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economictimes.indiatimes.com

Ten questions to ask before you buy

a house
By Babar Zaidi
19-24 minutes

No loans to repay, modest aspirations and not a very ambitious

retirement target. For Mumbai-based bank executive Alpesh
Mehta and his schoolteacher wife Deepali, saving for their child’s
education and marriage, as well as their own retirement, will be a
breeze. But this could change if another goal set by Alpesh
elbows its way into the Mehta’s financial planning. “I have always
wanted to have a house of my own,” he says.

His home buying plans can derail the family’s financial planning
and jeopardise all other goals. In Maximum City, the minimum
price of 800-1,000 sq ft house is Rs 1 crore. They will have to
liquidate all their existing investments (fixed deposits, stocks,
equity funds and even the Provident Fund) to raise about Rs 20
lakh for the downpayment. The balance Rs 80 lakh, if borrowed
at 10% for 20 years, will mean an EMI of Rs 77,200, which is
roughly 60% of their combined monthly income of Rs 1.3 lakh.
Either the Mehtas will have to stop saving for their child’s goals or
their retirement will have to be pushed back.

The Mehtas are not the only ones entering this minefield. Across
the country, a number of people are firming up plans to buy a
new house. The New Home Index of Zyfin Research, an indicator
of home buying plans of 3,000 households across 11 cities, has

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inched up in the past 12 months (see graphic). Though it is still in

pessimistic territory, buyers are less pessimistic now than they
were in May 2014. This trend has been fuelled by optimism about
future income and comfort with the cost of borrowing. “The
decline in pessimism has more to do with increased optimism
about future income and job security than lower borrowing costs,”
says Debopam Chaudhuri, Chief Economist and VP-Research,
ZyFin Research.

Despite the surge in buyer sentiment, real estate is still not a

good investment in most parts of the country. Property price are
still very high and despite the recent interest rate cuts, the cost of
borrowing has not come down significantly. For potential
borrowers like Mehta, a 15 basis point will shave off Rs 800 from
the EMI of a Rs 80 lakh loan for 20 years. Is that a big enough
reason for them to make the largest financial commitment of their
life?

This week’s cover story sounds a note of caution for investors in

real estate. In the following pages, we have raised 10 questions
that a potential buyer needs to answer before he takes the
plunge. Don’t get us wrong. We don’t want to shatter your
dreams to own a house. We just want you to take a reality check.
Your answers will tell whether you are in a position to buy and if
real estate is indeed the best investment option for you. If most of
them are answered in a ‘no’, take a step back and revisit your
plans. You may decide to save more for a bigger down payment,
buy a smaller house, invest in a cheaper city or not buy at all.
Whichever option you choose, rest assured, you will not regret
your decision.
Why buyers are getting serious

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Data from ZyFin Research shows how consumer sentiment has

perked up in recent months

Can you afford the home loan EMI?

It might sound a no-brainer, but many home buyers get this

wrong and bite off more than they can chew. The home loan EMI
should be around 40% of your net household income. But that is
if you don’t have other loans. A high EMI outgo can put your
household budget under pressure.

If the home loan EMI accounts for more than 50% of the net
household income, other goals will have to be downsized or
junked altogether. Banks have their own methods of calculating
your affordability.

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They will also take into account your liabilities before sanctioning
a loan. Don’t be fooled into thinking that the recent cut in home
loan rates have made property a viable investment. It will have a
marginal impact on the total EMI. A 25 basis point cut will reduce
the EMI of a Rs 50 lakh loan for 20 years by Rs 826.

If you go for a home loan, make sure you have enough room to
wiggle in case the interest rate cycle takes an unexpected turn. If
home loan rates go up, your EMI will not rise, but the lender will
extend the tenure. But if the tenure extends beyond your
retirement, the lender will have no choice but to increase the
EMI. If your income does not support the increased EMI, the
lender might ask you to make a part payment to reduce the EMI
to fit your budget.

So, make sure you don’t take a loan that stretches your finances
to their limits. It’s easy to get ambitious and go for a bigger loan if
you are expecting generous increments in the coming years.
Don’t make the cardinal mistake of leveraging on future income.
This year was good for increments and indications are that 2016
will bring more good news.

But not all sectors and companies will dish out fat increments.
According to a survey of 602 companies across India by the
Kolkata-based Genius Consultants, 48% companies say that
increments next year will be between 10-15% while 11% believe
they will be around 15-20%.

But 29% also expect increments to be between 5-10% while

another 10% believe they will be less than 5%. So, not everyone
will see a big rise in income. Also, while your income would
certainly rise, but so would your expenses and financial
commitments.

A good chunk of the increment is nullified by inflation and

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increased consumption. As your children grow, their education

costs and other expenses also rise. Your own lifestyle changes,
which means the entire increment may not be available for
paying the home loan EMI.

Have you factored in the other costs?

Like many other products, a house also has ancillary costs that
need to be paid for. The price advertised in the media is usually
the base price of the property. The add-ons are usually kept
hidden till you sit down with your cheque book. Many builders will
slip in charges for facilities that you thought were free with the
property.

Others will keep certain charges hidden from the buyer by

tucking them away in the fine print. Some charges, like the
preferential location surcharge or the gym membership fee, are
kosher, but others are not. There have been cases where
builders have been dragged to court for charging extra for
parking.

These apart, there are other big-ticket add-ons such as the legal
costs. The stamp duty and registration charges payable to the
authorities add up a neat 7-8% to the overall price of the
property. In all, these charges can combinedly push up the
property price by 20-25% (see table). Make sure you have
factored in these additional costs.

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Have you done a thorough rent versus buy analysis?

The old saying that “fools build houses and wise men live in
them” has been proved incorrect several times in the past. But
the high property prices across cities mean that renting is
certainly a better option now (see graphic). Let us look at a
hypothetical family planning to buy a house in Mumbai. A 2-BHK
house will cost them close to Rs 1.2 crore.

If they put in Rs 40 lakh as downpayment and take a loan of Rs

80 lakh, the EMI for 20 years comes to about Rs 76,500. They
also lose around Rs 23,500 in interest that the Rs 40 lakh
downpayment could have potentially earned. Their total cost per
month comes to Rs 1 lakh while they can easily get a similar
house on rent in Mumbai for about Rs 40,000-45,000 a month.
Don’t go by hypothetical examples.

Instead, do an empirical analysis to know whether you should

buy a house or live on rent. There are many rent-or-buy
calculators available online, but we particularly like the one
developed by Bigdecisions. com. It’s a sophisticated online tool
that takes into account several things, including the cost of the
house, the amount of downpayment, the rate of interest of the
home loan, the expected appreciation in the house price, the rent
payable for a similar accommodation in the area and even the
expected hike in the rent every year.

It may be argued that a house is an asset and any appreciation in

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its capital value adds to your wealth. That’s true, but prices in
Mumbai have either stagnated or risen marginally by 2-3% in the
past one year. However, the real estate market is very localised
and the situation may be different in other cities.

TAKE A TEST DRIVE

Planning to buy a house but feeling unsure? Before you take the
plunge, just calculate the home loan EMI you will have to pay
every month. If you take a loan of Rs 50 lakh at 10% for 20
years, the EMI works out to Rs 48,250. Now start putting away
that amount in a short-term debt fund or recurring deposit.

In 10-12 months you will figure out whether you can really afford
the EMI. If you find it difficult to put away that amount every
month, imagine your situation if you had actually bought the
house.

On the other hand, if you don’t feel the pinch and all other goals
have also been taken care of, go ahead and buy. In 12 months,
you would have saved around Rs 6 lakh, which means a bigger
downpayment. There are some fringe benefits as well: if you are
putting away a big chunk into savings every month, it will prevent
you from wasteful expenditure.

This strategy won’t work where asset prices are going up rapidly.
If your chosen project becomes costlier by 10% by the time you
decide to buy, you will have to pay more than you gain. But going

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by the current trend of prices, this is a remote possibility.

Will the value of the property rise faster than the interest on
loan?

In the early 2000s, when home loans were available at 6-7% and
property prices were galloping at 20-25%, it made eminent sense
to invest in an upcoming apartment project. You could book two
properties and sell one of them after a few years for a profit big
enough to repay the entire loan taken for the first property. Those
days are now history. Property prices are now appreciating at a
slower pace. In some markets, such as Noida and Greater Noida
in the National Capital Region, prices have even come down in
the past 12-18 months.

If you are buying property as an investment with a loan, first

assess whether its price will appreciate at a rate higher than what
you are paying on the loan. “If you are payings 10% on the loan
and the property price is expected to appreciate by 5-6%, then it
is a bad buy,” says Manish Shah, Co-founder and Chief
Executive of Bigdecisions.com. Shah says the expected rate of
appreciation is the single biggest determinant in their rent-or-buy
calculator. “It makes the biggest difference in the decisions,” he
says.

Now that there are signs of an economic revival, will property

prices start moving up? The Ficci-Knight Frank Real Estate
Sentiment Index offers some pointers. The index tracks the
expectations of stakeholders in the real estate sector, including
real estate developers, private equity funds, banks and nonbank
financial companies (NBFCs). The sentiment for residential price
appreciation has weakened in recent months (see graphic). In
September 2014, 68% of the respondents felt that residential
prices will move up, but now only 33% do so.

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Though fewer people expect prices to fall, a large chunk (55%)

believe they will remain the same for the next 6 months. But even
a stagnation in the price is actually a correction in real terms. You
will be paying close to 10% interest on a loan to buy an asset that
will not increase in value for the next 6-12 months.

Will this purchase force you to postpone other major goals?

Stagnant property prices and high EMIs are not the only
problems that potential home buyers should be wary of. Their
home buying plans can have serious implications on other
financial goals, such as saving for their children’s education and
marriage and their retirement.

If the home loan EMI is too big, it will push other goals out of the
financial plan. Worse, buyers might have to liquidate existing
investments to raise money for the downpayment.

Though parents are unlikely to surrender child insurance plans

and education related investments, many other goals are easily
sacrificed. Retirement planning is the most common victim.
“Younger people tend to think that retirement is an old age
problem and defer the investment,” says Shah of
Bigdecisions.com.

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It is easy for investors to raid their retirement savings to fund their

real estate dreams. You can take loans from the Provident Fund
for building or buying a house. Till recently, the NPS was an
airtight investment that could be accessed only at 60.

But even that can now be withdrawn for certain their real estate
dreams. You can take loans from the Provident Fund for building
or buying a house. Till recently, the NPS was an airtight
investment that could be accessed only at 60. But even that can
now be withdrawn for certain

Do you have a contingency fund?

Real estate is not a liquid investment. You can’t sell it at short

notice, nor break it up into parts. Invest in it only if you do not
need that money at short notice. This also means one must have
an emergency fund to take care of 3-6 months’ expenses. If you
plan to use your emergency funds to pay the downpayment, you
could be making a big mistake. A financial emergency can put
you in a terrible spot, with the home loan EMI exacerbating the
problem.

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To be fair, property can be used to raise loans in such

emergencies. Several banks are offering home equity loans, top-
up loans and ovedraft facility which can unlock the value of
property. But this is possible only if the property does not already
have an outstanding loan against it. If you have just taken a
home loan, there may not be enough room for a topup loan
against the property.

The only possible loan is if the house has been given out on rent.
Then you can take a loan against the rent receivable from the
property. But such loans come with strings attached: the loan
amount will be only 55-85% of the receivable rent for the residual
lease cover. If the lease is ending soon, the bank won’t offer a big
amount.

When you buy a house, make sure you have enough

investments in near-cash instruments that can be quickly
accessed in an emergency. Also, don’t touch this emergency
fund even if you find it difficult pay the home loan EMI.
Will you live there for 10-15 years?
We live in a society that assigns great importance to physical
assets. Owning a home is seen as a sign of achievement and
stability. However, buying a house too early in your career can
hamper your prospects.

You tie yourself down to a location at a time when job

opportunities are mushrooming across the country and even
overseas. The prohousing lobby will argue that you can always
move to another locatio n and live in a rented house.

But that will also mean paying an EMI as well as rent. Can your
pocket afford this double burden? The burden can be eased if
you rent out your house when you relocate. But finding a reliable
tenant and maintaining the property can be a pain. The hassles

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only get bigger if you are based in another city.

Selling off the house is not an easy solution. Property is not very
liquid and finding a buyer at the right price can take weeks, even
months. Plus, there are very high entry costs in the form of
registration and transfer charges.

Buy only if you are sure that you will live in the city for the next
10-15 years. There is also a lot of parental pressure on young
investors to buy a home early in life. Parents can’t really be
blamed. Their perception is based on their experience of how
property prices have gained in the past 20-30 years.

However, now things are very different. Property prices will

certainly appreciate but not at the rate at which they galloped in
the 1990s or even till the last decade. Also, the appreciation will
not be uniform across locations.

Will you be able to earn decent rent from your house?

Many investors in property are looking for two streams of income:

capital gains from the rise in its value and rental income from the
property. But don’t get carried away when you calculate the
potential rental income from your property. Many investors think
that the future rental income will be enough to pay their EMIs.
However, the rental yields (the annual rent received from the
property as a percentage of the value) are very low in Indian
cities.

Don’t expect a rental yield of more than 3-4%. This means a

property worth Rs 50 lakh will fetch a rent of about Rs 1.5-2 lakh
a year (Rs 12,500-16,666 a month). In some overheated pockets,
where property prices have shot up but supply is higher than
demand, the rental yield can be as low as 1-2%.

This will turn worse in future as more houses, which are still in

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various stages of construction, enter the rental market. This is

already the case in some markets where rents have not shot up
due to an oversupply of vacant houses. Also, there are lots of
unsold houses lying with builders (see graphic).

Nevertheless, the rental income provides some relief to the

investor. Even if the property price is not going up too fast, at
least he has a steady source of income.

What if your income stops?

We have covered this aspect earlier but this is different from a

short-term contingency plan. The Job Security index of ZyFin
Research has steadily climbed in the past 12 months. But have
you factored in the possibility of something untoward happening
to you? Is your family prepared for the worst?

Apart from covering their basic needs and future expenses, you
must also take an insurance cover equal to cover all outstanding
loans, esepcially the big-ticket home loan for the property. Avoid
insurance covers that are linked to the home loan and
progressively come down as you repay the loan.

They might appear cheaper but a simple term plan that covers
your life for a fixed amount is best for this purpose. A term cover

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of Rs 80 lakh for a 40-year-old male for 20 years will cost him

roughly Rs 15,000 a year. That’s a small price to pay for peace of
mind.

Will the builder deliver in time so that you don’t lose tax
benefits?

Delayed projects are no longer news. According to PropEquity,

the average delay in the Mumbai Metropolitan Region is 25
months. In the worst hit Delhi NCR region, it is 33 months.
Delays can be particularly debilitating if the buyer had expected
EMIs to replace the monthly rent payment. If the project gets
delayed, they have to fork out money for both. Even those who
buy property purely as an investment are hit. They are paying
EMIs but there is no sign of rental income.

The worst thing about delayed projects is that you could lose the
tax benefits offered on home loans if you don’t get possession
within a stipulated period. Home buyers get a deduction of up to
Rs 1.5 lakh a year for the principal repayment (under Sec 80C)
and a further deduction of up to Rs 2 lakh a year for the interest

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paid on the loan (under Section 24). However, to get the

deduction under Sec 24, the buyer must get possession of the
property within three years of taking the loan. If the 3-year
deadline is not met, the deduction benefit reduces from Rs 2 lakh
to only Rs 30,000 a year.

Imagine the plight of a buyer who has taken a Rs 50 lakh home

loan and hopes to reduce his taxable income by Rs 2 lakh. If the
project is delayed and he misses the deadline, it would translate
into a tax loss of Rs 10.9 lakh over a 20-year period.

Our advice to buyers: Buy from builders who have a good

reputation and are likely to deliver within the promised deadline.
Even then, factor in a 10-12 month delay into your planning when
you book a house.

FIVE TRICKS PLAYED BY BUILDERS

PAY ONLY 20% NOW: The builder offers to pay your EMIs for
the remaining 80%. Actually he makes you take a loan on his
behalf at 10%.

PRICES GOING UP: An old trick, this is used to make you sign
up in a panic. Prices may come down further as debtridden

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builders begin to sell.

ASSURED RENTALS: Builder pays rent to you till the project is

ready. Actually, he is paying you 12% interest on the money you
gave him.

SAMPLE FLATS: Sample flats look very big and spacious but
that’s because the walls are thinner and the furniture used is
smaller.

FREEBIES WITH FLAT: A free AC or a modular kitchen is worth

only Rs 30,000-50,000. Don’t let that influence you to invest Rs
60-70 lakh in the flat.

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