I was talking to my friend Vinod Kamble today. Vinod and his wife Amrita (hereinafter called 'Kambles') recently signed on the mortgage deal to buy a house in Mumbai.
Vinod works in a multinational with an monthly salary of about one Lakhs on hand. Amrita works in an IT company at a monthly salary of Rs.50000 on hand.
This is a house in the newly developing area near Mumbai. The cost of the house is about 1.5 Crores. The Kambles have taken a twenty year loan of about a Crore from a bank on which they pay an EMI of about a lakh per month.
I asked Vinod how they are managing to pay such high EMIs.
'My monthly salary goes directly to the Bank', he replied, 'we manage our monthly expenses through Amrita's salary'.
'What about savings? Any?', I queried
'No savings. We hardly are able to manage the monthly expenses', he replied.
'Why buy a costly house? Were there no better offers?', I asked.
'There was some available at a cheaper rate little farther away, but we wanted to live in this locality', he responded.
'Have you taken possession of the house?'. I enquired
'No, currently I am living in a rented apartment in the same complex. We will get possession next year', came the reply
'How much are you paying as rent?', I asked
'Rs.25000 per month', he responded.
I did some math. Kambles are paying about 1.5 Crores for an apartment from which he can expect a rental income of about 3 Lakhs per year. That is a measly return of 2% per year. If they stay in a rented apartment and invest amount of 1.5 Crores in an FD paying about 9% (6.5% post tax), still he will be getting a post tax return of about 4.5% after paying rent on his house.
Assume that Kambles want to have an investment that will pay their rent, at the above rate, they need to invest a principal amount of 47 Lakhs in an FD at 9% interest to get an annual income of 3 Lakhs which will pay off their house rent. It is still one third of the investment required to buy a house.
In addition they will have a surplus income of almost 10 Lakhs in a year which they can invest in Wealth building investments. Rs.10 Lakhs a year at an interest of 10% will grow to about 1.75 Crores in 10 years.
If you show the math to Vinod, he will tell me that the value of the house will appreciate in future and hence it is an investment worth making. But for people like Vinod, this is his home. He is buying this house to live there. This house is not an investment which he plans to sell off at a later point in time. Since he is planning to live here and is not planning to sell the house, any appreciation in value of the property is going to be only notional profit.
But, does he see how this purchase is impacting his long term future? Currently he is left with no surplus investment income. Kambles have no savings. They are not planning for the long term. They don't even have sufficient contingency funds. How will they manage 10 years down the line when they have kids and expenses shoot up?
So what is better? Is it better for Kambles to buy a house in a less expensive locality? Is it better for them to stay in a rented apartment and invest the surplus income in wealth growing investment opportunities? Anyway you look at it, staying in a rented apartment is better. You also get tax benefits if you stay in a rented apartment.
Considering that a home purchase can wreck havoc with the finances, why in the world should Kambles buy a house in Mumbai?