By Sanket Dhanorkar, ET Bureau|May 22, 2017, 11.01 AM IST | Economic Times
A roof over your head is a basic necessity, but if you spend too much of your income on shelter alone, you should be concerned. A big home loan EMI can render you “house poor”—a peculiar situation where the individual owns expensive real estate but has no money left for other expenses after paying the EMI. This week’s cover story focuses on the pitfalls of overinvesting in a house. We also tell you how to maintain a healthy balance between housing and other critical goals.
The downside of buying
One of the main reasons why family budgets go haywire is delay in getting possession of homes. The double burdens of EMIs and rent can be too costly. Mumbai-based businessman Chintan Valia, 33, should know. Valia booked a flat worth Rs 35 lakh back in 2009. As the builder was a reputed one, Valia was confident that the property would appreciate in value, allowing him to make a neat profit by selling it a few years down the line. He is yet to get pos ..
Chintan Valia, 33, Businessman, Mumbai
Bought a flat worth Rs 35 lakh on loan in 2009, but is yet to get possession. He is paying an EMI of Rs 15,000 and Rs 20,000 in rent. His monthly income is Rs 85,000.
Housing cost as percentage of income: 41%
THE WAY OUT
Sell the property as soon as construction is completed.
“The cost hurts. Very little is left for savings after catering to household expenses,” rues Valia. His story is hardly unique. There are thousands sailing in the same boat. The typical Indian who made a huge financial commitment while buying a dream home only to have it become a millstone around his neck. Even those who have got possession are finding it tough to service the home loans. These people own houses worth Rs 60-70 lakh, but after their EMI is paid, they have little money for other expenses.
Too often, lulled into a false sense of security, many home-buyers make the longterm financial commitment without factoring in the costs that come with the purchase. The home loan EMI is only a part. Society maintenance charges, home insurance premium, cost of décor and property tax can collectively make a big dent in a household’s finances. After shelling out these payments, many are left with hardly any money, ending up compromising on key goals. Turn to page 7 to know if you are paying more than you can afford.
With home loan interest rates at multi-year lows, advertisements are exhorting homebuyers to make a move. “This is the best time to buy a house,” chorus lenders and housing developers alike. It’s hard to resist the bait. At 8.4% rate of interest offered by a leading public sector lender, the EMI on a Rs 50 lakh home loan for 20 years now stands at Rs 43,075, as against Rs 48,251 at 10% three years ago. However, this luxury of low EMI will only be fleeting. “You are not locking in at the current low rate for the entire tenure of the loan. The lender will revise the interest rate upwards when the broader rates start inching up,” cautions Jayashree Kurup, Head of Content and Research, Magicbricks. Besides, the benign mortgage rates completely mask the fact that the price of the homes itself continues to remain beyond the average homebuyer’s budget.
Often, homebuyers build in certain expectations of how their income will grow over the years or how the value of the house will appreciate to build the foundation on which they commit to high-ticket loans even if current circumstances do not favour such an outflow. Ritesh Brahmbhatt, 34, from Mumbai, is banking on a better future earning profile to ease the burden he faces today owing to a hefty home loan. Brahmbhatt, along with his wife, is currently paying off two housing loans entailing a combined EMI outflow of Rs 72,000. He bought his first house for Rs 25 lakh nine years ago, but decided to opt for another under-construction flat worth Rs 74 lakh closer to his workplace a few years back. While the couple’s monthly income is around Rs 1.5 lakh, a household expenditure of around Rs 30,000 along with other annual commitments of around Rs 25,000 on property tax and insurance premium leaves them with meagre savings. However, Brahmbhatt argument is that while he feels the pinch of the high outflow now, he has the benefit of age on his side to overcome the difficulty. “I took a chance and opted to build assets at an early age that could provide me with a security blanket in future. I am banking on my own ability to do well and prosper in my career to support the high payout,” he insists. He is also confident that should he need to, he would be able to sell one of his properties at a good price.
Ritesh Brahmbhatt, 34, Banker, Mumbai
Paying EMIs on two housing loans. He invested in property banking on future income growth. While he earns Rs 1.5 lakh a month, Rs 72,000 goes towards loan repayment.
Housing cost as percentage of income: 48%
THE WAY OUT
Liquidate one flat to ease burden on finances and use funds to invest in higher yielding assets. Try to prepay loan using any surplus.
However, homebuyers would do well not to be so confident of being able to sell their poperty should they need to. Property is not a very liquid asset. It usually takes a lot of time for sellers to find a buyer and realise the value of their asset. The prevailing housing market serves as a cautionary tale. The secondary or resale market has been hit hard by the demonetisation exercise. Many homeowners like Valia, who purchased a house as an investment, are stuck with an illiquid asset. With home sales muted, developers continue to face severe cash crunch, forcing many to abandon projects mid-way. “The risk of delay has killed the market for investors and made it highly illiquid. Homebuyers should ideally look for completed projects instead of taking on the risk of a delay in construction,” says Kurup. While the Real Estate (Regulation and Development) Act (RERA) is expected to provide better protection for the homebuyer, there remains a degree of uncertainty on how effectively and uniformly it will be implemented across states. Besides, while house prices can appreciate a lot over the years, there can be periods or regional pockets where home values can remain stagnant or even witness a decline.
Also, one doesn’t become house poor overnight. It can happen gradually as your personal situation changes. Perhaps at the outset you are able to pay off the high EMIs, but you may end up house poor if your circumstances change. For instance, what if one partner is left jobless for an extended period of time? The current trend of mass layoffs across sectors should serve as a warning to anyone projecting sustained higher income into the future. The salaried class is also witnessing lower increment“It is prudent to base the home buying decision on current income profile rather than making assumptions about the future,” warns Amol Joshi, Founder, PlanRupee Investment Services. Likewise, if one partner decides to stay home after having children, or after the birth of the second child, housing payments can become a greater burden than what it may appear today.
Bigger is not always better
Homeowners may end up being house poor if they insist on buying more space than they really need. “Many homebuyers are biting off more than they can chew,” says Joshi. Most insist on buying a home that would continue to cater to their needs 15-20 years down the line, such as when the family grows larger. So even if a 1-BHK is an appropriate fit today, there is a tendency to opt instead for a 2 or even 3-BHK. This approach leads most to over-leverage. It is critical that buyers evaluate their requirements carefully. Do not stretch yourself to the limit just to own a bigger house. “Buy for today’s needs,” exhorts Kurup. “Opt for a smaller unit today. You can consider shifting to a larger unit a few years later when you have an idea about your actual requirements and possibly have a better grip on your finances,” she adds. Besides, purchasing a bigger house or one in a better locality will not only carry a higher purchase value, it is also likely to set the tone for higher future home related expenses that come with maintaining a certain lifestyle.
Most experts insist that the home loan EMI should not exceed 40% of the monthly income. Anyone spending more than that faces the real possibility of being house poor. The lower the percentage of income that goes toward housing costs, the more breathing room you will have to be able to handle any cash crunch that may arise owing to changes in your life, such as the birth of a child, an extended illness or a layoff. When setting the percentage you’re comfortable with for a housing budget, be sure to account for ancillary costs—property and water taxes, home insurance, maintenance charges etc.
Further, do not get enticed into opting for a large home loan for the tax benefits it can provide. While it can reduce your taxable income substantially and in some cases, even bring you to a lower tax slab, these deductions are only eligible for homes that are fully constructed. Tax exemption for property that is under construction is very limited. Besides, recent tweaks in the tax rules have taken away much of the tax relief for aspirants for second homes. The maximum deduction on interest payment towards home loan is now capped at Rs 2 lakh as against the entire interest that was tax-deductible earlier. “The decision to purchase a home should never be based on tax benefits it can bring,” warns Brijesh Parnami, ED & CEO, Essel Finance Wealth Zone.
Renting not a waste of money
Another fallacy that pushes people to buy a home they cannot really afford is the argument that paying rent is a waste of money. Experts say it makes more sense for prospective homebuyers to stay on rent rather than commit to a high-ticket purchase. “Buying property simply to save on the rent has put many under severe stress,” points out Suresh Sadagopan, Founder, Ladder 7 Financial Services. “It may be a better idea to stay on rent for the time being and invest the balance in a high-yield investment that can allow you to build savings so that you are in a better position to afford that house later.” Investing the savings on EMI through a SIP in an equity the house for at least another five years.
Renting may be the smarter option particularly in some cities where the home value-to-rental value ratio is very high (See table). The Arthayantra Buy vs Rent Report 2017 suggests that in cities like Mumbai, Delhi, Bengaluru and Chennai, anyone with yearly income less than Rs 25 lakh, Rs 16 lakh, Rs 12 lakh and Rs 16 lakh respectively, would be better off renting than buying.
Cost to rent compared with cost to buy should influence buying call
While it makes more sense to rent a home in Mumbai, the urgency-to-buy ratio suggests in Hyderabad, it is prudent to buy rather than rent a home.
Cost to rent includes sum of rent and maintenance charges
Cost to buy includes EMI and maintenance charges
The Urgency-to-Buy (UTB) ranking helps to decide whether you should buy or rent in a particular city. The UTB ratio indicates what extra payment one has to pay every month if the property is purchased instead of rented. The average monthly cost of renting is derived from the sum of rents and maintenance cost whereas monthly cost of buying is calculated by adding maintenance cost with the EMI.
Source: ArthaYantra Buy vs Rent Report 2017
Avoid a cash crunch
If you are still intent on buying that house and committing to a large EMI outflow, there are some things you should put in place at the outset, insist planners. First, build up an adequate contingency fund— equivalent to six months of EMIs—that you can dip into in case there is some interruption in your normal cash flow. Put this amount in a liquid fund. This will act as a buffer till the time your cash flow situation improves. If you haven’t already done so, take adequate health and life insurance cover to provide added protection to your finances. While many lenders offer bundled term insurance cover, do not feel compelled to opt for this. Take a separate term insurance cover instead. Most home loan insurance plans come with a reducing cover, where the quantum of cover is linked to your outstanding loan amount, so the sum assured reduces over time as the loan is being repaid. On the other hand, term plans offer a fixed sum—the beneficiary is entitled to the full amount irrespective at which point of the loan tenure the claim is made. The borrower’s family can use this pay-out to settle the outstanding loan amount with the lender and the balance, if any, can be utilised as deemed fit. Arun Ramamurthy, Co-founder, Credit Sudhaar, suggests homebuyers take a job-loss insurance policy, along with the term insurance. “In the event you are unable to service the loan for an extended period owing to an accident or job loss, the policy will cover the EMI for a specified time,” he says.
For some, the cash crunch can be severe if they are dealing with multiple loans. Take for instance the case of Nirdesh Jain, 28, a chartered accountant from Pune. Apart from a home loan EMI of Rs 21,000, Jain pays a car loan EMI of Rs 10,000 and a personal loan EMI of Rs 5,000. Together, the EMIs eat up 3/5th of his Rs 60,000 monthly income. Jain finds himself trapped in a vortex of short-term personal loans to tide over this crisis. . For such borrowers, consolidating the multiple loans into a single loan via balance transfer can provide some relief, suggests Parnami. “By consolidating the high cost loans into a lower cost loan over a longer tenure, the principal value of the loans will get amortised over many years, which will reduce overall EMI burden and improve cash flow,” he says. Even if you are on a single high-ticket home loan that bears a high interest rate, you should consider switching to a lower interest rate loan, particularly in light of the recent sharp cut in borrowing rates. As a rule, if the rate of interest payable on your home loan is 1% more than the rate on offer in the market, you should consider refinancing the loan.
Nirdesh Jain, 28, Business analyst, Pune
Has multiple loan commitments. As much as Rs 36,000 of his monthly income of Rs 60,000 goes towards paying off a car, personal and home loans.
Loan burden as percentage of income: 60%
THE WAY OUT
Repay costlier car and personal loans at the earliest or take top-up on existing home loan and consolidate other loans into a single low-cost loan.
Is it better to rent or to buy?
The cash flow of a household has to be kept in mind while deciding to rent or buy.
Figures indicate Arthayantra Buy vs Rent Score.
Source: Arthayantra Buy vs Rent Report 2017
Know when to sell
In the absolute worst case scenario, it would be prudent for the homeowner to cut the cord rather than dig a deeper hole. If you are under severe stress owing to housing related payments, consider selling the house and moving into a smaller, more affordable home. While you may not be in a position to enhance your income to support the payments, you can definitely get rid of a payment that is too large for your budget. “If you have exhausted all other options and are staring at a bleak situation where you are unlikely to make ends meet, it is better to cut your losses and let go of the property,” insists Ramamurthy.