His home buying plans can derail the family's financial planning and jeopardise all other goals. In Maximum City, the minimum price of 800-1,000 sq ft house is `1 crore.They will have to liquidate all their existing investments (fixed deposits, stocks, equity funds and even the Provident Fund) to raise about `20 lakh for the downpayment.The balance `80 lakh, if borrowed at 10% for 20 years, will mean an EMI of `77,200, which is roughly 60% of their combined monthly income of `1.3 lakh. Either the Mehtas will have to stop saving for their child's goals or their retirement will have to be pushed back.
The Mehtas are not the only ones entering this minefield. Across the country, a number of people are firming up plans to buy a new house. The New Home Index of Zyfin Research, an indicator of home buying plans of 3,000 households across 11 cities, has inched up in the past 12 months (see graphic). Though it is still in pessimistic territory, buyers are less pessimistic now than they were in May 2014. This trend has been fuelled by optimism about future income and comfort with the cost of borrowing."The decline in pessimism has more to do with increased optimism about future income and job security than lower borrowing costs.
Despite the surge in buyer sentiment, real estate is still not a good investment in most parts of the country. Property price are still very high and despite the recent interest rate cuts, the cost of borrowing has not come down significantly. For potential borrowers like Mehta, a 15 basis point will shave off `800 from the EMI of a `80 lakh loan for 20 years. Is that a big enough reason for them to make the largest financial commitment of their life?
This week's cover story sounds a note of caution for investors in real estate. In the following pages, we have raised 10 questions that a potential buyer needs to answer before he takes the plunge. Don't get us wrong. We don't want to shatter your dreams to own a house. We just want you to take a reality check. Your answers will tell whether you are in a position to buy and if real estate is indeed the best investment option for you. If most of them are answered in a `no', take a step back and revisit your plans.You may decide to save more for a bigger down payment, buy a smaller house, invest in a cheaper city or not buy at all. Whichever option you choose, rest assured, you will not regret your decision.
Can you afford the home loan EMI?
It might sound a no-brainer, but many home buyers get this wrong and bite off more than they can chew. The home loan EMI should be around 40% of your net household income (see graphic). But that is if you don't have other loans. A high EMI outgo can put your household budget under pressure. If the home loan EMI accounts for more than 50% of the net household income, other goals will have to be downsized or junked altogether. Banks have their own methods of calculating your affordability. They will also take into account your liabilities before sanctioning a loan.
Don't be fooled into thinking that the recent cut in home loan rates have made property a viable investment. It will have a marginal impact on the total EMI. A 25 basis point cut will reduce the EMI of a `50 lakh loan for 20 years by `826. If you go for a home loan, make sure you have enough room to wiggle in case the interest rate cycle takes an unexpected turn. If home loan rates go up, your EMI will not rise, but the lender will extend the tenure. But if the tenure extends beyond your retirement, the lender will have no choice but to increase the EMI. If your income does not support the increased EMI, the lender might ask you to make a part payment to reduce the EMI to fit your budget. So, make sure you don't take a loan that stretches your finances to their limits.
It's easy to get ambitious and go for a bigger loan if you are expecting generous increments in the coming years.Don't make the cardinal mistake of leveraging on future income. This year was good for increments and indications are that 2016 will bring more good news. But not all sectors and companies will dish out fat increments. According to a survey of 602 companies across India by the Kolkata-based Genius Consultants, 48% companies say that increments next year will be between 10-15% while 11% believe they will be around 15-20%.But 29% also expect increments to be between 5-10% while another 10% believe they will be less than 5%. So, not everyone will see a big rise in income.
Also, while your income would certainly rise, but so would your expenses and financial commitments. A good chunk of the increment is nullified by inflation and increased consumption. As your children grow, their education costs and other expenses also rise. Your own lifestyle changes, which means the entire increment may not be available for paying the home loan EMI.
TAKE A TEST DRIVE
Planning to buy a house but feeling unsure? Before you take the plunge, just calculate the home loan EMI you will have to pay every month. If you take a loan of `50 lakh at 10% for 20 years, the EMI works out to `48,250. Now start putting away that amount in a short-term debt fund or recurring deposit. In 10-12 months you will figure out whether you can really afford the EMI. If you find it difficult to put away that amount every month, imagine your situation if you had actually bought the house.On the other hand, if you don't feel the pinch and all other goals have also been taken care of, go ahead and buy. In 12 months, you would have saved around `6 lakh, which means a bigger downpayment. There are some fringe benefits as well: if you are putting away a big chunk into savings every month, it will prevent you from wasteful expenditure.This strategy won't work where asset prices are going up rapidly. If your chosen project becomes costlier by 10% by the time you decide to buy, you will have to pay more than you gain. But going by the current trend of prices, this is a remote possibility.
Have you factored in the other costs?
Like many other products, a house also has ancillary costs that need to be paid for. The price advertised in the media is usually the base price of the property. The add-ons are usually kept hidden till you sit down with your cheque book.Many builders will slip in charges for facilities that you thought were free with the property.Others will keep certain charges hidden from the buyer by tucking them away in the fine print.Some charges, like the preferential location surcharge or the gym membership fee, are kosher, but others are not. There have been cases where builders have been dragged to court for charging extra for parking.
These apart, there are other big-ticket add-ons such as the legal costs. The stamp duty and registration charges payable to the authorities add up a neat 7-8% to the overall price of the property. In all, these charges can combinedly push up the property price by 20-25% (see table). Make sure you have factored in these additional costs.
Have you done a thorough rent versus buy analysis?
The old saying that "fools build houses and wise men live in them" has been proved incorrect several times in the past. But the high property prices across cities mean that renting is certainly a better option now (see graphic). Let us look at a hypothetical family planning to buy a house in Mumbai. A 2-BHK house will cost them close to `1.2 crore. If they put in `40 lakh as downpayment and take a loan of `80 lakh, the EMI for 20 years comes to about `76,500. They also lose around `23,500 in interest that the `40 lakh downpayment could have potentially earned. Their total cost per month comes to `1 lakh while they can easily get a similar house on rent in Mumbai for about `40,000-45,000 a month.
Don't go by hypothetical examples. Instead, do an empirical analysis to know whether you should buy a house or live on rent. There are many rent-or-buy calculators available online, but we particularly like the one developed by Bigdecisions.com. It's a sophisticated online tool that takes into account several things, including the cost of the house, the amount of downpayment, the rate of interest of the home loan, the expected appreciation in the house price, the rent payable for a similar accommodation in the area and even the expected hike in the rent every year.
It may be argued that a house is an asset and any appreciation in its capital value adds to your wealth.That's true, but prices in Mumbai have either stagnated or risen marginally by 2-3% in the past one year.However, the real estate market is very localised and the situation may be different in other cities.
Will the value of the property rise faster than the interest on loan?
In the early 2000s, when home loans were available at 6-7% and property prices were galloping at 20-25%, it made eminent sense to invest in an upcoming apartment project. You could book two properties and sell one of them after a few years for a profit big enough to repay the entire loan taken for the first property. Those days are now history. Property prices are now appreciating at a slower pace. In some markets, such as Noida and Greater Noi da in the National Capital Region, prices have even come down in the past 12-18 months.
If you are buying property as an investment with a loan, first assess whether its price will appreciate at a rate higher than what you are paying on the loan. If you are payings 10% on the loan and the property price is expected to appreciate by 5-6%, then it is a bad buy. Shah says the expected rate of appreciation is the single biggest determinant in their rent-or-buy calculator. It makes the biggest difference in the decisions.
Now that there are signs of an economic revival, will property prices start moving up? The Ficci-Knight Frank Real Estate Sentiment Index offers some pointers. The index tracks the expectations of stakeholders in the real estate sector, including real estate developers, private equity funds, banks and non-bank financial companies (NBFCs).The sentiment for residential price appreciation has weakened in recent months (see graphic). In September 2014, 68% of the respondents felt that residential prices will move up, but now only 33% do so.Though fewer people expect prices to fall, a large chunk (55%) believe they will remain the same for the next 6 months. But even a stagnation in the price is actually a correction in real terms. You will be paying close to 10% interest on a loan to buy an asset that will not increase in value for the next 6-12 months.
Will this purchase force you to postpone other major goals?
Stagnant property prices and high EMIs are not the only problems that potential home buyers should be wary of.Their home buying plans can have serious implications on other financial goals, such as saving for their children's education and marriage and their retirement.
If the home loan EMI is too big, it will push other goals out of the financial plan. Worse, buyers might have to liquidate existing investments to raise money for the downpayment.Though parents are unlikely to surrender child insurance plans and education related investments, many other goals are easily sacrificed.
Retirement planning is the most common victim. Younger people tend to think that retirement is an old age problem and defer the investment. It is easy for investors to raid their retirement savings to fund their real estate dreams. You can take loans from the Provident Fund for building or buying a house. Till recently, the NPS was an airtight investment that could be accessed only at 60. But even that can now be withdrawn for certain needs, including buying a house.
Buy a house only if the purchase will not impact other goals. Otherwise, be ready for an asset-rich but cash poor retirement. Or not having enough money to send your child to a good college.
Will you live there for 10-15 years?
We live in a society that assigns great importance to physical assets. Owning a home is seen as a sign of achievement and stability. However, buying a house too early in your career can hamper your prospects. You tie yourself down to a location at a time when job opportunities are mushrooming across the country and even overseas. The prohousing lobby will argue that you can always move to another location and live in a rented house. But that will also mean paying an EMI as well as rent.
Can your pocket afford this double burden?
The burden can be eased if you rent out your house when you relocate. But finding a reliable tenant and maintaining the property can be a pain.The hassles only get bigger if you are based in another city. Selling off the house is not an easy solution. Property is not very liquid and finding a buyer at the right price can take weeks, even months.Plus, there are very high entry costs in the form of registration and transfer charges.Buy only if you are sure that you will live in the city for the next 10-15 years.
There is also a lot of parental pressure on young investors to buy a home early in life. Parents can't really be blamed. Their perception is based on their experience of how property prices have gained in the past 20-30 years. However, now things are very different. Property prices will certainly appreciate but not at the rate at which they galloped in the 1990s or even till the last decade. Also, the appreciation will not be uniform across locations.
Do you have a contingency fund?
Real estate is not a liquid investment. You can't sell it at short notice, nor break it up into parts. Invest in it only if you do not need that money at short notice. This also means one must have an emergency fund to take care of 3-6 months' expenses. If you plan to use your emergency funds to pay the downpayment, you could be making a big mistake. A financial emergency can put you in a terrible spot, with the home loan EMI exacerbating the problem.
To be fair, property can be used to raise loans in such emergencies. Several banks are offering home equity loans, top-up loans and ovedraft facility which can unlock the value of property.But this is possible only if the property does not already have an outstanding loan against it. If you have just taken a home loan, there may not be enough room for a topup loan against the property.
The only possible loan is if the house has been given out on rent. Then you can take a loan against the rent receivable from the property. But such loans come with strings attached: the loan amount will be only 55-85% of the receivable rent for the residual lease cover. If the lease is ending soon, the bank won't offer a big amount.
When you buy a house, make sure you have enough investments in near-cash instruments that can be quickly accessed in an emergency.Also, don't touch this emergency fund even if you find it difficult pay the home loan EMI.
Will you be able to earn decent rent from your house?
Many investors in property are looking for two streams of income: capital gains from the rise in its value and rental income from the property. But don't get carried away when you calculate the potential rental income from your property. Many investors think that the future rental income will be enough to pay their EMIs. However, the rental yields (the annual rent received from the property as a percentage of the value) are very low in Indian cities.Don't expect a rental yield of more than 3-4%. This means a property worth `50 lakh will fetch a rent of about `1.5-2 lakh a year (`12,500-16,666 a month). In some overheated pockets, where property prices have shot up but supply is higher than demand, the rental yield can be as low as 1-2%. This will turn worse in future as more houses, which are still in various stages of construction, enter the rental market.
This is already the case in some markets where rents have not shot up due to an oversupply of vacant houses. Also, there are lots of unsold houses lying with builders .
Nevertheless, the rental income provides some relief to the investor. Even if the property price is not going up too fast, at least he has a steady source of income.
What if your income stops?
We have covered this aspect earlier but this is different from a short-term contingency plan. The Job Security index of ZyFin Research has steadily climbed in the past 12 months. But have you factored in the possibility of something untoward happening to you? Is your family prepared for the worst? Apart from covering their basic needs and future expenses, you must also take an insurance cover equal to cover all outstanding loans, esepcially the big-ticket home loan for the property. Avoid insurance covers that are linked to the home loan and progressively come down as you repay the loan. They might appear cheaper but a simple term plan that covers your life for a fixed amount is best for this purpose. A term cover of `80 lakh for a 40-year-old male for 20 years will cost him roughly `15,000 a year. That's a small price to pay for peace of mind.
Will the builder deliver in time so that you don't lose tax benefits?
Delayed projects are no longer news. According to PropEquity, the average delay in the Mumbai Metropolitan Region is 25 months. In the worst hit Delhi NCR region, it is 33 months. Delays can be particularly debilitating if the buyer had expected EMIs to replace the monthly rent payment. If the project gets delayed, they have to fork out money for both. Even those who buy property purely as an investment are hit. They are paying EMIs but there is no sign of rental income.
The worst thing about delayed projects is that you could lose the tax benefits offered on home loans if you don't get possession within a stipulated period. Home buyers get a deduction of up to `1.5 lakh a year for the principal repayment (under Sec 80C) and a further deduction of up to `2 lakh a year for the interest paid on the loan (under Section 24). However, to get the deduction under Sec 24, the buyer must get possession of the property within three years of taking the loan. If the 3-year deadline is not met, the deduction benefit reduc es from `2 lakh to only `30,000 a year.Imagine the plight of a buyer who has taken a `50 lakh home loan and hopes to reduce his taxable income by `2 lakh.If the project is delayed and he misses the deadline, it would translate into a tax loss of `10.9 lakh over a 20 year period.
Our advice to buyers: Buy from builders who have a good reputation and are likely to deliver within the promised deadline. Even then, factor in a 10-12 month delay into your planning when you book a house.
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