Friday, July 5, 2013

Is a Home Loan Your Best Investment?

"Stupids are damn sure, while the intelligent are full of doubts" is one of my favorite quote. Not sure who said it. We can call it anonymous then. Why this is my favorite? If you ask a piece of advice from any one without much expertise in any area, he will say a definite answer, whereas if you ask the same question to an expert in that area, you will get a few pros and cons, which makes you more confused.

For example, ask an innumerate person how wise is a decision to invest in a house. Most probably, you will get a answer like "It is the best investment you can make". On the other hand ask a financial expert, definitely he will not be thrilled as much you expect. Well, he can figure out the pros and cons, but an yes or no depends on many factors.

I purchased a three bedroom flat three years ago. I was not a money conscous person at that time, so definitely I did not do my maths. But now I am, so I decided to analyze that decision. It is purely based on my personal experience.

I have a made Rs 10 Lakhs as down payment. and I went for a loan of Rs. 25 Lakhs for 20 years. I have to pay Rs 21,700 as EMI for this loan. Is it a wise investment? Assume my flat appreciates 15% Compound rate per year. So, at the end of 20 years, it will worth Rs 5.72 Crore.

Besides this, I can claim income tax reduction. I am in 20% tax slab, and assuming the tax laws will remain constant for this 20 years, I will save Rs 10 Lakhs.

So, my gain is a total of  Rs 5.82 Crores

Now, see how much I paid?
  • Rs 10 Lakhs downpayment
  • Rs 52 Lakhs as loan repayment
  • Approximately Rs 10 Lakhs as maintenance charges
This seems attractive. I paid 72 Lakhs and I got 5.82 Crore return. Let's just forget we have made many assumptions here.

Now consider another scenario. I had decided not to purchase the flat. and decided to invest the money in a bank recurring deposit. Assuming interest rates keep constant at 9%, let's recalculate.

I have paid Rs 10 Lakhs as down payment. I invest that right away for the 20 years. Also, I decide to invest Rs 21,000 that I pay as loan now. Wait, I cannot pay 21,000. If I did not purchase the flat I should have to pay rent. Also, more Income Tax.

However, if I decide to invest the Rs 10 Lakhs (which I paid as down payment) in an NBFC at 1% interest rate, I will get Rs 10,000 monthly. So this, can cover the rent. So, I am ignoring rent, but I have to pay income tax. Reducing that Rs 18,700 is left for investment every month.

So I invest 17,000 per month. This will be accumulated to 1.2 crore. Definitely this is not attractive as first scenario. But in both cases, we have made a few assumptions.

In first scenario
  • The price of your flat appreciates at 15% per year. Really? Think after 10 years, your flat will be old and obsolete.
  • There is no major maintenance
  • No insurance is not needed for the house (you know it is not true). Insurance charges are not considered in the calculation.
In the second scenario, the assumptions are
  • The rates of return is constant at 9% through out the years
  • You get 1% monthly return for the Rs 10 Lakhs investment you made for the next 20 years.
  • You invest in tax exempted schemes, so that no tax is not levied on the returns.
But there are some other factors, which you need to consider before purchasing a house.
  • The effort you put to find out an appropriate flat, background checks, and maintenance
  • Freedom and peace of mind of living a debt free life.
  • The pleasure of seeing your wealth getting accumulated. 
  • The freedom of life - If you don't like one rented house, you can move to another.
So, which one you should go? As I told you, the experts don't have the definite answers. They will confuse you more.

Please let me know your comments.

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