In the present situation of inter regional and inter city movement for jobs, one of the first big financial decision that an individual faces is whether and when he should buy a home. In the initial period of work there is pressure from parents and relatives to take an early decision on it. With time and as most people get married, the urgency of taking this decision increases both from a practical convenience view as well as from a societal angle.
The important thing to understand about buying a home is that it is not purely a financial decision unlike other financial instruments. So all the rent versus buy calculators of the world will have very limited utility in terms of helping you reach a decision. Having your own home is a huge emotional benefit as it gives you an unparalleled sense of security that no other asset can. If you are having a family it also means the world to your wife and children. So, from a fundamental point of view I am a strong supporter of people buying their first home. The question we need to answer is when do you buy it?
Let me get into specifics by taking the examples of Hyderabad and Chennai, two of the cities where I have stayed for a long time and have some knowledge of life there and costs associated. A person wanting to buy an apartment ( we’ll use that as 90 % or more people buy apartments ) in any of these two cities will have some fundamental decisions to make. These are, what kind of apartment should he buy and where should he buy it within the city. These choices will obviously vary from individual to indivial but we can make some generic observations based on the life stage of people. Someone who is newly wed or has a small family will probably want to buy a 2BHK flat and would not mind being in relative outskirts of the city. Others with a larger family or with children growing older will probably need to look at a 3BHK flat within the city for various reasons.
In my experience, people tend to overestimate their needs when they look at a first home. Many young people end up buying a 3BHK flat when they do not really need it in the near term. Now, if you are going to stay in the same city for the next 10-15 years there is nothing wrong with it. However, with jobs and careers being the way they are this is not something that any one of us can be assured about. If you have to move out of the city and rent out your house, you need to understand that rental yields are fairly low in Indian context. For people in their 30 s with a relatively stable job, the decision is slightly easier as their chances of remaining in the same city for a longer period are higher.
Location is the other important factor. Even though most of us buy a first home with an intention to stay there, it also needs to be a good investment as we may need to sell it or rent it out at a later time in life. I think buying something in a good location is very important even if it means you have to wait a couple of years in order to be able to afford it. In Hyderabad for example similar siz apartments in different parts of the city have a huge difference in their sale and resale values. In Chennai the price appreciation in some areas have been stupendous over the last 5-7 years.
Now that we have got these selection criteria out of the way let us look at the financial part. Home buying had become a rage due to the tax advantages given and the relentless marketing campaigns by builders and banks. The basic argument goes like something below:-
- You can save on rent, save taxes and buy an asset at the same time.
- Home loan is a good loan as it is helping you create an asset.
- If you add your rent and the taxes saved then much of your EMI will be covered.
- Why pay rent which is just an expense when you can buy something that is your own?
Till the prices went through the roof in real estate, the above logic seemed to work quite well. A 3BHK flat in Chennai was available for 30 lacs or so in a pretty decent locality in 2005 or so. Assuming you took a loan of 20 lacs at 10 % interest, you would be paying an interest of roughly 2 lacs in the first year. Your EMI would be approximately 25000 Rs and the savings on rent + taxes would come quite close to that. In Hyderabad the situation would have been even better, especially in the newer areas like Hitech city which were just upcoming locations then.
Of course the fact remained that you were paying reasonably high interest to get the tax benefit but this seemed quite worthwhile as you were acquiring an asset and getting to use it for your stay at the same time. So, in general, 10 years back it would have been a great idea to buy your first house as long as you were planning for some years in the city. How has the situation changed now and foes it still remain a good idea?
One of the things that has definitely changed in the last 10 years is the accent on lifestyle. Most people prefer living in gated communities now as opposed to single buildings. The amenities expected have also changed quite dramatically over the last decade. Add to this the general inflation and cost of land going up rapidly due to supply constraints and you have a situation of prices becoming exorbitantly high. In Chennai, prime locations such as Adyar will be almost impossible to buy both from a price and supply point of view. Hyderabad is slightly better off as the prices were depressed for years due to the Telengana issue but even here they are on the rise. In terms of aspirations 2BHK flat sizes needed will be at least 1000 SFT and 3 BHK at least 1600 SFT, though many would prefer larger ones for their living. With this in mind let us look at the finances again. We will first do it for a person of 32 years old who wants to buy a flat in Hyderabad.
- Assume flat value of 2BHK in West Hyderabad to be about 50 lacs. Down payment managed is 20 % or 10 lacs.
- A loan of 40 lacs at 10 % will have ENI of about 43000 Rs over a 15 year period.
- Total interest paid in this period is roughly 37 lacs.
- Assuming an interest exemption of 2 lacs from taxable income every year, savings on that score is about 70000 per year assuming the person is in 30 % tax bracket.
- Assuming rent he is paying today to be 15000 Rs the following is a complete picture:
- Expenses on interest payment is about 20000 per month.
- Excess cash outflow is about 22000 Rs per month after taking rent and tax savings into account.
- In essence he will be paying 22000 extra per month for building the asset in 15 years time.
- Based on this if he is planning to stay in Hyderabad for long and can make the extra payment, I think it makes a lot of sense to buy his first home.
The above, of course is a fairly simple depiction of the decision process in financial terms but can be used by everyone to come to a decision. Note that the things which go wrong when buying a house in financial terms are many:-
- Overestimating the payment capability and aiming for a more expensive house. In the above example a 3BHK will cost about 80 lacs and a 70 lacs loan will have an EMI of 75000 Rs.
- Not having the required down payment of at least 20 % to keep the EMI in check.
- Wrong assumptions of duration of stay in the place. If you move out and have to rent your place you will not be covering anywhere near the EMI amount.
In the next post I will present a comprehensive case study for better understanding of these aspects.
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