Should you buy or rent your next house?
In India, we observe that owning a house is considered the most important goal for many individuals. The reason for this could be either a sense of security or to achieve a sense of accomplishment. In the last decade or so we have seen people taking huge loans with long maturity periods to buy a house for living. Unfortunately, many of them land up spending the rest of their lives paying back the loan in EMIs. In this article, we will discuss whether it is really worth taking a loan to buy a house of better to just rent one.
Let us take the example of two neighbours, Geeta and Babita. Both, Geeta and Babita live in Shahadra (Delhi), but Geeta lives in her own house which she purchased last month by taking a home loan, whereas Babita lives in a similar house, but on rent.
Now, let’s assume-
- Price of the property (avg price for 3 BHK in Shahadra, Delhi) = ₹ 1.5 Cr
- Rent of the property (avg rent for 3 BHK in Shahadra, Delhi) = ₹ 50,000/month
- Loan Term Assumed - 20 Years
- Interest on Loan = 8.4%
The monthly EMI that Geeta pays for the next 20 years is ₹1,29,226, totalling to a total of ₹3.1 Crore at the end of the tenure. This totalled amount includes ₹1.5 Crore of principal amount and ₹1.6 Crore of interest amount as shown below. You can also observe that her total interest payment is more than the actual principal amount. In simple terms, Geeta owns her house but at the same time has debt on her for the next 20 years.
Source - HDFC
On the other hand, after paying the rent of ₹50,000, Babita is left with ₹79,226 (1,29,226 - 50,000) excess each month, compared to Geeta’s EMI. Babita decides to invest this excess amount in a good mutual fund as SIP. Historically the 20 years average return for a good mutual fund has been 15% p.a .but let’s assume a more conservative expected return of 12% p.a. (Average returns for last 20 Years of a good mutual fund are 15% on an average, Source -
- Babita’s total Investment will be ₹ 1.9 Cr
- The future value of Babita’s SIP investment will be ₹ 7.84 Cr
Deduction - At the end of 20 years, Geeta will own a house without any debt whereas Babita will have ₹ 7.84 Cr approximately, from which she can buy anything including a house of her own.
Why Babita’s living in a rented house and investing her money in SIP makes more sense?
- Babita has not locked her money in a property and therefore she can redeem her money, whenever required or immediately in case of any emergency.
Deduction - Investing in a property is like owning a fixed tangible asset, but it is extremely difficult to sell such an asset in a very short period at a reasonable price, whereas selling you units in a mutual fund is a very quick process (Note: some mutual funds may involve exit load if redeemed before 1 year). Also, it is important to note that the property must be sold all at once in case of an emergency. However, in case of investments in Mutual Funds, one may redeem part units which would get the required funds.
- Babita doesn't have any kind of debt on her. So even if she loses her job in the future, there is not much to worry. In fact, she will have the capital that she has invested to handle that situation.
Deduction - Buying a house involves a very large amount of investment, and therefore it is very common to take a loan to buy a house. But repaying that amount with interest becomes a lifetime process, people spend around 1/3 of their life in paying the EMIs.
- Since Babita doesn't own the house, she saves a lot of cost on managing the property and property taxes.
Deduction - Purchase of a property doesn't only involve one-time buying cost but also regular maintenance charges, securities charges, property taxes, etc. which are to be borne by the buyer.
- Investing in SIP and not buying her house helped Babita in diversifying her investment.
Deduction - Investing your money in mutual funds / Stock Market can help you diversify your investment into different sectors and stocks. In fact, even without buying a property, one can take an exposure in real estate and related sectors, by investing in a mutual fund of that sector or by buying stocks of real estate companies, cement or other building material companies, housing loan companies, etc. You can also buy units of REITs (Real Estate Investment Trusts).
Some people might disagree with the above and will ask about the profits from the price appreciation of those properties.
As the graph below shows, we have witnessed a decline in the growth rate of real estate prices over the previous 8 years. This growth currently stands at 5.3%. In fact, in certain geographical locations in the country we have seen a decline in prices over the previous few years. This is an effect of several reasons, including low yields on rentals, demonetisation and recently credit issues, such as defaults by companies like IL&FS and DHFL. These defaults have caused a liquidity crunch in our economy and has put the entire Non-Banking Finance Industry, which plays an important role in the demands of housing properties by providing loans, under the scanner. Another sector which is important for the housing demands are Banks, which have also been going through a very stressed scenario with rising NPAs.
Source - RBI
Overall the scenario is not so positive for the housing properties and high price appreciations of properties are not expected in the near future. So, does it mean no one should buy property at all? Not Exactly!
When does it make sense to buy a house?
- While some people have a dream to buy their own house, some want to buy it as a sense of satisfaction or security. If that is the reason, and the investors financial condition permits him to, he could go ahead and buy a property.
- People who already have a lot of exposure to equity and debt market can also buy properties as an alternative source of investment and to further diversify their portfolio. As an alternative they can invest in REITs which provides more liquidity than a property.
- Paying interest on loans provides income tax deduction up to a maximum of Rs 2 lakh under Section 24. Moreover, when you repay the principal amount, you can claim a deduction for up to Rs. 1,50,000 within the overall limit of Section 80C (Check the principal repayment amount with your lender or look at your loan instalment details). Hence if your benefits from such deductions are significant then you can consider buying a house for yourself. Also, do consider the rental income you’ll earn will be added to your overall income for income tax calculation.
- If you are in need of constant money, maybe because of retirement then you can consider buying properties for regular rental income. But before that, do compare your rental returns with AAA bonds or Government bonds return and invest wisely.