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Subject: Buying a house or staying on rent? - Taking a wise decision

From: Financial News Simplified. <fns@personalfn.com> on Tue, 11 Nov 2014 20:05:13
To: gautamreddy_g@rediffmail.com
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The Financial Planning Edition

Issue Date: November 11, 2014

Buying a house or staying on rent? Taking a wise decision

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, Ill stand to benefit in the long run; lets 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

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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 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, wherein 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 dont 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
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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 individuals 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:
Placed in:
Gross Salary per month(in Rs)
Basic salary per month (in Rs)
Assumptions:
The company pays him House Rent Allowance
Tax Bracket
Annual increment in salary
There is no change in tax laws for 20 yrs

Mr Sunil
Mumbai Suburbs
150,000
75,000

30.9%
7.0%

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 optionsStaying 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
Rent per month
Annual rent
Initial deposit
Increase in rent (pa)
Result:
Total expenditure on rent (over 20 years)

Yrs
Rs
Rs
Rs

20
13,500
162,000
100,000

10

Rs 9,278,550

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Tax benefit on house rent (over 20 years)

Loss of interest on initial deposit (over 20 years)
Total expenditure on rent after accounting for tax
benefits (A-B+C)

Rs 1,726,987
Rs 366,096
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 Rs 9,278,550 on 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 Rs 1,726,987. Also weve considered the loss of interest, which he has to bear on the
initial deposit doled out, as thats the opportunity he has foregone whereby he could have invested the same
sum and earned an interest of Rs 366,096 assuming 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

Loan amount
Tenure of loan
Rate of interest
EMI
Initial payment:
(a) Personal contribution (20% of property cost)
(b) Stamp duty (5% of property cost)
(c) Registration (1% of property cost)
Total initial payment (a+b+c)
Result:
EMI outgo (over 20 years) and initial payment
Tax benefits received from EMI (over 20 Yrs)
Loss of interest on account of initial payment (over 20 years)
Total expenditure after adjusting for tax benefits (AB+C)

Rs 7,500,000
Rs 6,000,000
Yrs
20
%
10.15
Rs
58,499
Rs 1,500,000
Rs
375,000
Rs
75,000
Rs 1,950,000
Rs 15,989,723
Rs 6,549,391
Rs 7,138,866
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 Rs 15,989,723. 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 Rs 6,549,391 on the EMI
paid over the tenure of the loan. Also like in option 1 , 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 Rs 7,138,866 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 (Rs 79,17,658) as against buying a house by availing a home loan (Rs 16,579,199).
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.
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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 familys well being.

Have you secured your Family's Financial Future?

If Not, PersonalFN can assist you plan your financial goals like:
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Child Education
Child Marriage
Dream House
Retirement

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