Buying your own house at 30 (Bane or Boon?)

We all must have read multiple articles of buying vs renting in real estate. Most of these articles are monetary comparison and clearly go in favour of renting due to high cost of loan and low rental yield. Despite such clear answer the desire of acquiring a house for self use is very high in India. Indian parents add fuel to this desire and even the most financially prudent people are forced to buy a house or plan for one. One big reason why people want to buy early is to escape paying the increased price later.

House for self use (Is it an investment or just a cost)

But there are other aspects to buying house for self use which are not discussed. Most of these people who buy house for themselves also consider it as an investment. This mistake leads them to investing their entire savings and commit a major part of their future income for this purpose. The definition of investment from Investopedia is as follows:

· In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit.”

The property for self use is very unlikely to be sold unless there is some crisis. This implies that the increase in value of the house has hardly any meaning as it will never be encashed. Hence a house for self use does not qualify as an investment.

Now some people might argue that a house saves the cost of renting place instead of paying interest to bank. In India we have 2–3% rental yield while the cost of borrowing is 9%. This implies that the cost of renting is 2.5 to 3 times cheaper than interest being paid.

What about the satisfaction

The supporters of owning a house can also point to the pleasure of living in a self-owned property which cannot be quantified. But even this comes at a great cost. The real estate developers and financial institutions lure the buyers by selling low EMI and higher eligibility. They stress the importance of buying early and are willing to give loans of tenure upto 30- 40 years long. While all these steps help people to buy their house as early at the age of 30, the economic cost and risk of such moves are very high. Some banks have even introduced “step up loans” where in the initial years you pay moderate EMIs, which will further step up during the subsequent years considering your income.

Who are the targets of long term loans

So who are the target of these long term loans. The young DINK(double income no kids)couples are the most targeted people for such loans. They want these couples/families to buy house early and repay over the longest period possible. The banks love such customers and earn huge income from these customers as explained in my previous blog.

The same scenario will payout with those earning more or less. For example if a couple earning 2 lacs per month buys a house worth 1.5 crore or if a couple earning 50k buys a property of 35 lacs. The only criteria is that if the EMI is higher than 45% of your take home salary. Lets assume one such couple who earns 1 lac per month at the age of 30

The purchase summary assumptions are as follows:

· Assume a young couple who are both 30 year old and jointly earn 1 lacs per month combined post tax.

· Typically people take the maximum amount possible which in this case can be assumed to be 75 lacs

· The down payment is around 19 lacs (including purchase cost) which would consume the entire saving corpus and may need parent’s support also

· Assuming loan of 60 lacs and tenure of 25 years the EMI comes to 50,000 per month

· The rental for such units would be around 18,000 per month if it was rented

· Assuming their income rises by 10% per annum

· One expense which adds up after house purchase is cost of minor improvements

The financial planning of the household can be summarised as below

The financial changes we can see are as follows:

· The lifestyle cost reduces drastically and leisure travels are the first casualty

· The emergency fund is fully exhausted and the monthly saving has dropped to 10,000

· The drop in saving makes them highly vulnerable in any emergency/job loss

· Any saving in 1st 5 years of home purchase cannot be used for prepayment due to low emergency corpus

· Hence the loan outstanding drops from 60 lacs to 56 lacs in 5 years

The social changes we see are as follows:

· Job loss is much more scary as the safety net is gone

· Even 10% increase in salary every year will feel low due to low savings

· The option of starting a new business/venture is almost nil

· Joining a company of your choice even with slightly lower pay cut looks very tough

What happens between 30 to 35

Lets assume their salary has increased to 1.60 lacs per month after 5 years. The emergency corpus will be around 10 lacs assuming everything went well.

At 35 couples cannot afford to delay a child. This has severe medical complications and the couple will probably plan a child. So lets see the financial implications of this step

· The family expense increases by 15,000–20,000 per month due to pregnancy and other related cost

· The cost continues due to doctor visit and multiple vaccination charges

· The mother may have to take a further break if support is not available

· A car may be required as travelling on 2 wheeler may not be possible

· So all this would ensure that the family focus is to ensure better conditions for the kid and not towards the home loan.

What happens between 35 to 38

· The next 2–3 years will be very tough for mother if she is forced to work due to financial reasons

· At 38 the family may have stabilised and start savings again

· Lets assume that the family income goes upto 2,00,000 per month as they reach 38 and they start saving 50,000 per month

What happens after 38

· Lets assume they start pre repaying once they reach the age of 38. The loan outstanding is still 52.5 lacs

· This will mean that even with a prepayment of 25,000 per month they will need 8 years to finish the home loan.

· And this is assuming that they will not go for another child or take a career break till they reach age of 46

· During 38–46 they may be able to regain the lifestyle and have some savings too

· Once they reach 46 they have to start planning for their kids future and retirement planning

The summary of these calculations are as follows

The household expense breakup is as follows

Assumptions involved

· I have assumed ready property so no GST and no upfront interior/furnishing cost

· I have assumed no property maintenance cost

· Since a saving of 19 lacs is not going to be available with the couple so they would have to take family help

· The salary increase has been assumed to be 10% every year

· No other loan is assumed in this tenure

· No cost of family support has been assumed

· A car purchase has been assumed between 30–35

· No windfall cashflow gains has been assumed in this tenure

· No job loss or income free tenure has been assumed for 16 years (30–46)

· No major family emergency or financial situation has been forecasted

· A frugal lifestyle has been assumed between 30–35 years to accommodate the loan EMI

· Only one kid has been assumed for the couple

Having written the assumptions I feel these are on the optimistic side. A 16 year period without any financial recession or job problems is unlikely. A family emergency or a special situation can not be ruled out for such a long time.

Please let me know if the assumptions are optimistic or pessimistic for feedback.

Conclusion and open questions

Buying a house at a young age and long tenure is a typical example of how compounding work against them. The couple has paid interest of 41 lacs against rental cost of 22 lacs in 8 years (assuming 7% annual increase). Another way to look at it is they paid 42,555 per month of interest cost against the rental savings of 23,084 per month. Infact the gap is significantly higher in initial years.

The high cost of home purchase not only drains the money earned by the buyer it also limits the risk taking abilities when a person is best suited for that. It also limits the opportunity to go for higher studies/MBA if his/her career path has not gone right.

The conclusion may be different for different couples. But the following questions should definitely be considered before making such a big purchase at the start of his/her career.

1. Are these sacrifices worth staying in a self owned house

2. Can the couple afford another kid with such financial pressure

3. What if one of the them had to leave a job or wanted to try a new business

4. Is it ok to deplete your emergency fund for such a long tenure

5. Will a 2 BHK be enough for a family with 3 members. What if their parents want to join them in old age

There is a popular saying which says that “If you don’t love your job, take a home loan. You will start loving it”. This statement seems to be vindicated by this analysis.

Please let me know your feedback if you think buying a house early in your career is a boon or a bane.