Rent vs buy a house decision is a dilemma that majority face while buying first home.
There is no denying of the fact that it is one of the tough decisions of life.
When people decide to buy house, they are actually taking a decision to lead a less-abundant lifestyle.
Buying a house of course needs money, but before money, it needs a strong willpower and motivation.
While people are living on a rented apartment, they take a decision, to buy their own home. Paying rent is a lot easier than paying an EMI. How?
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Let’s see this with an example.
Suppose there is a real estate property in Bangalore. Its present market valuation is suppose Rs.40 lakhs.
If one decides to live in this property on rent, it will cost the tenant Rs.15,000 per month.
But when the same property is purchased on home loan (80% Loan – 20% down payment), it will cost the owner Rs.35,000 per month asp EMI.
So you can see, the difference in cost of rent vs buy house is substantial.
Paying EMI is almost 2.34 times that of rent per month.
For a newly married couple (example), this cost difference is too high.
They would rather save those differential Rs.20,000, by staying on rented house, to lead a more lavish lifestyle.
This simple mathematics proves why majority people delay the purchase of their first home.
But the point is this, the cost difference will always be there.
It is not that after few years, EMI vs Rent ratio will come below 2.33.
In fact, it is more likely that the EMI vs Rent ratio will increase with time.
In cities like Mumbai, New Delhi (NCR), Bangalore, Hyderabad, Pune, Chennai, Kolkata etc this ratio has only increased.
The property within the city is becoming more and more costlier. The affordable properties get pushed on the suburbs.
This phenomenon is more predominant in above cities. But a subdued version of the same thing can be seen in Tier-II cities of India as well.
Hence, it becomes essential for people to know how to maintain a balance between their lifestyle and buying a house.
To maintain this balance, it is essential that people must be aware of some facts.
These facts in turn will help the person to time their purchase of first house.
Till now we have understood that, at a given moment of time, living on a rent will always be more cost effective than paying an EMI.
But does it mean that people would continue living on a rented property for all their life?
To understand this, we will have to see the requirement of house from a different perspective.
Lets first establish why eventually everyone starts living in a self-owned property over a rented house.
There must be some reason why people eventually buy their own house.
The EMI payments that is looking costly now, how it becomes a viable option when years pass by?
One big reason is, with time people become wiser and also gather more control on their spending’s.
Yes, buying a home for self, over a rented apartment, is a wiser choice.
You may say that before even starting this article, we have already reached the conclusion.
Sorry, but this is a fact.
No matter whatever a financial calculators say, buying a house for self EARLY, is the best financial decision one can take in their life.
But still, lets try to play with some numbers and logic to substantiate this claim.
#1. Why people buy house in first place
These can be several reasons why people end up buying a house for self occupation. But the biggest and foremost reason is more psychological.
Paying rent sucks. In the first few months when people pay rent, they get a sense of accomplishment of having a shelter above their head.
But with time this sense of accomplishment dies-off.
Rent payment starts becoming more like a burden and a self-imposed, forced need.
When these people meet their friends and relative who own their own home, the demon of RENT becomes even bigger.
In childhood we grownup living in house of our parents. That house we used to call as OUR HOME. There, it was no landlord.
But here, there is a landlord who keep knocking on our doors time and again. Sometimes for rent and sometimes as part of routine visits.
These things keeps reminding us that, this house is not ours.
With time, this emotion becomes so severe that some people impulsively buy a home.
Emotionally there is a huge pride associated with living in a self-owned house.
This feeling is not something that becomes feeble with time.
Your society will keep reminding you that you are an owner of a property. And why not, in today’s world owning a house for self is not a small milestone.
#2. Rent vs EMI
We have discussed that how potential EMI vs Rent ratio (2.34 times) keeps constant or rather increases with time.
It means, buying a house becomes more expensive.
But these is a way one can even reduce the EMI vs rent ratio. This is one big reason why in the battle of rent vs buy house, buy house always wins.
The solution is simple, buy the house.
While the person is not buying the house, EMI vs Rent ratio will either remain as high as 2.34 or will keep increasing.
But the moment one buys a house for self, EMI vs Rent ratio will start reducing.
How? To understand this, let’s consider a hypothetical example of two friends, Jacob and James. Both are 30 years of age.
Let’s assume that both Jacob and James lives in a rented house. Both of them pay a rent of Rs.15,000 per month.
The house in which they live has a market price of Rs.60 Lakhs.
At this moment of time, Jacob decided to buy a similar house in which he is living (Loan of Rs.50 Lakhs @9.5% p.a., 20 years).
While James decided to continue living on rent. We are assuming that after every 11 months, his rent will be hiked at a decent rate of 8%.
Lets see how the cost of Jacob and James change with time.
During the first year itself, James is paying as rent 32.18% of what Jacob is paying as EMI.
By the 7th year, James is paying as rent 51% of what Jacob is paying as EMI.
By the 15th year, James is paying as rent 102% of what Jacob is paying as EMI.
From the 15th to 20th year, James is actually paying more rent than what Jacob is paying in EMI.
But what happens in 20th year is more revealing.
Jacob (50 years old): He finished paying all EMI’s. His house, which whose papers were on mortgage, is not free from bank.
This EMI that Jacob was paying all these years are now available to Jacob as free cash. In this age, Jacob can very well use these extra cash to enjoy his life.
No doubt, for the first 10-12 years, Jacob may be living a life less flamboyant than James.
But in this middle age he will have more security and freedom than James.
James (50 years old): James has lives a carefree life.
He continued to stay on rent thinking that living like this is more economical. But is this assumption right?
James has already paid 80% of what Jacob has paid to own a home, but he still has no house of his own.
He will probably have to dig into his retirement savings to buy a house after retirement.
#3. Paying EMI is cost but it also builds wealth
People hate paying EMI’s. This is a cost, so it is only natural to hate it.
But the cost of not buying a house early is even more dreadful.
Let us see one more benefit of buying a house, even if it is on a loan (EMI).
When one buys a home on loan, 20% is paid from pocket and balance 80% is financed from bank as a home loan.
But till one pays back full 80% plus interest back to the bank, all original papers remain with the bank.
In other words, property remains in hands of the bank.
The borrower (you and me), can live in the property, but technically we are not the owners.
When we become real owners? When 100% loan is paid back to the bank.
The process of loan payment happens gradually.
Every EMI paid, brings the person one step closer to the complete ownership.
And what does owning a residential property means to us?
Apart from the psychological benefits, a property adds to our wealth.
Lets see how the wealth of Jacob has increased over the last 20 years.
Every year, with the ongoing EMI payments, a portion of home is getting paid-off.
The speed in which the loan gets paid, in the same speed the wealth building also takes place.
At a certain point in 2nd year, 2% of loan got paid-off. It means, Jacob is now 2% owner of his residential property.
A point in 5th year, 10% of loan got paid-off. It means, Jacob is now 10% owner of his residential property.
At a certain point in 10th year, 27% of loan got paid-off. It means, Jacob is now 27% owner of his residential property.
By the end of 20th year, 100% of loan got paid-off. Now Jacob is 100% owner of his residential property.
Now the most interesting part. In these 20 years, the value of property doesn’t remain constant.
The value of property increases at least at the rate of inflation. In Indian, property prices in Tier-1 cities grows at an exorbitant pace.
On an average, I have assumed property price in India will grow at 8% per annum.
At this rate, the property which is valued at Rs.50 lakh today will be worth Rs.2.33 crore after 20 years.
Jacob (50 years old): He owns a real estate property which is worth Rs.2.33 crore.
James (50 years old): He does not own any property.
#4. Arranging Down payment
In this debate of rent vs buy house, the biggest hurdle in buying a house for self is arranging for the first 20% down payment.
In these days, income of Indian middle class has increased.
They are able to pay much higher EMI (as portion of their income) compared to middle class of 80’s, 90’s and 2000’s.
But the perennial problem of arranging for the down payment still remains.
This happens because the more middle class is earning, the more they are spending. Very less remains as savings.
Hence, when the moment of arranging for the down payment comes, even well-to-do people find themselves searching for answers.
If one can arrange for funds ok, otherwise there is no other way but to wait for few more years.
During this time people must save and build sufficient corpus to at least pay the 20% down payment.
Till then, the person as no choice buy to say on a rented apartment.
#5. Affordability analysis
Buying house is a good thing. But it must not happen that one ends up buying a very expensive house.
How to know one’s affordability?
This is a very simple calculation. What I am saying here is not even a rule of thumb. It is based on real life experience.
So let’s call it a “Supposition Rule”.
Let’s do some calculations.
Suppose Jacob’s months salary which gets credited in his bank account is say Rs.150,000. Lets call it Jacob’s “salary” for simplification.
As per our supposition rule, a person must pay EMI not more than 45% of his “salary”. This is the upper limit.
Our supposition rule also says that, a person can easily pay EMI which is 30% of his “salary”. This is the lower limit.
So in case of Jacob, whose monthly “salary” is Rs.150,000, he can afford to pay an EMI as follows:
Lower Limit : 30% of 150,000 = Rs.45,000
Upper Limit : 45% of 150,000 = Rs.67,500
If a property is available within these two limits, one can go ahead and buy a house for self.
In this debate of rent vs buy a house, this affordability calculation plays a very important role is wise decision making.
One must always do back calculation. Start with affordability. Then arrange for down payment.
Only after that go for searching a right property.
Generally what we do is the opposite.
#6. When you will be ready for prepayment?
I know, while people are buying their first home, it is terribly difficult to think about prepayment of loan.
But again, this is a wise thing to plan early.
Like it is important to buy a property, it is equally important to start the process of loan prepayment as early as possible.
Why it is necessary to plan early?
Once target should be to take a bank loan from that bank which does not discourages borrowers to make prepayments.
Take example of HDFC, they will allow a borrow to make prepayment only if the prepayment amount is 2 times of the monthly EMI.
While on other hand there are banks like SBI which encourages borrows to make prepayments by providing them with Maxgain accounts.
Private sector banks like Axis Banks accepts prepayment of even Rs.500.
Being selective about banks (who allow easy prepayments) may look slightly overboard to first time home buyers.
But soon after owning your home, you will realise the importance of home loan prepayment.
At that time of realisation, if you are stuck with banks like HDFC, you will have little choice.
There is procedure of loan transfer from one bank to another, but it is not simple.
So better to have loan from such a bank which makes prepayment easier.
Rent vs buy a house is a debate which is continuing since ages.
But not buying a house today, is like not delaying your gratifications for living a more abundant life.
This is not a wise choice.
Move out of rented house to your own house as soon as possible.
Yes of course, there are conditions where people cannot buy house immediately.
Those are one-off cases.
There are people who do not have job security. Such people cannot afford to commit to a home loan.
People who work in a city they don’t like. Such people may not like to buy home immediately.
There are also people, who buy home for self only after their retirement. This is a wilful decision, not taken in ignorance.
Such people get huge retirement benefits which they can divert to buy a house for self.
One such example is, high ranking people retiring from Indian Defense Services.
These are examples which is not applicable to majority.
Not buying a house today, and staying on rent is an individual’s choice.
But if there are no big bottlenecks, it is always better to buy a house for self than to live in a rented apartment.