This post is inspired by an interesting comment that was made on my previous post on home buying. The basic contention of the reader was this – he could save 50,000 Rs per month in an MF through SIP, instead of paying a home loan EMI, see that money grow into some 5 crores or so and buy a home for much less amount. On the face of it, this seems to be an attractive proposition but does it work on the ground? Let us see why or why not?
First things first – this strategy is obviously only workable for someone who is relatively young and well paid, assumptions that we can make of many people of today’s generation. For such a person let us go through the relevant working:-
- We assume he gets 1 lac per month today and is able to save 50000 out of it for home buying. He may also need to save another 20000 odd for his other goals. As he is single this may be possible.
- A 50000 Rs EMI will let him buy a house today which has a price of about 45 lacs, purely on the basis of home loan. When he is starting out he will not have much funds to bring to the table on his own, but let us still take he adds another 10 lacs. So we are looking at a 55 lacs house in today’s price.
- At that price he will at best get a 2BHK apartment in a decent location in Hyderabad, Bangalore, Chennai, Pune etc but not in Mumbai or Delhi. Let us assume he is looking at Hyderabad for purposes of simplicity.
- 15 years hence, when he is 40 years the family circumstances would have changed radically and he would definitely need a 3BHK home. The price of that home today in a good location in Hyderabad is probably 90 lacs.
- Let us assume the Hyderabad prices go up by 8 % every year. This is probably conservative as markets have been depressed for the last few years here. But with an 8 % CAGR, the home which costs 90 lacs today will end up costing Rs 2.85 crores. Not a very surprising figure when you consider 3BHK apartments in Adyar, Chennai selling for 1.5 crores today. Is there a possibility of price inflation being less than 8 %? I would say very unlikely.
- How will his investments grow? Over a period of 15 years if he does a SIP of 50000 every month and gets 12 % annualized returns, he will end up with 2.52 crores. Close enough to buy the home of his choice.
- What is missing here? Well, obviously he has to stay in a rented accommodation for 15 years and this will have its’ own costs. Assuming he starts with 15000 Rs rent today and it increases by even 5 % every year he will pay double the amount after 15 years. In reality this will be much more as with increasing family size and requirement he will need to upgrade his current accommodation standards.
- The focus on RE goal here can compromise his other goals as he may well be losing out on the time needed for his other investments to grow.
It will be fairly obvious from the above that I do not think this is a good strategy. My belief is that you need to have a simpler mechanism for buying a home. Let us look at how this can be done:-
- When you start working, have an aggressive goal of reaching a 20 % down payment figure for the home you want to buy in 5-7 years time. If you start working at 24 after your PG, then it will roughly coincide with your marriage or birth of your first child, when having a home would be really nice.
- Assuming the home you want to buy is at 50 lacs today, with 8 % price increase every year it will cost 85 lacs in 7 years. 20 % of this is 17 lacs which you need to have available at that point.
- For getting to the 17 lacs at 12 % CAGR, you will need to do an SIP of 13000 Rs per month. For the time period we are talking about, your focus on other goals is limited so this should be quite possible.
- A home loan of 68 lacs will have an EMI of about 75000 Rs but in 7 years your compensation would probably have grown to that extent to be able to afford it. Your spouse may also be working which will help.
- This strategy will let you buy a home you want at around 30 years of age, pay off the home loan at 45 or before that and still have enough time to bump up your retirement investments beyond that point.
Buying a home is the single most important financial decision you will make and there is no one way of doing it. However, putting it off till very late and hoping that your investments will allow you to buy a better home is flawed because of another reason and that is the constraint on availability. Prices in areas get pushed up to abnormal limits, not only because of inflation, but due to limited availability. So the general market may grow at 8 % and so on but there is no saying what will be the rise in costs for the area you are looking at.
Bottom line – plan early for your down payment, buy at the right time, buy something you can stay comfortably for at least 10 years and try to pay off your home loan early if you can.
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