Unfortunately, there is no magic number.
As with most things with personal finance, the answer will vary across borrower families.
Yes, the banks cap fixed obligations to income ratio (FOIR) at 40-50% as a safe bet and to ensure that you don’t overborrow. Fixed obligation to income ratio (FOIR) = Total EMI outgo including the loan under consideration / Net take home salary. And this is a decent heuristic.
However, that does not mean you borrow as much as the bank permits.
In real life, while assessing the right level of EMI, you must consider your expenses, job security, and the type of property too. In this post, let’s consider all these points so you can assess the right level of EMI for you.
You don’t really select the EMI. Your loan EMI is a function of the loan amount, interest rate, and the loan tenure. Interest rates are usually not under your control. The loan amount depends on the cost of the house and the downpayment. However, once you know your comfortable level of EMI, you can work backwards and choose an appropriate loan amount (and possibly house) and the loan tenure accordingly.
#1 Your income matters, but surplus matters more
Don’t just look at the total take home salary.
From this, you must pay rent, groceries, utilities, kids’ school fees, medications, fuel, insurance. All these items are non-discretionary. EMI must come out from what’s left after these non-discretionary expenses.
Let’s consider an example.
Net take-home salary: Rs 100,000.
Non-discretionary expenses: Rs 40,000 (rent Rs 20,000, food Rs 10,000, school Rs 5,000 etc.)
After these expenses, you have Rs 60,000 left.
Now, house purchase is not your only life goal. You must plan for other financial goals as well. Let us say you are comfortable with EMI of Rs 25,000. You believe this wouldn’t affect your savings for other goals. Rs 25,000 per month is only 25% of your net take home salary. Far cry from 40-50% FOIR that banks may be fine with.
Moreover, the two borrowers may have the same take-home salary but different levels of expenses. OR similar expenses but vastly different incomes.
For instance, same salary of Rs 1 lacs, but non-discretionary expenses at Rs 20,000 (perhaps because you are staying with your extended family). In this case, you have Rs 80,000 spare and you may be comfortable with a much higher EMI, say 35,000.
Alternatively, your salary increases to Rs 3 lacs, but expenses have gone from only 40,000 to 60,000 per month. Now, you have Rs 2.4 lacs per month spare. In this case, you may be comfortable with even EMIs exceeding Rs 1 lac.
Hence, your income matters, but surplus matters more.
#2 Ready-to-move-in or Under construction property
If you are buying a ready-to-move home, your rent vanishes overnight. Since the home loan interest rates are much higher than the rental yields, you can expect EMI to be much larger than the current rent. Still, as the rent goes away instantly, EMI is less of a burden.
On the other hand, with under-construction properties, the rent does not go away that soon. Hence, you must pay rent + EMI. A minor relief is that the banks usually charge interest (or the EMI) only on the disbursed amount during the construction. So, the full EMI may not start right away. However, at some point, this will start becoming painful.
Therefore, look at the tentative timeline for payments to the builder, and assess how the outgo (EMI + rent) will go up over time.
#3 You buy your dream house only once
You don’t buy a house too many times in your life. Perhaps once or twice in your lifetime.
Hence, it is possible that the current level of EMI may look like a very heavy burden at the current level of income. However, as your income grows, the pressure may ease.
Hence, while deciding your EMI (or rather the home loan amount), give this aspect a thought.
Yes, you may have to stretch for a year or two, but as income grows, the pressure or the cash flow crunch may ease.
Alternatively, if you expect a decent annual bonus or a cash windfall, that can be used to reduce the home loan amount and concomitantly the EMI.
I do concede this is a risky suggestion. At a time when AI is disrupting the job market, many are unsure whether they will be able to retain their job after a few years. And I am asking you to consider future salary hikes. Still, do consider this aspect when settling upon the loan amount and the EMI.
#4 The ideal home loan tenure
The loan tenure is an important variable in EMI calculation.
Everything else being the same, a longer tenure means a lower EMI and vice versa.
A Rs 50 lac loan at 9% for 15 years has an EMI of Rs 51,700.
Increase the tenure to 25 years and the EMI falls to Rs 42,000.
Yes, a longer tenure means you pay more nominal interest over the loan term. However, a lower EMI also means comfort.
When in doubt, opt for a longer tenure (and a smaller EMI).
You can always reduce the tenure later through prepayments.
But you can’t increase the loan tenure (and reduce EMI) when you are under stress because an increase in loan tenure will count as restructuring and the banks will have to make extra provisions for this.
#5 Keep buffer
You think you can easily pay an EMI of Rs 30,000. You choose the loan amount and tenure so that the EMI is 30,000.
However, the EMI can go up if the interest rate goes up. Alternatively, there may be a dip in income or increase in expenses. This can push your cashflows under strain. Hence, while assessing a comfortable EMI, do check how an interest rate hike will affect the EMI.
A robust emergency fund will also help.
I understand some of the points I have mentioned here are contradictory. For instance, keeping a buffer for interest rate hikes is completely opposite for factoring in future salary hikes while deciding loan amount/EMI. However, the financial situation of the two borrowers is not the same. Then, why should the solution be the same? The heuristics are a fine starting point but need refining. Hence, you must see how each of these factors are relevant for you and decide a comfortable level of loan amount/tenure and accordingly the EMI.