in, it is imperative to recognise that the purchase can have big impact on your finances, where in you may even have to compromise on some of the other long-term financial goals such as such your children education, their marriage and even your own retirement needs. Thus you need to weigh your pros and cons wisely.

While buying a house carries advantages such as hedge against inflation, diversification, rental yields and capital appreciation; these benefits really don’t matter if you are looking out for a house to live in and not reap investment benefits. You should be more concerned with factors such as:

Affordability - Budgeting should be the starting point of your assessment process as this will help you decide upon the city or locality within a city you can afford to buy property in. It is noteworthy that desire to own a plush home in a prime locality may affect your long-term finances if you fail to estimate your future income and expenditure.

So even when you opt to avail a home loan, ensure that your entire EMI-to-income ratio does not exceed 40% of the total household income. You see, loans create obligation on the buyer to pay regular Equated Monthly Instalments (EMIs). EMI affects an individual’s cash flow in a big way as usually very less sum is left after having accounted for EMIs and expenses for investment purpose to meet other short and long-term financial goals.

Property exploration: Once you are sure of affordability, you should be doing background check considering the following nitty-gritties amongst host of others...
  • Who is the builder?
  • What has been his track record?
  • Has he completed the construction of his projects as per schedule?
  • Visit the site and inspect the quality of construction
  • The rate which he is offering for the amenities
  • You may also visit other sites developed by the same builder just to check whether he has fulfilled all promises made and offered amenities as promised
  • Title of the property on which the construction is taking place or has taken place (to ensure that it free from any encumbrances and litigations and save you from inconveniences in the future)
  • Has he obtained all statutory permissions
  • In case of on-going construction, the time lag for getting the possession
  • In case of a ready property - i.e. newly constructed or a resale property, has a society being formed and age of construction of the property
  • Is the builder listed or recognised by the housing finance company (in case if you want to avail a home loan facility)
  • Quality of Construction

Also for your long-term financial, you should be taking into account the maintenance cost you would defray and proximity to other work place, commercial areas and other essential services which can reduce the cost and the time involved in travelling.

You see, both - buying a house and renting one, have their own unique set of costs and therefore it is imperative to evaluate both to make a prudent choice. The following illustration here would help you get better insight.

Name: Mr Sunil
Placed in: Mumbai Suburbs
Gross Salary per month(in Rs) 150,000
Basic salary per month (in Rs) 75,000
Assumptions:
The company pays him House Rent Allowance
Tax Bracket 30.9%
Annual increment in salary 7.0%
There is no change in tax laws for 20 yrs

Mr Sunil is salaried individual placed in Mumbai drawing a basic monthly salary of Rs 75,000 falling under the highest tax bracket and is exploring two options-

  • Staying in a rented accommodation; or
  • Buying a house to live in availing a home loan

Option 1: Live in a rented house
Tenure of residency Yrs 20
Rent per month Rs 13,500
Annual rent Rs 162,000
Initial deposit Rs 100,000
Increase in rent (pa) % 10
Result:
Total expenditure on rent (over 20 years) [A] Rs 9,278,550
Tax benefit on house rent (over 20 years) [B] Rs 1,726,987
Loss of interest on initial deposit (over 20 years) [C] Rs 366,096
Total expenditure on rent after accounting for tax benefits (A-B+C) Rs 7,917,658

Now well, if he opts for living in a rented house where he will pay a monthly rent of Rs 13,500 along with an initial deposit of Rs 100,000 (refundable once he vacates the house) and assuming he stays there for 20 years and is subject to an annual escalation clause of 10% for rent; over the tenure of residency (i.e. 20 years) he would be paying a sum of Rs9,278,550on rent. However, as per Section 10(13A) of the Income Tax Act, he is entitled to a tax benefit for House Rent Allowance (HRA). Therefore, over the 20-year period he is estimated to receive a tax benefit of Rs1,726,987. Also we’ve considered the loss of interest, which he has to bear on the initial deposit doled out,as that’s the opportunity he has foregone whereby he could have invested the same sum and earned an interest of Rs366,096assuming a steady rate of interest @ 8.0% p.a.

Taking into consideration all these aspects, i.e. his expenditure on house rent, the opportunity loss and the tax benefit he would receive, the net expenditure for renting the house would amount to Rs7,917,658.

Now say he explores the second option i.e. to buy a house to live in availing a home loan...

Option 2: Take a home loan to buy a house
Cost of the house Rs 7,500,000
Loan amount Rs 6,000,000
Tenure of loan Yrs 20
Rate of interest % 10.15
EMI Rs 58,499
Initial payment:
(a) Personal contribution (20% of property cost) Rs 1,500,000
(b) Stamp duty (5% of property cost) Rs 375,000
(c) Registration (1% of property cost) Rs 75,000
Total initial payment (a+b+c) 1,950,000
Result:
EMI outgo (over 20 years) and initial payment [A] Rs 15,989,723
Tax benefits received from EMI (over 20 Yrs) [B] Rs 6,549,391
Loss of interest on account of initial payment (over 20 years) [C] Rs 7,138,866
Total expenditure after adjusting for tax benefits (A-B+C) Rs 16,579,199

Here with the aforementioned details on the cost of the house and loan he would avail, his initial contribution (including the stamp duty and registration) would be Rs 19,50,000. Also over the tenure of the loan of 20 years, he would pay an EMI per month of Rs 58,499. Including the initial payment and EMI his outgo over 20 years would be Rs15,989,723.Nonetheless having availed a home loan, he would be entitled to a tax benefit under Section 80C and Section 24(b) of the Income Tax Act, 1961 together amounting to Rs6,549,391 on the EMI paid over the tenure of the loan. Also like in option1 , here too we have considered the loss of interest on the initial payment of Rs 1,950,000 which could have otherwise earned him interest amounting to Rs7,138,866 had he invested in an instrument offering a steady rate of interest @ 8.0% p.a.

After taking into consideration all the aspects such as total home loan repayments, tax benefits and the opportunity loss, the net expenditure on buying a house would have amounted to Rs 16,579,199.

The comparison between option 1 and option 2 reveals that over a period of 20 years staying on rent is much cheaper (Rs79,17,658) as against buying a house by availing a home loan (Rs16,579,199).

But mind you the outcome of this exercise would be different as variables to each of the two options change.Therefore it is imperative that you take cognisance of the environment in the property market while you are taking the decision of buying a house or living on rent.

Having said that we recognise the fact that in India buying a house is filled with emotions, and more so, when one is moving in with a family, making it a home. Nevertheless, while you are thinking of buying your dream home, please take into account financial and non-financial factors (individual needs and aspirations), to make the a prudent and feasible choice for your and family’s well being.



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