Ravi, a software engineer from Hyderabad got married five years back to Swathi, a banker. Ravi and Swathi are now 34 and 31 years old, respectively. Two years into their marriage, they decided to buy a house which cost them Rs 54 lakh, funded by a joint home loan of Rs 45 lakh. At the time their combined salary was Rs 1.1 lakh (Rs 65,000 and Rs 45,000, respectively).
Fast forward to the present and the couple is expecting their first child in a few months. Swathi has decided to be a stay-at-home parent to take care of the child, but it is not going to be an easy road ahead. As they transition from a double-income-no-kids household to a single-income household with a child, they are worried about servicing the EMI which is about Rs 42,500.
"At the time of buying the house, we did not think about such a situation arising. We exhausted all our savings in the down payment while buying the house," said Ravi. This couple is not an aberration to the norm; owning real estate is considered a proud purchase by many households and is normally funded through loans.
While a house is one of the biggest investments you make, it may not always be the best investment. You need to assess this asset class on the metric of affordability and future serviceability of any loan you take. Here are a few factors that should help you decide if you are ready.
Unlike financial assets that are liquid (you can redeem your mutual fund units and realize the money in a few days), real estate is not liquid. It can take days to months to find a buyer and the ensuing hassle to sell off the property really makes it a sticky asset. Any financial plan starts with ensuring a solid emergency corpus is in place that will take care of any unforeseen events. Maintaining an easily accessible fund that can cover about six to nine months of your expenses should do the job. This could be kept in your bank account or a sweep-in fixed deposit, for instance.
Next, you have to think about your short-term goals and how these may impact your EMI payments. Reshuffling your priorities can affect the income of the household if, for instance, an earning member puts their career on hold. At the same time home loan EMIs will continue to accrue. It is best to think about this now rather than later. When looking at these near-term goals, ensure that funds set aside for this goal will be liquid by the time the goal arrives, and also make sure to have a back-up plan in case some aspect of your initial plan should fall through.
Start by making a list of your expenses – both monthly and annual. Also, note down any near-term (up to three to five years) goals and the funds needed for these goals.
Whether you can afford a loan is a serious question you need to ponder upon. Without touching your emergency corpus or disrupting your other financial goals (both short- and long-term), you should be in a financial position to make a decent down payment. Work towards accumulating at least 25% of the amount. If you can afford to contribute 40% to 50% of the property value as down payment, you will certainly be more comfortable paying off the loan.
Then comes the EMIs. A good thumb rule is to ensure that your EMI does not make up more than a third of your take home salary. You need to figure out how you will service the loan in case of an emergency like loss of income or unexpected increase in expenses.
Besides taking a larger loan than they could afford, the other mistake Ravi and Swathi made was making pre-payments of the loan as and when they had additional funds. This prevented them from building assets that would have now come in handy.
To live in or rent out
Then comes the question of whether you will actually live in the house you buy. If you are constantly moving home because of work and are uncertain about where you will live, it may not make much sense buying a house when you will also have to pay rent in another city.
If you are not planning to live in the same city for at least another five to seven years, it is better to stay on rent. Take into account the fact that relocating will involve both paying rent in the new city and servicing the EMI of the house your purchased. Selling the house and buying another house in the new city is not feasible as it involves a lot of effort. The transaction cost—stamp duty, registration fee and brokerage—is also very high.
If on the other hand you decide to let out the house, you may not necessarily get a tenant immediately. However, you will still be obligated to pay maintenance costs which can be quite high, especially in larger housing complexes with many amenities. Other than the cost, it can also be very time-consuming to maintain a house in another city.
Finally, buying a house should not come at the cost of other important goals like your child's education and your own retirement, neither should it impact your lifestyle significantly. If goals like travel or starting a business are important to you, understand that these could get affected by you having to service an EMI. You may also have to wait longer to retire.
So, besides servicing the home loan EMI, one should have enough savings to invest for other goals and expenses. Taking a loan to buy a home is indeed a huge decision, one that should be made after careful consideration of your monies, your goals, and where you will be in the next few years.