Home loan – your options now

Over the past few days there have been significant changes in the home loan rates. Though this was being anticipated for quite some time, it was only with the demonetization impact and with a serious nudge from the PM that SBI went ahead and made a huge cut to their MCLR. Other banks followed suit and the effect has been to see the lowest home loan rates for quite a while. SBI and many are at around 8.65 % and I believe Bank of Baroda is the lowest at 8.35 %.

So if you are thinking of taking a home loan now to buy a house, is it a good time? To begin with if you want to stay in it, that is definitely a good idea. In case you are looking at the purchase as an investment, my suggestion will be that you wait to see how the realty market settles down in the next few months. Look at the following for the loan:-

  • Take a loan that you really need and pay as much as you can on your own. Remember even at lower rates of interest you are paying for the loan.
  • Negotiate on the rates as well as the waiver of processing fees.
  • Do not go for loans with a tenure of more than 15 years, 10 would be preferable.
  • Make sure there are no prepayment penalties associated with the loan.
  • Go for a pure floating rate loan, avoid ones that are part fixed for the first few years etc.

What if you are already having an existing loan? Well, that will depend on the context – see below for how you should go about it.

  • If your loan was taken after April 1, 2016 then it is linked to MCLR. In this case, you do not need to do anything, your rates will get adjusted to the new ones.
  • Remember the MCLR reset is done at different frequencies by different banks. Check with your bank to know when the rates will get reset.
  • In case you have an older loan, it is probably linked to BPLR and you need to look at possible switch. There will be a switching fee associated with the change. This is normally between 0.5 % to 1 % of your outstanding loan amount for most banks and is capped at 10000 Rs.
  • Check the EMI difference you are getting and multiply it with the outstanding tenure in months. If this amount is significantly more than the switching fee you should switch your loan.
  • If, for some reason, your bank is not being cooperative look at other options.
  • When you switch, do not reduce the EMI but ask for a reduction in tenure.
  • As a general strategy continue to prepay whenever you can.

As you would know, I dislike any kind of loans and would suggest you avoid them if possible. However, you do need to take a loan for housing in all probability. Make sure that you are discerning while taking the loan, limit the amount by paying as much as you can on your own and prepay aggressively.

Your home should be a great asset to you, not a liability in the form of an outstanding home loan.

Guide for buying a first home

Over the last week, I have published a few posts on my blog dealing with issues of first time home purchase. I thought it would be a good idea to combine all these posts to make a guide for home buying. As before you can follow the hyperlinks to get to the individual posts. New readers should read all of these to get a complete understanding of all the relevant aspects.

Should you buy your first home now outlines all the important factors that need to be taken into consideration when you are planning to buy your first home. The first case study talks of a situation where a family can afford the home they are seeking to buy. The next case study is of a situation where buying the kind of home the family is looking at will not be financially prudent. 

There is an idea some people have that investing in equity now and buying a home later on will work out better. This post handles that aspect and discusses it thoroughly. This first time home buying checklist will help you to make a better decision on whether you are ready to buy the home or not.

Most of us will need home loans to buy a home, get a fuller knowledge of it here. The next post outlines why you must try to pay your home loan quickly. The final post of the series looks at my own experience of home buying and home loan.

I hope armed with this knowledge many first time home buyers will be able to buy their own homes in a financially productive manner.

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My experience with home buying & home loan

I had wanted to write this post as a follow up to the other home buying posts that I had written last week. However, i got distracted with the 100th post etc and was surprised to see that a few people asked me about it. So, here is the post I had promised about sharing my experiences of buying a home and managing a home loan.

When we came to Chennai in 1998 it was still possible to rent an apartment in a decent locality for not too much of a rent. We were able to get a good quality and new 2BHK apartment in Adyar for 6000 Rs and this went up to 8000 Rs when we left it after about 5 years. As Chennai was the first place we had lived in the south, we did not initially have any real plans of buying an apartment there. The trigger came in 2001 when I joined a new job where I wanted to be for some time, and we started looking in earnest when I became CEO of the company in January 2002. The children were in school by then and a long term stay in Chennai seemed like a real possibility.

There were several projects going on in those days and we liked one which was very close to where we lived in Adyar. It was a good locality and nowhere near as busy as it is today. The standalone building would have just 12 flats and was right on the MG Road, on the way to the beach.The builder was a reputed one and would arrange for the loan needed. At a price of 1925 per SFT and size of 1400 SFT for a 3 bedroom apartment it seemed the right deal for us. We ended up spending about 37 lacs finally with registration and interiors etc and were able to move in there by October 2003.

Funding the apartment required some careful thinking as I was not very keen on taking a big home loan if I could manage without it. The EMI was not the issue with my earning, but I have never fond of paying too much of interest if it could be helped. Fortunately, we got my wife’s PPF maturing around that time and could use it for the down payment of the house. As the payments were construction-linked we made a few of the initial payments on our own. The loan from SBI that we took was for 20 lacs at 11 % interest for 15 years. Till we took the entire loan amount we had to pay simple interest on the loan disbursed and EMI would start after that.

We shifted to our new home in October 2003 and started paying the EMI. With the tax break, it was a fairly decent deal – between rent for a similar accommodation and tax breaks we saved about 18000 Rs every month and our EMI was only a little more than that. Even then, I was interested in exploring paying off the loan quickly if possible as I was not fond of long term liability and realized that interest paid over the 15 year period would be substantial.

Though the rate was a floating one from SBI and the interest rates were coming down sharply, the bank wanted to charge us for shifting to the lower rates. We did that reluctantly as the rates had climbed down to 8 % within only 2 years of our taking the loans. However, I saw this practice as a discriminatory one to older customers and resolved to get out of the loan as soon as we could. To this end, we started making payments whenever we would save up 1 lac, typically every 2-3 months. My annual variable pay was also directed towards it. Some of our FD that matured in 2004 was also deployed towards these payments. Over the whole of 2004, we were aggressive in paying off the loan quickly and this meant that we had to jettison our other investment plans to some degree. However, that did not matter too much as I was clear we could get back on track with investments as soon as we were done with the home loan.

At the beginning of 2005 we took stock and saw that we had to pay another 5 lacs odd to square off the loan. This was also the time I was discussing a new job role which would require me to spend some time in Pondicherry and Delhi from March. Though it would stretch us financially quite a bit, both my wife and me thought it would be a good idea to get out of the loan before I took up the new job. We managed to pay off the loan completely by March 2005, much to the surprise of our Bank manager, who obviously wanted us to continue with the loan !! 

How did we manage to pay off the loan in the short time period? Some of the factors were as follows:-

  • The overall loan amount was a manageable one, as opposed to what one will require today.
  • We were lucky to be making a fairly large down payment so as to keep the loan amount under control. This was possible as my wife’s PPF maturity coincided with our decision to buy a home.
  • My salary was a relatively high one and it enabled me to pay off parts of the loan every alternate month.
  • We had some assets like FD etc which we used to pay off the loan in a faster manner.
  • For this period of 18 months, my entire focus was on paying off the loan. This was reflected in all the financial decisions I took in this period of time.
  • In the final stretch, we were able to get some lucky breaks such as settlement money from my last organization etc which enabled us to pay off the final 5 lacs in just 2 installments.

What do I feel should ideally be done today? Well, given the fact that loans will be more in the range of 60-70 lacs for a 3BHK house ( not in Adyar, Chennai there it will need to be much more ), it will be difficult to set up the kind of schedule I did in 2005. Even then, I feel most people should look to pay the loan off within 6-8 years if possible. There is no point in paying a lot of interest and keeping your money in FD and debt MF which do not give you any real incremental returns. I think if you are having a home loan then one of your important goals will be to pay it off as quickly as you can.

Getting back to my story – we were in Chennai till November 2007 and shifted to Hyderabad thereafter, when I took up a job there. We have not bought an apartment here and the rent from our Chennai house is used to pay for it. Meanwhile the apartment in Chennai has gone up a great deal in value, mainly due to the location. We may sell it sometime in the future when we want to settle in Kolkata etc. looking back it was a good decision to buy the home then and to pay off the loan.

Why have I not bought something in Hyderabad? That will be the topic for another post.

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Strategies for home loan pre-payment – not “if” but “how”

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In the previous post I covered why the tax breaks alone do not make a home loan attractive. In this post, I will cover what considerations you should have when taking a home loan and when does it make sense to pre-pay and how. I always believe in understanding issues from the ground-up so I will not use a calculator for making my point. Once you understand the purport of this post, you will be able to use any of the numerous calculators available online.

Let us first understand the break-up of EMI figure into the two components, principle and interest. For the sake of illustration we will take a 40 lac home loan, with 10 % interest for 15 years. Observe the following through the tenure of the loan:-

  • EMI for the loan is 42984 Rs and this will remain constant for all of 180 months.
  • Month 1 break-up : Interest 33333 Rs and Principle 9650 Rs
  • Month 12 break-up : Interest 32410 Rs and Principle 10573 Rs
  • Month 24 break-up : Interest 31303 Rs and Principle 11680 Rs
  • Month 60 break-up : Interest 27236 Rs and Principle 15747 Rs
  • Month 120 break-up : Interest 17074 Rs and Principle 25909 Rs

The outstanding amount of loan after 60 months is still 32.53 lacs. So in effect you have paid only 7.47 lacs of the actual loan taken, even though you are paying more than 5 lacs on EMI every year. What are the key learning that we can get from the illustration that we just saw? Firstly, long tenure loans will mean that you are paying a lot of interest in a front-loaded manner. This benefits the bank as they get their profits earlier. Secondly, it will not make a great deal of sense to pay off the loan when you are well into the schedule – in this case even if you want to pay off after 5 years, you will end up paying a total of about 58 lacs, out of which 18 lacs is the interest amount.

So, what are the important considerations when you take a home loan in the first place? There are several:-

  1. Make sure you are having at least 20 % down payment to limit the amount the loan. If you can have more, great !!
  2. Choose a house that you need today and in the next 8-10 years. If you think too much into the future you will tend to go overboard on the house and therefore on the loan amount.
  3. Ideally go for a 10 year loan tenure if you can afford the EMI. If not go for 15, but no more than that.
  4. Ensure that there are no charges or penalties for paying off the loan earlier than scheduled tenure.

Taking a home loan needs to be seen as a necessary evil and therefore we must look to pay it off as soon as we can. The longer we delay it the less effective pre-payment becomes. Why is this so? Simply because, with every passing month you are paying a hefty interest. The moment you pay off some part in addition to the regular EMI, you reduce the outstanding amount and now a greater portion of your EMI is used to pay off the principle amount.

What are the ways you can begin to start paying off your loan faster? Well you can put any surplus amount after EMI and regular investments towards this, any bonus or incentives can be used to pre-pay and when you get salary increments or some other one-time inflow you can use it to reduce your outstanding. The key aspect is to keep doing it regularly from the beginning and not waiting till you accumulate a significant sum of money. I would say any time you have 1-2 lacs available to make a payment do so. Remember even after 5 years you pay only 7.47 lacs of principle through your regular EMI.

Buying a home is an important event in one’s life and it has several beneficial aspects. By following the 3 pronged strategy of buying the right kind of home you can afford, taking the right kind of loan with good terms and being aggressive in paying it off you will ensure that you are on top of things from a financial sense.

In the next post I will discuss my own example of buying an apartment in Chennai and how I dealt with the loan.

The real truth about home loans

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The two aspects of personal finance that have been relentlessly marketed as something close to panacea are SIP in MF and tax breaks through home loans. You may want to read about the SIP aspect in this earlier post. In the current post I will talk about home loans and try to examine the real picture.

Now everyone from your family, friends, neighbors and financial advisers of all other ilk would have told you that the home loan is a great product. Even several years back, when loans were considered to be a bad thing in India, home loans were considered to be a “good” loan. In fact, the huge push for owning homes by the middle class that started in 1990 was really started by the tax breaks offered by the home loans. Today, when loans have become commonplace and do not have any stigma attached to them, home loans are seen to be an obvious choice for almost all people.

Before we examine home loans in greater detail from a financial aspect, let us first understand the basic need for the demand of it reaching such levels. If you want to buy a house in any Metro city in India today, you will probably spend about 50 lacs for a 2BHK apartment. Assuming you want to pay for it on your own, it will at least take you a decade or more to invest and have that amount available. With the societal pressure from everywhere, along with your own needs when you start a family, owning a own home faster becomes a priority. As long as you can put down about 20 % from your end and have a seemingly stable source of income, loans are available easily too. You can take a loan of 40 lacs for 15 years, pay 45000 Rs as EMI and feel great about shifting to your own home. On top of it you get a tax break on the interest payment, whereby your tax outgo reduces by about 70000 Rs if you are in the highest tax bracket.

If you want to buy a house relatively early in life then home loans are a very useful thing. But the point of this post is to examine whether or not it makes financial sense too. Let us first examine the tax break part. The benefit here is really not what most people would have you believe. On a 40 lac loan at 10 % interest, your first year payments will be nearly 5.4 lacs and interest payment is about 4 lacs. You are getting a benefit of reduced taxes to the extent of 70000 Rs by paying this 4 lacs interest. But then you are staying in your own home and the asset price appreciates over time.

So now let us look at the overall picture once more from a cash flow angle:-

  • Initial cash outflow for down payment in year 1 = 10 lacs
  • EMI outflow @ 45000 in the first year = 5.4 lacs
  • Rent saved @15000 Rs in year 1 = 1.8 lacs
  • Tax saved on home loan interest = 0.7 lacs
  • You are therefore paying an interest of 4 lacs in year 1 and saving 2.5 lacs overall.

This does not suddenly sound so good, right? Over a 15 year period you will be paying an interest amount equivalent to the principle amount. The total tax saved will be equal to about 10.5 lacs, assuming the tax breaks continue. So in essence you are paying 40 lacs in interest payment, in order to get a tax benefit of 10.5 lacs.

Obviously, if one can afford to buy a home without loans, it will be a great idea. However, for most of us that is not possible in practical terms. We need to understand that benefits of buying a home are from an emotional angle of security, to make sure that you are not subjected to the whims of your landlords and to invest in an asset that may well appreciate.

Get a home loan for all of the above reasons and not for the tax breaks that it gives you. We need insurance even though it is an expense. See the interest paid on home loans as an expense you need to incur as you do not have enough money to buy a home outright. The tax break is a bonus but it definitely can never justify taking a home loan. Also with increasing prices the tax break is only available to a portion of your interest payment only.

In conclusion, there are unfortunately no good loans. All loans make you pay fairly high rates of interest. You need them if you do not have the resources to pay outright. Therefore, a prudent course of action is to pay your loans quickly if you can.

In the next post we will examine a strategy for pre-payment of home loans.

First time home buying – A checklist

In this post I wanted to share a simple check list that first time home buyers can use to find out their state of readiness in going for the purchase. Note that you can just have a yes/no response to the questions below:-

  1. Are you in a job where you are likely to continue medium term ( 3-5 yrs)?
  2. If you were not to have this job would you be able to find another job in the same city?
  3. Are you likely to be in the same city for the next 10 years or more?
  4. If you were to move cities will the rent available from your home suffice for renting in the new city?
  5. Is your proposed home consistent with your needs in terms of size over next 10 years?
  6. Is the location consistent with your needs – closeness to office, children’s school etc?
  7. Have you checked on all amenities including availability of public transport for the location?
  8. Are you comfortable with the cost of the proposed home, based on your overall financial context?
  9. From all available data, does it seem that the home will appreciate well in value over the years?
  10. Do you have 20 % of down payment saved by now?
  11. Is your EMI for a 15 year loan less than 40 % of your total take home income?
  12. After paying your EMI will you still have bandwidth to save for your other goals?
  13. Do you anticipate any sudden expenditure in the near future that can make payment of EMI difficult?
  14. Have you paid off all your other earlier loans by now?
  15. Do you have access to contingency funds, covering regular expenses and EMI for 6-8 months?

If you have answered with a “Yes” to all of these questions, then you are definitely ready to buy your first home. In case there are a couple of “No” answers it should not matter a great deal. However, make sure that you have answered in the affirmative for the questions that are in bold.

If the above is not true, you have more work to do. Do not take up a long term financial commitment in an uncertain situation. Creation of a long term liability without having adequate certainty of being able to use it well.

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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.