What percentage of monthly income should my home loan EMI be?

How high can my home loan EMI be? What percentage of my gross monthly income can I afford to set aside for servicing my home loan EMI? These are questions that I have often seen in personal finance forums. When I recently saw it at Facebook group Asan Ideas for Wealth, I thought of discussing the issues with deciding a “comfortable EMI” amount.

The house/apartment decides the EMI!

Simple is it not! We can think long and hard, search for thumb rules for a comfortable EMI. All that would get thrown out of the window when we actually decide on the property that we wish to buy. The property decides the EMI. The “comfortable EMI” rarely decides the property!

That comfortable EMI figure = 4o% of monthly income can easily get stretched to 45% or even 50% of monthly income if the ‘right’ property comes along.

Property purchase almost always affects investments

This is what I tell myself: If I ever want to buy a property to live in, the EMI would be 30% of my post-tax monthly income. God willing, only 30% would be my monthly expenses, 30% would be my investments with a 10% buffer.

Unless I buy property in the middle of nowhere, I cannot get my EMI to be 30% of my post-tax income. The typical EMI is anywhere between 40-55% of post-tax income. With expenses amounting to 40-45% for most people, there is little to invest. For many, at least initially, the only invest they make is the mandatory EPF contribution!

Renting is better than choosing a small house just to keep the EMI down. So the only way in which the EMI will not affect investments for long-term goal is to postpone buying the house until one ‘settles’ down in a career and until the family is complete. This way, the income would have hopefully increased.

However, the EMI would increase pretty much at the same pace too! In today’s corporate world, no one ‘settles’ down! There is no job security.

Buying early vs. buying late

Many advice to buy asap, clear the loan asap and then focus on investments! Both strategies – buying early or late – have disadvantages.

Buying early – pros

Chance to get a good property ‘cheap’
Can live debt free sooner
Comfort of owning roof
Sense of accomplishment
Done duty as provider
Better to service liability when young and employable

Buying early – cons

EMI would be too high for comfort
Not be able to invest enough: retirement planning is the first casualty
House would be too old at retirement for reverse mortgage
Complications if we need to relocate
Early retirement not possible if income does not increase substantially

Buying late- pros

Clarity on where we would retire
EMI likely to be manageable and hence loan can be serviced longer
Reasonable net worth if invested right and clarity on financial goal planning.
The property will not be too old at retirement. Reverse mortgage an option, even if not necessary.

Buying late-cons

Not being able to buy the ‘right’ property
Taking on liability in middle age
Early retirement not possible if investments are affected.

Choosing between buying early and buying late is not so easy! Buying early make sense for those who are well paid, well qualified and employable regardless of economic conditions. Buying late makes sense for those who need to hone their skill sets with experience, so that they would be paid better.

One argues that the future is uncertain and therefore, it is best to buy early. From what I see, paying heed to an uncertainty wrt property ownership, results in an uncertainty wrt retirement planning.

Only a substantial income growth, combined with prudent investing with expenses at bay can bail out those who buy a home early.

Answering, What percentage of my gross monthly income can I afford to set aside for servicing my home loan EMI?, is not easy.

One must understand the impact of a high EMI on our long-term financial goals. This cannot be done with thumb rules.

Some questions to answer:

If I take on an EMI of X, will I be able to reach my financial goals? Can I make up for investing less now, later when my salary increases? You can use theintegrated financial planning template to understand ‘where you stand’.

If you are already running a home loan EMI, use the Calculator: Prepay Home Loan or Invest? to understand if you should close out your home loan asap or let it run.

End note: It is said that delaying a purchase often provides a better perspective. This is true in my case. With time, the desire to own property has diminished and the desire to grow liquid net worth has grown. So I would recommend not rushing into the decision and understand the impact of a home loan EMI on long-term financial goals.

What do you think?

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