Your dream house is only a ‘half-step’ away

Recently, while discussing financial planning with one of our clients, my boss advised him to take a half-step towards buying a home.

I was aware of the perpetual debate between rent and buy, but this half-step towards buying a home was something new to me.

I became more inquisitive and started digging for details. Here is what I came to know, which is worth sharing with you.

As a new home aspirant, our client had saved around Rs7 lakh and his income was around Rs50,000 per month.

The real estate prices had shot up over the last few months and were still rising. Moreover, home loan rates also increased by 100 to 200 basis points (1-2%) making it more difficult for people who are looking to buy home as EMI will rise to Rs965 per lakh at 10% per annum for a 20-year loan, from Rs836 per lakh for 8% interest rate.

The pace at which real estate prices have moved up, coupled with the increasing loan rates, had made it really difficult for those who wish to have a house of their own.

The client wanted to buy a flat in Mumbai at the cost of around Rs60 lakh. His home loan eligibility at his given income was around Rs25 lakh.

The maximum loan amount being 80% of the property value, he could take property worth Rs31 lakh only, where he would need to pay around Rs6 lakh as down payment.

He could take the loan for the remaining amount. But getting a property worth Rs30 lakh was not possible in the area he wished to stay.

However, for that amount he could get a decent flat in the suburbs and rent it out.

My boss suggested that he buy a ready possession property in the suburb. He could rightly rent out the property at say Rs7,500 per month.

The EMI on the loan taken would be around Rs24,000 at the interest rate of 10% per annum and tenure of 20 years.

Thus his net cash outflow for this property would be (Rs24,000 (EMI)-Rs7,500 (rent)) which would be around Rs16,500.

At present, he is renting a flat in the main city for Rs12,000 per month. Thus, the total outflow would be somewhere around (Rs12,000+Rs16,500) equal to Rs28,500. Thus he will have an available cash balance of Rs21,500 that can be used to take care of his monthly expenses.

After a period of three years, assuming an annualised return on real estate returns to be 10%, the price of the said flat will be around Rs40 lakh. As he had taken a loan of Rs25 lakh, over a period of three years, he would have already paid Rs1,37,500 towards the principal repayment.

So the outstanding loan amount after three years would be around (Rs25,00,000 (loan amount)-Rs1,37,500 (EMI paid)) amounting to Rs23,62,500. If he plans to sell the flat, then he will have surplus of (Rs40,00,000 (the present price of the flat)-Rs23,62,500 (outstanding loan)) which is equal to Rs16,37,500 after paying back the bank loan.

Here, we assume that in these three years his income would have increased considerably. He can use this surplus amount towards the down payment of the new home. With an amount of Rs16 lakh he can now afford to buy a home worth Rs80 lakh where he can pay Rs16 lakh towards down payment and take a home loan of the remaining amount that is `64 lakh if his income justifies it now. Since he will be married by then, he can also choose to take a combined loan with his spouse at that time to increase his loan eligibility.

The total investment in case of this property was around Rs6 lakh initially, when the property was bought, for which Rs16,500 per month was paid as EMI. As mentioned above, at the end of three years, the client will receive Rs16,37,500 fetching an annualised return of 14.2%.

But, the question which immediately crossed my mind was what if the property prices move downward?

Considering that property prices decline by 7% per annum over the three years, then the price of the flat will come down to Rs24.8 lakh from 30 lakh. The loan outstanding amount will remain the same at Rs23,62,500. In case, he plans to sell the property now and repay the outstanding loan, he will be left with only Rs1,17,500 with which he can hardly buy anything, forget another house in a place of his choice. So if you are planning to take this half step towards home buying, better think of the other half as well.

But if you have already done this, then you can continue staying on rent or else shift to your own flat in the suburbs for sometime. Once the prices are back, you can choose to sell it off and buy another flat in the locality you always wanted to stay.

This move has its tax benefits too. A client like ours can hugely benefit from this step from tax point of view as all the gains from real estate would be exempted under LTCG (long-term capital gains) and it is being reinvested again in real estate.

Also, during the time the property is on rent, he can take the benefit of the principal repayment under Section 80C and interest repayment under Section 24.

This will decrease his investment into tax savings products under Section 80C, thus not worrying him too much on the tax savings part.

He can also claim the benefit of HRA under the IT Act.
This way I came to the conclusion that our client will always stand to gain in case the prices move upwards, but he should be aware of the risk of such a strategy when the prices move downwards.

The writer is head-research, Apnapaisa.com, a price & features comparison engine for loans, insurance & investments. He can be reached at abhishek.singh @apnapaisa.com