How Much Home Loan EMI Can You Afford?

I do not think there will ever be a crisp answer to this question. First, when the “right property” comes along, you will convince yourself to stretch your budget and go for a larger home loan. So, all the calculations and discussion on this topic may be futile to some extent. Well, nothing wrong in making an attempt.

Why Is This Question Difficult to Answer?

Your salary will keep changing (hopefully increase) as you grow in your career. For instance, your home loan EMI may be 40% of your monthly salary at the moment. However, after a couple of years, as your salary increases, the EMI may only be 30% of your monthly salary. Your expenses will keep fluctuating due to various life events (marriage, birth of a child, education etc). A few of your financial goals will be met and new goals added. With so much uncertainty about your cash flows, how do you arrive at the right EMI amount for you?

A part of this problem is solved by the banks. A bank will ensure that EMIs for all your loans combined do not exceed 40-45% of your take home salary. However, beyond that point, banks may have no idea. It is quite possible that your expenses form a very high portion of your take home salary. In that case, if you take the loan, investments for your other goals may get compromised. Your retirement corpus may be the first casualty. Do not forget that a home loan is a long term commitment.

How Much Should You Invest?

In my opinion, you should invest at least 20% to 35% of your income every month. This is no hard and fast rule. If you can invest more, nothing like it. Early in your career, your ability to invest may be fairly limited because you may not have much left after accounting for non-discretionary expenses. Your ability to invest must improve as your salary grows.

Now, You Can Work Backwards

Once you have investment percentage in mind, you can work backwards to arrive at EMI level. If you want to invest 25% of your take home income (to put it another way, if you need to invest 25% of your income for other high priority goals) and your expenses are about 30% of your in-hand salary, you can keep up to 35% as EMI. 10% is your buffer. This buffer will be useful for unplanned expenses, changes in EMI or perhaps even for prepayment.

25% (investment) + 30% (expenses) + 35% (EMI) + 10% (buffer) = 100%

Remember you take a loan, compounding works in the favour of the bank (and against you). When you invest, compounding works in your favour.

Buy vs. Rent

It is easy to get into “Buy vs Rent” debate. Firstly, this is a debate only for those who have a choice. If you can’t purchase a house using cash or a loan, you don’t have a choice. You have to stay on rent. Do not mistake inability for discretion. You may not be able to purchase the requisite house now because of affordability and career uncertainty. In that case, you can plan for it. Set yourself a goal and start savings towards it. Increase your ability. I firmly believe you should purchase a house before retirement. Ask a 70 year old person to shift house every 2 years. So, you may not purchase right away but you must have (or develop) the ability to purchase.

It is another matter if you want to go back to your family house after retirement. How many of us even have that option?

Points to Note

Your investment should NOT suffer beyond a point.
Choose a loan tenure that makes the EMI affordable.
Keep buffer since interest movements may take EMI higher.
Make regular prepayments, if possible

Should You Buy Early or Should You Leave It till Late in Your Career? I will discuss the pros and cons and leave it to you to decide.

Pros and Cons of Buying House Early

You will be debt free relatively early in your life.
You will have the choice to choose the comfortable tenure for you.
You provide a sense of emotional and financial security to the family.
Assuming property prices go up, you may be able to purchase at a lower price.
On the flip side, a major portion of your salary/income may not go towards other goals, compromising investments for other goals.
I believe you are more likely to make strong career decisions when you are quite young. You may move to another city or even to another country. In that case, you have to go through the hassles of putting the property out on rent. Extra income no doubt but comes with some hassles.

If You Buy House Later in Your Career

You will have much better clarity about the type of house you want to buy or where you want to buy.
With a higher salary, EMIs may be affordable. Investments for other goals may not have to suffer (there is no such guarantee though).
You may not have much discretion with respect to loan tenure.
The family may miss the financial security of owning a house for a long time.