Should You Buy a Second House Using Home Loan?

Real estate is expensive in India, at least in major cities. It is difficult to purchase a house without a loan. And it takes many years to repay the loan. Despite all this difficulty, the desire for house does not end here. For the fortunate few who have been able to purchase their first house, there is desire for more. Many of my clients who already own a house and are about to finish off the housing loan for the first house almost always inquire about purchasing a second one.

And there are many benefits of buying a second house.

  • You can earn rental income from your second house. It becomes a second source of income. Moreover, rental income, just like fixed deposits, is very easy to understand. Therefore, there is heavy inclination to purchase a second house in single income households. If your spouse is not as financially savvy, you may have a greater desire to go for a second house. Why? Because in your absence, your family can make mistakes in picking up complex financial products. It is difficult to mess up rental income. You know that your family will keep getting this income.
  • Potential for Capital Appreciation. If you believe that real estate prices always go up, this itself is a good enough reason to purchase a second property. This house purchase is also a leveraged investment (if you have taken a loan). The home loan is cheap too. Therefore, if you get your bet right, you stand to earn very good returns.
  • Tax Benefits. You get tax benefits for repayment of housing loan for the second house too. Not just that, the potential for tax benefit is even higher as compared to a self-occupied property. Loss from ‘Income from housing property’ is now capped at Rs 2 lacs. Since income from a self-occupied property is NIL, the maximum tax benefit on interest payment is capped at Rs 2 lacs. However, in case of a let-out property, the tax benefit on interest payment can be much higher. For more on this topic, refer to this post.

If we look at the above points, the case for purchasing a second house looks stronger. However, for a proper assessment, we need to look at the negatives too. For the many benefits of purchasing a second house, there are a few things you must keep in mind.

  • Rental yields are quite low in India. From what I have observed across many cities in India, the rental income from a residential property is not more than 2-3% of the market value of the property. And even this is before any maintenance costs and taxes, which will bring down net yield much lower. A bank fixed deposit will fetch you a higher better return. Therefore, unless you are betting on capital appreciation of the property, rental income from the second house will never be good enough.
  • A second home loan can crowd out investment for other goals. We don’t have infinite capital. If your financial resources are diverted towards repayment of a loan, you may have to compromise on some of your other goals. Most home loan borrowers try to close out their loans as soon as possible. When I interact with clients in their early 30s, this is a common trend I have seen. They have focused almost all their financial energy into squaring off their home loans (or at least make it more manageable). Though there are merits and demerits of doing this, this is still a fine thought. However, the flip side is that such people have little to show in their balance sheet except their house. When such people ask whether they should purchase their second house, my answer is almost always in the negative because they need to focus on building other assets in their portfolio. If they now purchase a second house, they may not be able to invest enough for their other goals and diversify their portfolio well.
  • Real estate, as an asset, has some inherent issues. There are heavy transaction costs. The asset is not very liquid per se. In times of need, you can’t swiftly sell your property. Price discovery is not easy. Many investors live with too optimistic a view of the market value of their properties. You can’t part liquidate your asset. You can’t sell just 1 bedroom in your house to raise funds, can you?
  • Purchasing a house comes with own set of problems, especially if you are purchasing an under-construction property. You just got out unscathed in purchasing your first house. You want to get into this mess again?

What Should You Do?

I am not saying that you must not purchase a second house. There is nothing wrong in doing that. Just that, don’t buy the second house too soon or else you might run the risk of under-investing for your other goals. Once you are done with your first housing loan, focus on adding other financial assets (both growth and income) to your portfolio first. Thereafter, you can consider purchasing a second house.

This is a not a generic advice, which will work for everyone. If your cashflows can support both repayment of the second loan and the investment for your other goals, the decision will revolve more around whether the real estate investment under question will give you good returns. In such a case, you are not bothered about the loan repayments crowding out your other goals. You need to weigh the benefits for your finances against the limitations that such an investment would bring to your finances and then decide. This answer can be different for different families. After all, personal finance is personal.

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