Are you ready to buy your first house? Some are never ready. Some think they will never be ready. Some want to buy after working for a few years. And some are eager to act with their first salary.
Buying a house is a big life decision. Emotional security, your past, upbringing, peer pressure, social status. Intangible aspects but all these drive your decision to buy a house and how soon you must buy a house. But these things count for little until you are financially prepared to buy a house.
In this post, we will see how to evaluate your financial readiness to buy the house. A house purchase requires 2 financial commitments.
- Down-payment
- EMI payments over the next 15-20 years
How Will You Manage the Down Payment?
The bank will NOT give you the loan for the entire value of the property. Depending on the bank and the loan size, you would get a loan of only up to 75-90% of the property value. Thus, you need to put 10-25% of the property value from your own funds. So, if the property value is Rs 1 crore, you will get loan for only 75% of the property value. You need to manage Rs 25 lacs from your own funds.
If you are buying a ready-to-move-in property, then you must put the money down upfront. Plus, there will be registration expenses and stamp duty that you will have to bear from your own pocket. Do you have the money ready?
In you are buying an under-construction property, then you may get relief since payments will be construction-linked. Thus, your payment will also be spread over a few months. However, it won’t be long before you must arrange the money. Better to prepare as if you are buying a ready-to-move-in property.
If you have Rs 10 lacs ready for down-payment, you may still be ready to buy a house. But not a Rs 1 crore house. You are ready for a house that costs Rs 40-50 lacs.
However, you cannot just go buy a cheaper house. It may not be the desired size or in the preferred location. If you want to go with the more expensive house, you must bring the deficit amount from somewhere.
So, if you don’t have enough down payment amount set aside already, you have a few options to bridge the deficit.
- Take out a hand loan from family/friends: You can do this. This will probably be a zero cost or a low-cost loan. But are you sure you will be able to return the money on time? If you don’t repay on time, this can affect your relationship.
- Dip into your emergency fund: What else is emergency fund for? To access in times of need. But what if you encounter a real emergency subsequently?
- Sell assets earmarked for other goals: What happens to financial planning for those goals? Will you be able to make up for the withdrawals in the coming months or years?
- Take out another loan to make the down payment: Now, this is super tricky. You can take out a personal loan or a gold loan but these loans must be repaid too. Can you manage both the EMIs (personal loan and home loan)?
If you do not have answers to these questions ready, you are NOT ready to buy a Rs 1 crore house. You are ready for only a Rs 50 lacs house.
Can You Afford the EMIs?
Let’s assume you have been able to manage the down payment amount and the bank is ready to disburse the loan.
When you take a home loan, you must repay it over a period through EMIs. The bigger the EMI, the less you have left for your monthly expenses and investments. Are you sure you can manage everything with this EMI in play?
The banks do you a favour here. They check your loan eligibility before sanctioning your loan so that you do not end up borrowing too much. During the credit appraisal exercise, the banks will look at your Fixed Obligations to Income Ratio (FOIR).
FOIR = Your monthly loan commitments (including loan under consideration) / Net income.
Let’s say your monthly income is Rs 1 lac and the bank has a FOIR threshold of 40%. In this case, the bank won’t sanction a loan amount where the EMI for all the loans (including existing loans) breaches Rs 40,000.
While the banks, on their part, try to ensure that you do not borrow beyond your means, the banks can never know more about your finances or financial commitments than you do. Hence, if you foresee financial commitments for any reason (say wedding in the family), then you need to consider if you will be able to pay home loan EMIs and still meet those commitments.
If you are buying a completed property, you can move in the property after the purchase. Thus, you do not have to pay the home loan EMI and the house rent at the same time. However, if you are buying an under-construction property, you may not get possession for a few months or years. During that time, you will have to manage both the home loan EMI and the house rent. This can be a huge burden on your pocket. You can reduce the burden by opting for Pre-EMI (instead of Full EMI), but pre-EMI structure has its own drawbacks. Such payments are for a limited period only and pre-EMIs don’t reduce your principal outstanding.
If you took a loan for meeting the down payment deficit too, you must pay EMIs for such a loan too.
There are other aspects to consider too.
- Do you have a stable job? You do not want to lose your job when you are running a big loan. I understand you can never ensure this. Therefore, do you have a robust contingency fund to take care of 6-8 months of expenses?
- Would this affect your other goals? Buying a house is an important goal for almost everyone. But there are other goals too. Prominent ones are children’s education and retirement. Would you have anything left after the home loan EMIs?
- Can your cashflows withstand sharp rate hikes? Home loans are floating rate loans. The new home loans are now benchmarked to Repo rate or other such external benchmarks. A rate hike means an increase in EMI. Hence, while the initial EMI may be manageable, the increased EMI may not be. For instance, a 20-year Rs 75 lac loan will have an EMI of Rs 62,733 at 8% p.a. and Rs 72,376 at 10% p.a. While I see no merit in planning for the Armageddon, see if you can manage at least a 2% interest rate hike.
The EMI affordability is more complicated than the down payment angle. With down payment, you either have the requisite money or you don’t. With EMIs, it is quite complicated. You are young and your income will only grow. Therefore, while the EMI burden may constrain your cash flows now and affect your ability to invest for other important financial goals, it may not be the case after a few years (or even after your next salary hike or when you switch your job next).
However, when taking a loan, do not build in expectations of very aggressive salary hikes. Rather than taking a big loan banking on big salary hikes, in the future you take the loan when you actually get the salary hike. The bank cannot consider such aspects. Only you can.
If you figure out that you will struggle to meet EMI payments, then it is best to delay the house purchase until when you are better prepared. Or go with a less expensive house.
It is NOT a race
Do not get too influenced by what others are doing around you. Some in your circle will buy a house early. Some will buy it later. Their decisions will be guided by their individual circumstances and preferences. And their levels of financial preparedness. If you want to buy a house and can manage down payment and EMIs, go ahead. If not, it is better to wait, plan, and revisit your readiness later.