If you are planning to buy a house in the next few years with a home loan, here are some tips to maximize benefits. Wanting to live in a place that we call our own is an emotional and instinctive need. There can be no doubt about that. Very few of us would have no issues with “renting forever”. However, careful planning and an all-around perspective is necessary to buy the house or property that we desire. A hurried emotional purchase can come back to bite us years later. If you are servicing a home loan, you can share your experiences in the comment section below.
This post is not about renting vs buying. If you are still debating this, I would recommend the following articles:
I will state one thing though: Considering the rate at which people buy property “as an investment”, renting is an awesome deal if you have no emotional bonding with a property.
Consider this: According to Magicbricks, a 2,200 sqft three bhk Mylapore apartment has a rent of 65,000 rent (incl maintenance) per month. The current cost of a sqft is about 17,800 (avg). This makes the house valued at about 4 crores (min).
Even before tax, this is a rental yield of only ~ 2%. Keeping that 4 crores in a bank will not fetch more, but also fetch it regularly!! Current home loan rates are about 8.5% ish. As a fellow Mylapore resident, I would say, 65K rent for a 2,200 sqft house is a pretty reasonable deal even if the landlord does not furnish a Pan card!
If you are thinking about when to buy a house, you can have a look at this.
When to buy a house: now vs later vs never. Do read the fantastic article by Yamini Sood, VP sales of DSP Blackrock (linked within).
Buying a house: the initial steps
Now, if you have decided that you need to buy a house, here are some initial steps:
- Do not be in a hurry! Buying property is the important decision in your life. Most of will not be able to buy another.
- If you have just started earning, think about this and decide if you want to buy and when you want to buy. It is better if you give yourself at least 5 years time to prepare and invest aggressively towards part payment of the house cost.
- You can take a chance with an equity-oriented balanced fund and aim to pay anywhere between 20-40% of the property cost. The rest you will pay for with a home loan.
- Start investing for the downpayment and then scout for property (give yourself at one year)
- Home loan advertisements are meant to give that “fear of missing out”. Do not fall prey.
Planning a house purchase: additional considerations
Speaking of advertisements, there is a “Rent = EMI” campaign going around. The idea is,
“why to pay rent when you can pay the same amount as EMI and own a house?”
This is flawed reasoning. The rent paid for a house in the centre of the city (or old parts of the city) is not the same as EMI paid to a house in the suburbs. There will a difference in logistics:
- electricity (power cut frequency; restoration)
- Water supply
- Proximity to schools and basic amenity shops
The point is, will the quality of your lifestyle suffer if you start paying EMI instead of rent? This is the key question to answer. This requires time and maturity to do so.
Buy a house before you have children or at least before they start school. After that, uprooting them can cause them issues if you need to shift schools.
Buying second-hand property makes a lot of sense (especially retirement homes, more on that later), but the price should be reasonable. I know a family that purchased a 20-Y flat for almost one crore close to my house. A 20-Y independent house for a few crores, I can understand, but a 20Y flat? I cannot stomach that.
How to choose a home loan for buying a house?
- Try not to get a home loan for more than 70% of the cost of the property.
- Shorter the loan duration, higher the emi, but lower the interest component
- Here is an example: A 30L loan at 8.5% for 10Y has total interest component of ~ 33%. That if you add all the emis paid, 33% of that will go towards interest. If you increase the tenure to 15Y it becomes ~ 44% and if the duration is 20Y it becomes ~ 52%
- The EMI for 10Y loan is ~ Rs. 37,200, 15Y is Rs. 29,542 and 20Y is, Rs. 26,000
- Try to keep the total interest component below 50% of the total amount repaid. This is lower the home loan amount, the better.
- Try to keep the EMI to about 40% of your take-home pay (post Tds and deductions). Plan for 40% expenses, 40% EMI, 15% investments, 5% emergency fund from your take-home pay
- You should still be investing at least a small amount when you are repaying the home loan
What kind of home loan to take? Overdraft (eg. SBI Maxgain) or Normal?
An overdraft loan is one in which the interest charged is not on the principal outstanding (aka drawing power). The interest is charged on:
Principal outstanding – Amount you put in the loan account (available balance).
In a normal home loan, the interest will be on the principal outstanding.
I would recommend that you choose a normal home loan where you have a facility to make part payments at once a year (or more) instead of an overdraft home loan product like SBI Maxgain. Why?
1: Most home loan takers have a tendency to pre-close the loan after about half the tenure. At the very least, they want to do so and be rid of it. A normal home loan is better suited for this.
2: Overdraft loans are a touch more expensive. The rate could be a few basis points higher. I would rather invest separately.
3: Overdraft loans are only for those who get surplus money from time to time and can use the benefits of the product.
While Ashal Jauhari’s videos linked below will help you understand how to use SBI maxgain quiet well, please ask yourself: “Do I really have a surplus?”
If you listed all your short term and long term financial goals and have started investing for them or at least have a plan to do so, any so-called “surplus” amount will go (should go) towards that plan!
If investment and insurance should not be mixed, why should I mix a mortgage with “parking money”?!
Instead of reducing interest burden by having a non-zero available balance, I would prefer to lower the principal directly and either the lower the EMI or lower the duration with a direct part-payment.
‘Who is Ashal Jauhari?’, you ask? Read this to find out: Interview with Ashal Jauhari: Relentless Financial Awareness Activist. He is the owner of FB group Asan Ideas for Wealth.
How to manage the home loan?
It is important to plan this ahead. Keep it simple! Get a normal home loan for not more than 15Y. Set up a separate fund called – prepayment fund. Maybe it could be the same balanced fund you used earlier. After accounting for your goals and investing for them, if you have a surplus, put it in this prepayment fund.Let it grow for a few years. Read more: Why this Kolaveri to pre-pay home loans?!
Once your interest component falls to about 50% or less than the EMI, you can start pre-paying the loan gradually from your fund. In the meanwhile enjoy the so-called tax saving benefits for the interest component of the EMI (principal component also has benefits, but it falls under 80C).
So-called tax saving benefit because it is only an effective reduction in your EMI outgo, not a real tax saving.
Before we head to Ashal Jauhari’s Maxgain videos, note that I am not differing with him with reg overdraft accounts. Such accounts are only meaningful if you have surplus cash to park (he would agree). I am merely asking you to dig deeper and ask, do you really have a surplus? Just as he is asking, Can you really save tax on a home loan? Be sure to this as Ashal talk about when you can save tax on a home loan. (Some tax rules have changed since then wrt second home).
Home loan management Resources
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Re-Assemble: money management basics for young earners
Re-assemble is a series focussing on the basics of money management for young earners.
Step 3: How to buy Term Life Insurance
Step 13: How to start investing in equity?
Step 14: What should be my first mutual fund?
Step 16: How to buy a house with a home loan: Tips to maximize benefits (this post).
Ashal Jauhari’s SBI Max Gain Home Loan videos
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