ATM :: Bearish real estate sector: Time to take a home loan?

Adhil Shetty CEO, | Source:
Potential property buyers must keep a track of property prices, the home loan interest rates and the tax benefits associated with it. A comparative analysis can help arrive at the right answer.


Timing the market—whether in equity or real estate—is fraught with risk. Future prices can never be predicted with any degree accuracy that provides any comfort. However, in the real estate market, the price volatility is not as severe as in the equity market. Therefore, a buyer or an investor can still take a relatively sanguine bet on the future price movements in real estate.

As the situation stands today, buyers expect a further drop in property prices before they recover and start moving northward in a year or two. Not just that, they expect the interest rates to fall further and enter the sub-9% region. These are the two possibilities holding back many buyers from taking a plunge into the real estate market.

Often, it helps to know the likely impact on the buyer’s cash outflow and net savings under different circumstances—likely price fluctuations, interest rate movements and tax savings.

In an attempt to decode the impact of these market forces on your real estate investment, we outline different scenarios and evaluate the impact of these scenarios on a prospective buyer’s financial positions by analyzing three different cash flows: gains or losses from property prices fluctuations, home loan interest rate movements, and the total tax savings.

Scenario 1: Buy now, prices are down, rates are down, also get tax savings

One of the prime attractions for investors of investing in a home property is the potential tax savings under Sections 80C and 24 of the IT Act. However, when the real estate market is already bearish, any appreciation in property prices can offset the gains from tax savings.

So, it may be worthwhile to consider buying property now or in the near future when property prices are muted and interest rates have come down.

Suppose the property you intend to buy currently costs Rs. 50 lakh. If you were to buy this property today, you would take a loan of around Rs. 43 lakh (85% of the property price) for, say, a period of 20 years at a rate of interest of 9%.

Scenario 2: Buy later, prices remain down, rates may go further down, also get tax savings

Another option can be to wait for a few months to see if interest rates fall further while property prices still remain muted, therefore there’ll be three savings: on property price, on interest repaid on home loan, and on taxes.

Let us say the property price goes down to Rs 45 lakh after a few months. For this, your loan requirement would go down proportionately to Rs 38 lakh over a period of 20 years. Let us also assume that interest rates fall further to 8.5% after 6-12 months.

Scenario 3: Buy later, prices may go up, rates may go further down, also get tax savings

The final scenario is, while you wait for interest rates to fall further, property prices may appreciate in the meantime if demand starts picking up. This may potentially wipe out some of or all your gains from the lower interest rates and tax savings.

Assuming the price of the same property goes up to Rs 55 lakh after a few months, your loan requirement would shoot up to Rs 47 lakh, however at a lowered interest rate of 8.5% (assuming they have decreased further from the current 9%).

In all scenarios above, we have assumed that the average interest rate over the loan tenure of 20 years would be the same as it is in the first year.

Comparing the scenarios

Scenarios 1 versus 2: In scenario 2, you pay Rs. 5 lakh lesser for the property. You also pay Rs. 8.7 lakh lesser interest on your home loan over the next 20 years. However, your total tax savings also go down by around Rs. 70,000 as compared to Scenario 1.

Nonetheless, you make a net saving of around Rs. 13 lakh by waiting for the property prices and home loan rates to come down.

Scenario 1 versus 3: Now, while you wait for interest rates to fall further, what if the property price goes up to Rs. 55 lakhs. In this case, you pay Rs. 5 lakhs more for the property price, your interest cost over the 20-year period goes up by around Rs. 1 lakh as compared to Scenario 1. However, you get higher tax savings of around Rs. 31,000 than what you get in Scenario 1. As compared to Scenario 1, your net cash flows go up by around Rs. 5.7 lakhs despite the higher tax savings and lower interest rates.

From the above two examples, it is clear that even a small appreciation in property prices is enough to negate completely or reverse any gains from tax savings and lower interest rates. While awaiting further lowering of home loan interest rates is a fair expectation and a smart move, the buyer stands to gain only if property prices too go down simultaneously, or at worst, remain at current levels.

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