Home Loan vs Investment in India

The average price of a 1BHK (1 bedroom hall kitchen) house in Mumbai is approx ₹70 lakhs to ₹1 crore. The further you go towards Mumbai city (towards Colaba), the price keeps on increasing upto average ₹3-5 crore. On the other hand, a graduate/post graduate with around 3-5 years of experience (in late 20s) earns around ₹30k to ₹80k a month. Hence, this question, should you buy a home loan or invest in this city of India. My Home Loan vs SIP comparison.

“Is it possible for a middle class person to buy a house in Mumbai with their own salary?” My friend asked. I think this is a very important question from finance point of view. However, 99.99% of individuals who say a “Yes” to this question comes up with only one solution – Get a home loan.

Really? How can a person who earns a mere ₹30,000 monthly buy a house worth ₹70 lakh. I’m not trying to demotivate anyone who think he can. However, 1) I’d like to give a broader perspective on why the prices are so high even when people are not able to afford it, 2) Is it really an investment, 3) Comparison of home loan vs investment options in India and 4) Alternative solutions to this problem.

My view on why the prices have inflated so much

Now, let’s suppose you’re a hard-working engineer at a multi-national company. You have a few years of experience, and earn about 7 lakhs annually. However, you are not from Mumbai. If you’d like to stay here and buy a house then the only house you can afford within Mumbai’s city limits is – a 1RK. I’m dead serious. If you are from Mumbai, I’m 100% sure you’re able to relate to this and validate this claim.

A 1RK in Andheri will cost you about ₹40-50 lakhs (I’m 100% sure I’m quoting a less price here). If you’re lucky, it’ll have an attached bathroom. With ₹7 lakhs per annum, you can afford to pay its EMIs for 25 years.

The alternative solution to this would be to go outside city limits, like Vasai-Virar or Ambernath-Panvel. Where you can get a 1 BHK for that amount. But are you prepared to commute long distances to your work place, by changing 2 trains and spending a few hours?

Though I’m a not a pure Mumbaikar, I stay with my parents in a Mumbai Suburb, who bought this property about 25 years ago. Today with my salary, I can’t even purchase a house in the building where I stay ! And its an ordinary middle-class building, not some Hiranandani or Lodha-style complex. So now, you will have a question, why the prices are so high and who buys it?

Real reason why the prices are so high

All this has been wrought upon by the nexus of politicians and builders, who’ve pumped black money and inflated land prices in and around Mumbai. There is one more party who is to be blamed for high prices which is mentioned below. In the absence of a government regulator, land prices and their funding mechanisms are unchecked, resulting in unaffordable prices for middle-class people.

We’re facing a similar problem which USA faced before the 2008 crises. If you’re someone who don’t know the real reason for the 2007-08 recession then you should definitely read it once as it was the most latest recession the world witnessed.

In short, the real reason for 2007-08 recession was people assumed the prices of houses/real estate will always increase with time. The theory that land is a limited resource and the population only increases which means the price of land will go up proved to be wrong when people started defaulting on home loan EMI and the banks were forced to do foreclosures which led to increase in supply of houses when nobody had money.

Bottom line is that, in my opinion the prices of real estate will not increase the way it did in last 20 years. The reason is salaries and income have not gone up in proportion to the way home prices have gone up. The minimum wage paid to labor in the year 2000 was ₹4000 and now it’s around ₹8000/10000 or less. The minimum salaries, tax bracket have also only doubled but the housing prices have increased significantly which cannot happen for longer period.

Is buying a home loan EMI really an investment?

Let’s do a simple calculation

Let’s assume there were 2 friends Rocky and Jacky. Rocky did a graduation in finance hence he had little knowledge about stocks and mutual funds hence decided to put his money there for investments. Jacky was an engineer and wanted a smooth life hence bought a home via EMI.

Jacky bought a house for ₹40 Lakhs with other charges his total cost came to ₹43 Lakhs. He made ₹10 lakhs as down payment and for remaining ₹33 Lakhs he availed bank loan at 9.5% interest. For which he pays an EMI of ₹29691 for 20 years.

Assumed cost of the house = ₹ 40,00,000
Stamp duty and registration fees( assumed 7% on Average) = ₹ 2,80,000
Bank processing fee and MOD etc.., assumed at 0.5% = ₹ 20,000
Total Cost =₹ 43,00,000
Down payment = ₹ 10,00,000
Loan taken = ₹ 33,00,000
Home Loan EMI = ₹ 29,691
Average Home Price Inflation = 9.5%
Total Interest paid = ₹ 38,25,830
Total Cost of home = ₹ 81,25,830
Market value of house after 20 years (assuming 7% returns as per past record) = ₹ 1,54,78,737

Now let’s look at how Rocky’s investments have been:
House rent per month (Assumed the cost of the house to be 25 times the annual rent paid.) = ₹ 13,500
Interest-free advance to homeowner (5 Months’ rent) = ₹ 67,500
Initial investment of ₹10,00,000 excluding rental advance towards mutual fund = ₹ 9,32,500
Average mutual fund return = 15%
Monthly SIP = ₹ 16,191
Corpus generated after 20 years = ₹ 3,81,51,359

Other important points worth noting

  • House is not going to give now return more than 7%. This is because on peak already. Only if you purchase a land in a fast developing area then you can expect a higher rate.
  • I’m not counting rent as an income as you’re living in the house.
  • Government of India is trying everything possible to increase the GDP hence the consumption of Indians will grow. To enjoy the benefit of this growing economy, you can invest in mutual fund and fetch 12–20% return.
  • You will not have any liquidity issue as you can sell Mutual Fund Unit in shorter term whenever you have any requirement like son/daughter’s study expense.
  • Home will go in bad shape in 20–25 years till the time you actually own the house. I’m not considering the amount you’ll spend on renovation and repair.
  • If you are working you will have flexibility to change area, city or even country.
  • In case of bad time, you won’t have pressure of paying loan EMI consistently for 25 years.
  • Jobs are not stable the way it used to be in the past. Your father may have worked for the same company for 20 years but look at how people are changing jobs.
  • Last and important point worth noting. A person who pays home loan EMI hardly gets any moving for saving. This is because a large chunk of their salary is debited for the loan EMI. Which means they are putting all their eggs in one basket. However, you have flexibility to choose different types of Funds such as government bond funds which gives guaranteed returns. Even if there is a recession, 20 year is more than enough to recover easily.

However if you are not very ambitious (not looking to start own business, think different to uplift the standard of living) or does not want to take risk and you have surety to give loan back even if you don’t have a job. Then you can go with the loan option. However, only to those specific locations which are being developed faster.

Conclusion

People were able to afford buying houses or properties easily 15-20 years ago through salaries or business incomes and by keeping extra cash at home. For example. If the monthly salary of an engineer in the year 2005 was ₹20,000 (₹2,40,000 annually). They could easily save for 4-5 years and buy the house on cash. Because the prices at that time were well within the reach of a common-man. Since the demand for property was high and so the prices increased drastically. It’s not the case anymore. You have to go through the home loan route now because you can’t carry so much cash at home. Also the way we’re spending nowadays because of Amazon and Flipkart doesn’t make it possible either.

The mindset of Indian consumers have always been to save more and spend less. However, this mindset of Indians are shifting with their lifestyle more like the westerners (USA) where the consumption/expenses are higher and low savings. Even a person earning ₹15,000 monthly salary will have a mobile phone worth ₹30,000 and an Amazon Prime or Hotstar subscription.

The impact of social media has been huge, especially on the way we’re spending on vacation trips and showing-off. It was not the same case in the past. Think about it! This impact is more on younger generation who think saving is boring

The India economy is following somewhat similar to the trends USA did in 1990s. Hence, my analysis concludes that the price of property will increase at a much slower rate in next 20 years as compared to last 20 years.

Investing in Mutual Fund would be the best idea to take part in this high consuming new society of India. Because when the companies make more profit, the shareholders’ make more profit. Hence the share price increases and so the Mutual Fund gains.

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