Should we buy a house or rent it : Let's understand the implications

In our fathers or grandfather time buying a house use to be the final priority generally when at retirement they want to settle-down. IN those days getting loan was not easy and the housing market was also not that much developed. But even today buying a house is a dream for young generation. However with property prices having gone off the roof, especially in a metro such as Mumbai, this primary need has actually became a distant dream. Even in extended suburbs prices are touching roof and its almost impossible for a middle class person to buy a home there. There is argument that buying a house is still a good decision as over the years the capital appreciation will make it profitable but how much true it will be a big question.

In Mumbai there is lot of unsold properties lying. The reason for which is:

·         property prices are unaffordable to the middle class;

·         Income not going in proportionate to the housing prices

·         Higher Interest rates making home loan costly;

·         Alternate investment options like equity market encouraging many to invest in equities

As we can see that the supply is outstripping demand especially in big cities like Mumbai. This limits the scope for capital appreciation in near future. As a result the property prices have stagnated.

However owing a house still is a very important factor for many of us in life. However it is very important for us to understand that the purchase of house can have big impact on our finances, wherein we may even have to compromise on some of the other long-term financial goals such as such children’s higher education, their marriage and even our own retirement needs. Therefore we need to weigh the pros and cons wisely. 

While buying a house carries many advantages such as stability of place, hedge against inflation, capital appreciation, diversification and rental yields; these benefits really don’t matter if we are looking out for a house to live in and not for investment purpose. For living in that house we should be more concerned with factors such as: 

Affordability – We all want to buy the best but we need to look at our income and litations while buying a house. We should understand that to own a plush home in a prime locality may affect our long-term finances if we fail to estimate our future income and expenditure. Hence proper budgeting should be the starting point of to decide upon the city or locality within a city where we can afford to buy the property. Generally our EMI-to-income ratio should not exceed 40% of the total household income. We should be very careful while availing home loan as EMI affects the cash flow in a big way as usually very less sum is left after having accounted for EMIs and expenses for investment purpose to meet other short and long-term financial goals.

Also while checking the affordability we should be taking into account the maintenance cost you would defray and proximity to other work place, commercial areas and other essential services which can reduce the cost and the time involved in travelling. 

Property exploration: Once we have calculated the amount we can afford to buy home, we should be doing background check considering the following nitty-gritties amongst host of other things...

• ·         Who is the builder?
• ·         Builder’s past track record?
• ·         Has he completed his previous projects on time?
• ·         The rate which he is offering for the amenities
• ·         Prices of similar properties in same locality
• ·         We should also visit the site and check the quality of construction
• ·         WE can also visit the other properties of the same builder to check the ground reality regarding his promises
• ·         To check with the title and all other statutory permissions
• ·         If the constructions is still going on then what would be the time lag for getting the possession
• ·         If the property is ready for possession i.e. newly constructed or a resale property; then the age of building and has a society being formed
• ·         Is the project and builder are approved by the banks for loans
• ·         Quality of Construction

As we all know that - buying a house and renting one both, have their own unique set of costs and therefore it is very important to evaluate both to make a prudent choice. The following illustration here would help you get better insight.

Mr Mehta is salaried individual placed in Mumbai drawing a basic monthly salary of Rs 50,000 falling under the highest tax bracket.  

Mr. Mehta, lives in Mumbai Suburbs
Gross Monthly Salary (in Rs)	125,000
Basic Monthly Salary (in Rs)	50,000
Monthly HRA (in Rs)	15,000
Assumptions:
Tax Bracket	30.90%
Annual increment in salary	10.00%
Tax laws remains same for next 20 Yrs

He is exploring two options-

1. Staying in a rented accommodation; or
2. Buying a house to live in availing a home loan

Option 1- Staying in rent for 20 Years
Tenure of residency (Years)	20
Rent per month (Rs.)	15,000
Annual rent (Rs.)	180,000
Initial Deposit (Rs.)	150,000
Increase in Rent (P.a)	8%
Result:
Total expenditure on rent (over 20 years) [i]	9,462,305
Tax benefit on house rent (over 20 years) [ii]	5,491,436
Loss of interest (@8%) on initial deposit (over 20 years) [iii]	549,144
Total expenditure on rent after accounting for tax benefits (i-ii+iii)	4,520,013

Now suppose, if he opts for living in a rented house where he will pay a monthly rent of Rs 15000/- along with an initial deposit of Rs 150,000 (refundable once he vacates the house) and assuming he stays there for 20 years and is subject to an annual escalation clause of 8% for rent; over the tenure of residency (i.e. 20 years) he would be paying a sum of Rs 94,62,305/- on rent. However, as per Section 10(13A) of the Income Tax Act, he is entitled to a tax benefit for House Rent Allowance (HRA). Therefore, over the 20-year period he is estimated to receive a tax benefit of Rs 54,91,436. Also we’ve considered the loss of interest, which he has to bear on the initial deposit doled out, as that’s the opportunity he has foregone whereby he could have invested the same sum and earned an interest of Rs 5,49,144 assuming it remains same @ 8.0% p.a. for the whole tenor.

Taking into consideration all these aspects, i.e. his expenditure on house rent, the opportunity loss and the tax benefit he would receive, the net expenditure for renting the house would amount to Rs. 45,20,013/-.

Now say he explores the second option i.e. to buy a house to live in availing a home loan...

Option 2- Buy home by taking home loan
Cost of the house	8,000,000
Loan amount	6,500,000
Tenure of loan (Years)	20
Rate of Interest for Home Loan (%)	9.75
EMI (Rs.)	61,654
Monthly Maintenance Cost (Rs.)	1,500
Initial payment:
(a) Personal contribution	1,500,000
(b) Stamp duty & Registration (6% of property cost)	480,000
Total initial payment (a+b)	1,980,000
Outcome:
EMI outgo (over 20 years) and initial payment [i]	14,796,960
Tax benefits received from EMI (over 20 Yrs) [ii]	6,566,512
Maintenance Cost (growing by 5% annually) [iii]	889,612
Loss of interest (@8%) on account of initial payment (over 20 years) [iv]	7,248,695
Total expenditure after adjusting for tax benefits [i-ii+iii+iv]	16,368,755

Here with the aforementioned details on the cost of the house and loan he would avail, his initial contribution (including the stamp duty and registration) would be Rs 19,80,000. Also over the tenure of the loan of 20 years, he would pay an EMI per month of Rs 61,654. Including the initial payment and EMI his outgo over 20 years would be Rs 1,67,76,960. However since he has availed a home loan, he would be entitled to a tax benefit under Section 80C and Section 24(b) of the Income Tax Act, 1961 together amounting to Rs 65,66,512 on the EMI paid over the tenure of the loan. Also like in option 1, here too we have considered the loss of interest on the initial payment of Rs 19,80,000 which could have otherwise earned him interest amounting to Rs 72,48,695 had he invested in an instrument offering a steady rate of interest @ 8.0% p.a. He would also require to pay monthly maintenance cost which is assumed at Rs. 1500/- first year growing by 5% annually.

After taking into consideration all the aspects such as total home loan repayments, tax benefits, maintenance expenses and the opportunity loss, the net expenditure on buying a house would have amounted to Rs 1,63,68,755. 

The comparison between option 1 and option 2 reveals that over a period of 20 years staying on rent is much cheaper (Rs 45,20,013) as against buying a house by availing a home loan (Rs 1,63,68,755). However we have not considered the future sales value of the house in this calculation.

However these numbers can change if the scenario or assumption differs.  Therefore it is imperative to take understand the environment in the property market while taking the decision of buying a house or living on rent. 

Further as we all know that in India buying a house is filled with emotions, and more so, when one is moving in with a family, making it a home. Our own house also gives a stability  which can never be in case of a rented home. So while we wish to buy our dream home, we should account for not just financial factors but also the non-financial factors (individual needs and aspirations), to make the a prudent and feasible choice for your and family’s well-being.