Why NOT to buy a house - II

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I received some comments on my earlier post. Jyoti said :


Your post lists all the valid points for "Buying a house after taking home loan at very high interest rate". But one point is missed - taking a house a investment and selling it after making decent profit and in process accumulating some fund.


I did mention this point in my earlier post


If you really had all the time in world to buy a house and sell it after 2-3 years, then I think you should go ahead.


Jyoti pointed out that a house can be helpful for old people who have no one to take care of – Sell the house and live on interest OR put the house on rent.


Well first thing, if you are old with no earning and entirely dependent on your children to support you, then it is for sure that either you really goofed up prioritising your financial goals OR you had blind trust on your children for support. I agree that there are lots of people who fall under this category and this is an important lesson of all of us in our generation.


Let me tackle her options (assuming I am that old person):


1) Put the house on rent


If I put the house on rent, then I too have to live in a rented apartment, unless I have more than one house. I can gain only if my rent is less than my tenant’s :) Simple maths. If I want to do that I have to lower my living standards. For example, if I have a house which can be put on rent for 14K, then to successfully live on that rent, I need to stay in a house with a rent say 4K-5K. If I as flat owner want to charge more rent, so will be my flat owner :) Doesn’t make sense…. (Another option exists, you rent out the flat in a metro and go and stay in your village/small town, but that is my whole point, if you have to do that why not purchase a house in the same village/small town, it wont cost much and you can use the money earned during lifetime in some better investment avenues)


2) Sell the house and live on interest


This is only possible if you earned a handsome while selling. Imagine for example, today you buy a flat in Bangalore costing 25-40 lakhs, when you retire (30 years from now) how much you expect the returns? Keep in mind that when you sell, so many factors can kill your calculations. Imagine the plight of people who bought houses near old airport (in Bangalore) few years back, now with the airport shifting, the prices have come down, and no guarantee that prices will bounce back and to what levels. I was talking to one of my office-mate who works in Fremont (USA). He was telling me about his friend who bought a house in USA few years back and now when he wants to sell he is finding no takers, he is now even willing to have a loss and sell it. Yes, ofcourse you can gain a lot, but basing your entire post-retirement life on this is not a sound idea (unless you have other investments which can take care of that). BTW, we have not factored the amount of money you have invested over the period in home loans (A 40 lakh house post home loan interest can cost you even 60 lakhs or more based on interest rates). And what about the inflation? Say your 60 lakhs house (including interest) sells at 5 crores (just a random number), do you think that would be enough after 30 years?


As an example, my dad started earning Rs 500 per month 40 years back and lived handsomely (he used to say lavishly) despite the fact that out of Rs 500 he used to pay Rs 200 for his brother’s studies. So essentially he stayed lavishly in Rs 300. After 40 years, i.e. now, if you want to stay that lavishly probably you need around Rs 1 Lakh (just a guess) in a metro. Let me lower it to Rs 50000 [post tax]. If you want to be more conservative in your living, you can even live in Rs 25000 [Rent, travel, grocery etc etc assuming no liabilities] That is close to 50 times. So to maintain current living standard you need may be 50 times that you earn per month. So Rs 25K now, would translate to Rs 12.5 lakhs per month (what about inflation causing rupee depreciation). This is the interest you need per month, so you need a whopping Rs 150 lakhs per year as interest with investing Rs 4.4 crore (34 % per annum). I hope my calculation is correct :)


But at any rate assuming at old age and no responsibility exist, just to live at the same standard, you can not do it alone on a house.


Conclusion:


  • Buy a house for living in it, at old age.

  • Don’t expect your children to stay with you (unless you keep them dependent on you)

  • Don’t just buy because everyone is buying, think long term, where you want to settle in your old age. Timing and location are important.

  • Buy a house which you can maintain. In old age, it is difficult to spend huge money on maintaining big house. Security is also a concern.

  • There are so many investment avenues other than house, think about that. In old age, big house won’t help, but surely the life long memories of your world travel can help. Spend money to enjoy life, and not to get imprisoned by the enormous house loan burden.

  • Keep accumulating small portion of money and buy a house when you are in your forties. At that age, your will be at the peak of your responsibilities, you can have your priorities clear.

If you are earning in dollars or have loads of money, then only buying a house makes sense as investment.

Why NOT to buy a house - I

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If you are living in Bangalore (or for that matter any Indian urban city), everyone would be telling you to buy a house (in case you haven’t already done). I talked about this earlier.


Last month I met my old friends from IIT-K. Some of them are still unmarried and the priority for them is to change their marital status. For those who are married, they are thinking of either buying a house or already have booked one.


One of my friend ‘S’, is at the stage of becoming father and he recently bought a house worth Rs 40 Lakh in Bangalore. Despite the steep price it is just a 3BHK apartment, and the home loan costs him more than Rs 40K for next 20 years. Recently with the interest rate rise, the tenure increased to 25 years and EMI by Rs 600.


I am not questioning his decision, since it is a personal one, but if we look purely in financial terms, it is a double whammy, an exorbitant EMI outgoing every month and the expenses of fatherhood. It is a different matter that he is very cool about it. But for a paranoid like me, it is like choking yourself.


A 3BHK apartment in say close to your office would not cost more than 15-18K, while the apartment not being in so close to your work location increases the travel cost. With EMI of Rs 40K + Petrol Expenses would be humongous.


Ofcourse there are lots of argument for and against it, let me think through it :


1) Buying a house is like building an asset


Has anyone thought why we want to build an asset? My father worked as professor in a little known town “Indore” for almost 45 years. He started at a meager Salary of Rs 400 per month and reached to Rs 10K after so many years. The pension he receives now is Rs 5K per month. In such a small amount he built two houses, but all his children, no longer want to stay in Indore, since more opportunities exist in other cities. My parents spends most of year with each of us, and hence the two houses he built are of no use to any of us. We sold one and he is earning interest on that amount.


So how does the “asset” helped him? I guess rather it deprived him of the much needed “extra” money he might have used during his younger years.


So for sure, the “asset” can not be for your children. Also I would rather not believe that our children would be “emotionally attached” to the house. Bollywood funda “Es ghar ke saath hamari bachpan ki yaadein judi hai”. I guess, most of their formative student life will be spent in hostels in India or abroad.


2) Buying a house gives you security


This asset takes months to sell off, so in case of emergency, it is of no use as a liquid asset. If you are salaried, then you will rarely come across situation where you would need so much money (Rs 40 Lakh etc) to sell a house (unless some medical emergencies come, but then medical insurance should help rather than the house).


It also cannot give you security if you loose your source of income. The logic people have is that if you loose your job, you don’t have to pay the rent, but don’t you have to pay the EMI? Try not to pay your EMI for 2-3 months and then see the volte-face of the same bank who pestered you into getting that loan. So till the time your loan is over, in next 20 years/25 years, you better not loose your job.


3) Buying a house is like investment


If you have investment in mind while buying a house, then why not stock markets. Everyone agrees that investment in stock market has overshadowed any other form of investments over a long horizon (say 10-15 years). So why not build a corpus based on stock markets. If you really had all the time in world to buy a house and sell it after 2-3 years, then I think you should go ahead. But may be you better do it on a full time basis. This can only help if you buy just before the booming time and then sell if after 2-3 years. With markets saturating in Bangalore, it does not make sense, if at all you want it as an investment, then focus on emerging areas like Mysore, Pune etc.


4) Buy a house now before it is unaffordable


I simply don’t understand this logic. The assumption here is that your salary will never increase. I think many of us came from smaller cities, and because of lucrative money we came, so even many years from now, you will get opportunity and if you grab it you will earn much much higher than you do today. Also if the assumption is that salary will not increase, you anyway cannot survive with a house loan. Interest rates can go up based on many external factors and assuming salary remains same for next 15 years, won’t you be expanding your family, kids & their education etc etc. So I guess the equation remains same, but the perspective of how you look matters. Mumbai is considered saturated in terms of real-estate, but even now you can buy a decent house (after so many years of saturation). I know because my brother recently bought an apartment in Mumbai.


To be continued …

What is Indemnity?

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I am a big fan of Outlook Money, b’coz they explain most of the things in simple terms. If you ever took an insurance you might have came across a word “indemnity”. Most of the us either ignore it or say “What the damn is Indemnity?” and chances are that even your insurance agent is not aware of the meaning.

Outlook Money, explains it in simple words, here is how :

  • This applies to non-life insurance policies
  • Say, you bought a car insurance. The car costs you Rs 5.5 Lakhs
  • The insurance policy will say that it will cover loss due to damages or theft.
  • Does that mean that you will get Rs 5.5 Lakhs if the car is stolen at some later date (say after 3 years)

If this would be true, every car owner would be buying a car and either making sure the car gets stolen :) or damage it themselves. Here comes indemnity rule to save the insurance company. What this concept says that

“Compensation paid by insurance company will never be greater than the value of the loss at that time

Essentially it makes sure that whoever insured the car will never get monetary benefit out of it. Hence the  insurance company is only liable to pay for the value of the car at the time of loss (post depreciation and wear/tear). Interesting !!

Home Loan Trauma, Some Tips

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If you had taken a home loan in recent time, you would be an extremely worried person. With rising interest rates, you would be cursing your bank, the Reserve Bank of India, government, even Israel for raising oil prices and what not. Cursing never solves a problem, but a pragmatic rethinking will surely help. Typically when home loans are taken the household budgets are anyway streched to the hilt, so even a small increase will be felt very sharply. Instead of grunting about the root-causes of such a massive increase recently, it would really help if you worry about what your next step should be.

Facts: Interest rates are up and so is inflation. Your home loans outgo is same (without any reduction in the burden) and you also end-up paying more for the daily household items. But your salary is same.

Effects: Your incoming money is same, but your outgoing is increasing, including reduction in your investments. (an 8% return on your fixed deposit, now is earning negative since inflation is going to be around 9%)

What to do? Here are some easy steps for pondering over and including as your action items:

1) Think of those FDs or post-office investments lying around earning negatively, so why not unlock them and pre-pay your home loans. Make sure you recalculate your emergency funds and if there is an excess, use that for prepaying the loan.

2) Think about that huge amount of jwellery your wife accumulated over the period of time, it would make sense to partially liquidate it and use that to reduce your loan burden. This will give you some breather in your cash-flows with reduced home loan outgoings.

3) Re-estimate your insurance needs, if you are under-insured, seriously think of buying term-insurance to cover any unfortunate occurances. If you are over-insured, you can think of reducing few of those unnecessary policies which is eating up your expenses without much value addition.

4) Dont be a miser, but if you are into the habit of going for weekend parties or weekeend travels stop it for just few months. It doesn't cost much for each single party or travels or movies, but colelctively it can offset your increase in home loans.

5) Start a recurring desosit for next 3-4 months and whatever amount is accumulated, use that to prepay your loans.

6) Take out all of your credit-cards including the one your spouse has, keep it inside a locker. If you dont have easy access to credit card, you won't spend. This can help reduce your outgoing on those monthly credit card bills, which never seem to go away. Once you are out of this crunch you can take them out again.

7) Redution of car loans should be given more priority than home loans or education loans. You dont get any tax benefit on car loans and you are not building any asset.