Which is a better decision: taking a home loan or buying once I have the money?

By May 4, 2017 Trading No Comments
Which is a better decision: taking a home loan or buying once I have the money?

As always let’s do the math to understand the answer to the above question first and put the finances in perspective and make an adjustment based our personal finance situation.  

Option 1: Taking a home loan to buy a property

Let’s consider buying a property valued at 60L and you must pay down roughly 20% as the initial payment and rest you go in for a home loan. At 8.6% home loan rates, currently for a 50L loan the EMI for a 20-year loan comes out to be around INR 43700. That equates to an annual pay down of INR 5.24L. The initial payment will also include a 10% additional costs when you include stamp duty and registration on the buying amount and some home loan processing charges. So, in a nutshell buying a 60L house will cost you around 18L initial pay down and a INR 48-50L home loan with an annual pay down of INR 5.24L from there on till 20 years.

Hence, cash outflow in buying home of 60L on loan

Initial amount: 18L

Year 1 to Year 20: INR 5.24L per year (at current home loan rate of 8.6%)

Also Read : How to invest smartly to buy a house in 5 years?

Option 2: Staying on rent and saving money to finance your home later

What is gross annual rental income?

The gross annual rental income, expressed as a percentage of property purchase price. This is what a landlord can expect as return on his investment before taxes, maintenance fees and other costs.

According to globalpropertyguide.com a leading research website on global property India’s average rental yield is 2.39%, one of the lowest in Asian nations with yields ranging from 1.57% to 8.61% across major Asian countries. Across major Indian residential cities like Bangalore, New Delhi and Mumbai the rental yields range from 2-4%, again pretty low compared to prevailing home loan rates.

So assuming an average rental yield of 3% on your property and a house of INR 60L again to rent your total outflow would be 3%*60L= INR 1.8L for the year. Also since brokerage would be involved in rental property you would pay every year an amount which typically is 1-month rental as brokerage amount. In this case, that would be additional amount of 1.8L/12= 15K INR.   

Hence, cash outflow in renting home of 60L on loan

Initial amount: 15K INR brokerage

Year 1 to Year 20: Annual rental of INR 1.8L increasing by 10% or so

*Brokerage might be charged annually

Option 3: Self-funded investment in property

The self-funded property will not involve any EMI and will save all the interest cost associated. The catch is one should have enough savings. If you already have cash, it hardly makes little sense to go in for a home loan because you would be paying 8.5-9% home loan rate for twenty years. On the contrary, if there is a better investment for your cash that gives you more return than that (one idea is investing in mutual funds where long term returns are better) one should go ahead with it.

Tax treatment

The amount of HRA exemption is deductible from the total income before arriving at a taxable income. This helps the employee in saving tax. The HRA received is fully taxable if an employee is living in his own house or if he does not pay any rent. HRA thus is only applicable if you are living on rent and not in your own house.

Who can avail HRA? 


The tax benefit on HRA is available only to a salaried individual who has the HRA component as part of his salary structure and is staying in a rented accommodation. Self-employed professionals cannot avail the deduction. 

How much is exempted? 


The exemption for HRA benefit is the minimum of: 
i) Actual HRA received 
ii) 50% of salary if living in metro cities, or 40% for non-metro cities; and 
iii) Excess of rent paid annually over 10% of annual salary 

On the other hand, if you are buying property on loan, the interest component is exempt up to INR 2L. In our example the owner will get an exemption on interest of INR 2L for the first 14 years as interest component on 50L loan is greater than INR 2L till that time. This amount can lead to additional savings. Assuming HRA tax benefit would be lower than tax waiver on interest this can lead to a difference of amount up to INR 20-30K per year for the person who goes for a home loan.

Also Read : Does Buying a Home Score Over Investing in Stocks?

Maintenance costs

For the person going in for a home loan, maintenance costs would be extra. In case of rental property, the maintenance must be paid by the owner of the property. Hence maintenance would be an additional burden if you own your property.

Legal issues and other factors

Housing bought yourself must be maintained as well as taken care of from a legal perspective. The homeowner and the builder might have issues related to society’s amenities and other legal aspects. In case you own the house, you also own the headaches to manage such issues. Also, there is an asset which must be taken care of. Although it’s a rarity to get into legal tangles but in Indian real estate market it can be a major issue with builders who have a reputation and history of cutting corners and troubling owners.

Pros of owning a property

Since you own a very important asset it gives a sense of comfort. Also, the value of property will appreciate over time, hence there is capital appreciation of your investment. Once you have settled down, the other costs of shifting, finding a new home once your rental lease expires etc is not a perennial issue. From a family perspective, there is a social connect to where you stay and a sense of belongingness.

Cons

Owning a property can turn out to be expensive if the capital appreciation is low over time. There could be legal tangles with the builder. Although a rarity, but in a country where property companies can cut corners for small issues, it can be a real headache as an owner. Maintenance issues can bother too. In case of city transfer, it might be troublesome to manage a property. Since property is an illiquid asset, it might not be easy to sell off in market downturns.

Conclusion

To each his own is always the best choice. But we would recommend considering all the financial calculations above, it would be wiser to rent a property in the early part of your life, maybe up to 35 years of age and once the clarity in career and savings are better, one should go for in for his or her own property. If you already have the savings to fund a house, taking home loan is wiser only if you think you can beat the loan rate through your investments which effectively says raising housing debt but putting the amount in a different investment. Financial leverage is only recommended to people well versed with investing world or taking help of an expert.

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