When I relocated to Pune in 2003 due to professional commitments, I decided to rent a flat close to my work place. The idea of buying a flat instead of renting never occurred to me until my boss broached the topic. We did some simple calculations taking into consideration my gross/disposable income, age, finances and the expected rate of appreciation of property prices based on historical price movements.
On the basis of this calculation, we were able to conclude objectively that it made sense for me to buy a house by availing a housing loan rather than staying on rent.
If history were to repeat itself and if I were to evaluate the same decision today, I can assure you that it will not be an easy one to make. In fact, the decision may be altogether different from my earlier one. Thanks to slump in the real estate sector and the economic downturn which we witnessed in recent years, the rent vs buy decision is no longer a simple one to make.
The popular belief that one must buy a house as soon as possible because it is a great investment does not hold good any longer. A number of factors, in combination, influence the prices of property and no one can accurately predict the direction of price movement in this sector. Hence potential home buyers should take into consideration various financial, social, personal and emotional factors involved before making a decision.
Here in the first of a series, I have detailed out some of the financial factors that can influence this decision for most of us. I will be covering the remaining factors extensively in my subsequent posts.
You must specifically find answers to the following two questions:
- How much of your own money can you set aside for buying a house/renting a flat? This is a very fundamental question applicable for people who may be thinking of taking a bank loan to purchase a property, as well as those wanting to stay on rent. Most financial institutions lend only up to 75-80% of the property value. This essentially means that you will have to contribute at least 20% of the total purchase value of your house upfront. For renting a place, most landlords require a lump sum amount to be paid as a security deposit. This amount is negotiable as there is no standard prescribed security deposit amount. Normally it is 4 – 12 months’ rent which is refunded when the house is vacated.
- In case of people looking to buy a house by availing a bank loan, assuming that you are in a position to invest the 20% referred above, will your income be sufficient to cover your monthly loan instalments (EMIs) and your personal/living expense comfortably? A thumb rule for potential borrowers is that their monthly EMI amount should not exceed 50% of their total disposable income. If you stick to this rule, you can stay assured that even after paying the monthly EMI, you will have enough to cover your expenses.
In case you have even the slightest of doubts about your financial ability, it is advisable to rent rather than buy a house. For example, if you are thinking about changing your job in the near future that may impact your earnings, it may be worthwhile to postpone your buying decision till your job change happens. Similarly, if you are anticipating changes in your income that can impact your overall spending, it may be better to rent rather than buy.
Banks and financial institutions also look for financial stability while lending. Most lenders stipulate the minimum period for which borrowers should have been employed with their current employers before considering their loan applications.
In short, if you are unsure about your employment prospects in the near future, postpone your home buying decision and rent instead.
Inflation and cost of living
Let us assume that you meet the income requirement for availing a loan. Also, your monthly disposable income is sufficient to cover your monthly expenses and EMI. What happens if inflation shoots up after you buy the house?
Such a rise will adversely impact the total cost of living. The hike in petrol and diesel prices a couple of years ago is a classic example. The hike indirectly impacted the cost of a number of essential goods and services that we make use of in our everyday life.
The government on its part did take measures to curb inflation. The regulatory authorities did this by reducing the money supply in the economy. This in turn resulted in an increase in the cost of borrowings by banks and financial institutions. Ultimately this cost was passed on to the borrowers in the form of hike in interest rates. As a result, borrowers ended up paying higher EMI for their existing loans.
All this goes to show that other things remaining same, unless your income rises in proportion to the rise in cost of living, your net disposable income will reduce. Combined with price rise, this can majorly impact your finances and your ability to service your monthly EMI. Under such circumstances, it may not be a prudent decision to buy a house by availing a loan.
Renting a house under such circumstances would be a better option. Economic downturn and inflation are not capable of impacting rents in a major way. This is because rentals are largely based on demand and supply position. Also, once you enter into an agreement with the landlord, the amount of monthly rental will be fixed and will remain the same for the entire duration of your rent agreement.
In short, if there are visible signs of economic downturn or inflation, it may be worthwhile to postpone your buying decision and rent a house.
Return on Investment
Real estate is a very good investment option for retail investors. In fact, for a very long time it was believed that buying is always better than renting. Generally speaking, during stable economic conditions when there is not much element of uncertainty, property prices in developing economies like India can appreciate at the rate of 10-15% pa. The crucial factor here is the timing and location.
To quote an example, there are a number of upcoming residential projects in India which claim to be close to upcoming infrastructure projects like airports or metro stations. Often buyers get lured by these claims only to realize later that these projects may take years to complete. As a result, buyers are stuck with homes which may not appreciate in value significantly or may appreciate only after a long period.
In my opinion, if you are looking for quick returns, property may not be the best investment choice for you. The value of property does grow, but it happens over a period of time. Depending upon how well you choose your property, it is bound to appreciate sooner or later.
However, unless you are willing to wait for at least 7-10 years, you cannot expect any significant return on your investment from this sector. It may be worthwhile to park your savings in shares/mutual funds/other investments, and rent an apartment if your financial goal is to make quick returns in the short run.
In recent times, low interest rates combined with attractive residential projects has got many people to buy rather than renting a house. However, the true cost of buying and owning a house is much more than the mere cost of the house. Following are some of the additional costs which home owners have to bear before/after buying the property.
Registration and stamp duty. In most of our states, stamp duty is 5-7% which implies that a for a property worth Rs 25 lacs, the stamp duty will be around Rs 1.8 to Rs 1.9 lacs. In addition, registration fees amounting to 2% of total property cost has to be paid to the courts for registering the property. Also, for handling payment of stamp duty and registration, home buyers may have to engage services of lawyers who will charge their fee.
Renovating/ Furnishing. Once you buy a house, to live in it, you may have to decorate the interiors. Although this amount will vary depending upon your individual taste and preferences, roughly it may involve expenses amounting to ½ – 1% of the total property cost.
Insurance. You will have to insure your property once you buy it. This will take care of risk that may arise due to any unforeseen circumstances. In fact, most banks and financial institutions lend only if the property is insured.
Repair & Maintenance. Home maintenance and costs of repairs is a sizeable expense which is borne by homeowners. Depending upon the condition, age and size of your house, you may have to set aside funds annually to take care of periodic maintenance charges and any repair work that may be required.
To Buy or Not To Buy – Conclusion
For most of us, buying a house is a major lifetime decision. There are advantages as well as disadvantages of both renting as well as buying. As mentioned in the beginning of this article, a number of financial, social, personal and emotional factors are involved in making this decision.
While some of these, eg. financial factors, can be quantified and assessed objectively, it is not possible to evaluate emotional and sentimental reasons. So how do you arrive at the right decision – do calculations for matters of the mind and listen to what your heart says for the rest!