Buying a home – Invest now buy later?

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.

Interested readers may pls follow my blog on email by clicking on the relevant button on the right hand panel. I will shortly be stopping the practice of posting the links in different Facebook groups. Following the blog will ensure you get intimated whenever there is a new post.

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9 thoughts on “Buying a home – Invest now buy later?

  1. Hi Sir, I have been following your blog for some time now. Its a great one and I thank you for putting your thoughts across for the younger generation to learn. But here is what I think on this subject:

    Someone who buys home in the early part of his career, say late 20’s, may have to stretch all his means to pay the high EMIs and will still be able to purchase a house which may be in outskirts and not comfortable to commute daily.It will also not be his dream house and will barely be one he can just manage to afford.

    (Apartments in the center of the city are much costlier and difficult to afford in the early part of our career).

    Moreover, people working in IT are no longer certain of their work locations and may keep moving across all the time. Therefore, is it not better to stay in a rented place closer to work and keep accumulating money for purchasing house. After few years, say mid to late 30’s, when people are more settled in their jobs comparatively, can assess the saved amount and purchase a house accordingly in may be a tier-2 or tier-3 city which will be cheaper than a metro or may still be in a metro if it is affordable at that point of time. I am saying this because already I am observing people prefer tier-2 or tier-3 cities to settle down because of lower costs of living.

    Let me know your thoughts.

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    • Hi Vishal,

      Yes, I also agree that you should not buy a house by over leveraging on the loan.

      This really depends on your bandwidth to invest in the house. There are 2 case studies I have published, in one of them the person has enough bandwidth and in the other one he has not. Read both of these.

      I also believe that till the point of time where you have 20 % of down payment saved from your side, you should not look at buying the house.

      Finally, buy it when you are reasonably sure of being in the city for at least the next 8-10 years. Postponing the buying decision may not always be a good idea due to reasons of cost increase and availability, as I have explained in my last post.

      Thank you for your comment. Best wishes. Raj

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      • The strategy that I am using is that I have purchased my first house at the age of 28 for 25 odd lakhs and I pay around 20% my take home as EMI. It is in a tier-2 city which I am expecting to grow in 4-5 years time and have reasonable work opportunities for me to move across and settle there. If this does not happen, I can sell that off with some appreciation, and I should be able to at least make a down payment from that amount. In the next 4-5 years, I should be more certain of the city to settle down that I currently am.

        Not sure whether this is a good strategy or not. Just wanted to share. Thanks for your earlier response.

        Like

      • The strategy that I am using is that I have purchased my first house at the age of 28 for 25 odd lakhs and I pay around 20% my take home as EMI. It is in a tier-2 city which I am expecting to grow in 4-5 years time and have reasonable work opportunities for me to move across and settle there. If this does not happen, I can sell that off with some appreciation, and I should be able to at least make a down payment from that amount. In the next 4-5 years, I should be more certain of the city to settle down that I currently am.

        Not sure whether this is a good strategy or not. Just wanted to share. Thanks for your earlier response though.

        Like

      • Looks OK, except the fact that you are paying for both rent and EMI. Are you getting any rent from the place you have bought? Hope this leaves you with enough money to invest for your other goals.

        Like

  2. Sir,
    This is a good illustration to show the a home loan can increase your affordability. Nothing beats it when we want immediate increase in affordability. 100% agree when buying a home is an emotional or need based decision.
    But when we consider it from a financial perspective, will it not be better if we include the tenure to pay off the loan too? In this example, it take 7 years from today to buy and lets say 10 more years to pay off the loan.
    Option 1 which you have illustrated is to take a home load after 7 years and pay it off over next 10 years.
    Option 2 could be to have a SIP running for 17 years (7 + 10) and then buy at the end. In this case, the monthly SIP will be much smaller and more easily manageable. SIP will be

    Like

    • If you are buying home later your down payment will be much higher and therefore loan amount is less. Also at that point your income is likely to be higher so you can pay off the loan faster. If there is high equity growth, there can be a happy situation where you do not need much loan at all ๐Ÿ™‚

      Like

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