Time is money, and patience sure pays

DNA Money reader Ramesh should build up a corpus before taking the plunge into property

Arvind A Rao

Ramesh (24) has just finished his MBA and joined a multi-national company. Since his teens, he has observed his father struggle to buy their own house and something or the invariably come in the way.

This has made Ramesh resolve, the first thing he would acquire once he starts earning would be his own house.

Though Ramesh is clear on his goal, he is not sure how he would be able to achieve the same. He wants a plan that can help him realise his dream.

Financial goal
Ramesh’s only goal is to buy a house, at a current value of around Rs 22.5 lakh, by the end of next year (2008).

Current income

He is currently employed at a cost-to-company of Rs 4.25 lakh per annum as per the following structure:
Salary components Amount (Rs)
Basic 2,12,500
HRA 85,000
Telephone reimbursements 6,000
Special allowances 96,000
Employer’s contribution to PF 25,500
Total 4,25,000

Ramesh is currently paying a rent of Rs 6,000 p.m. to his parents and claiming the same for his tax benefits.

Current investments
As Ramesh has just started his career, he doesn’t have much investment, except the money invested in his name by his parents.

Financial diagnosis & remedies

Achieving financial goal
In view of his current investments and current salary, it is difficult for Ramesh to achieve his goal within next year. Ramesh is faced with a two-pronged problem.

He definitely has the option to borrow the funds required for the house next year, but typically, financial institutions lend only 75-80% of the total cost of the house.

So, he has to arrange for the balance portion of the funds required for the house.

Secondly, even if he is able to arrange the funds through some of his informal borrowings, repayment of the loan would result in a glaring mismatch between his cash outflows and inflows.

Ramesh would do well to defer his decision to purchase the house for three years (March 2010).

At a projected growth rate of 10% p.a. in the real estate sector, his dream home would then cost him Rs 30 lakh.

His yearly savings (as per his cash flows) would have to be diverted into a mix of debt funds, balanced funds and a small portion of diversified equity funds, with more weight to debt and balanced funds.

On a conservative basis, these investments would help him earn a modest return of 12% p.a.

It is not advisable to invest most of his funds into the equity sector, although he is young and has a big risk appetite, for the simple reason that his goal is due within the next 3 years and its characteristic prevents his capability to take more risk.

At the end of 3 years, his projected yearly savings would fetch him around Rs 7 lakh. His current investments, maturing at the end of 3 years, would add another Rs 3 lakh.

He can go for the house with own funds of Rs 10 lakh and borrowings of Rs 20 lakh.
Managing risk

Ramesh is currently covered for medical treatment cost up to Rs 1,00,000 under his employer’s medical scheme. He does not have any family health history problem and is thus adequately insured.

As his parents are not dependent on him in financial terms, he does not need much life cover. However, to take advantage of cheaper insurance at a lower age, it is recommended that he opt for a life cover of Rs 5,00,000 for a term of 20 years with an indicative premium of Rs 2,500 p.a.

At the end of 3 years, when he opts for a housing loan, the insurance cover will have to be increased to cover his loan liability. Accordingly, the increased premiums have been factored in his cash flows.

Tax planning
Ramesh currently contributes around Rs 25,500 towards his provident fund, which qualifies for tax deduction under section 80C. The insurance premiums recommended above would also help with the same. 

Additionally, it is recommended that he invest only the balance amount (after accounting for provident fund contributions and insurance premiums) to add up to Rs 75,000 towards his tax planning (through 2007 to financial year 2010), in view of the fact that the tax-saving instruments has a lock-in period of 3 years.

If most of his savings are locked in such instruments, it could hamper his ability to make funds available for his goal.

The proposed housing loan would also enable him to enjoy the tax benefits associated with the same.

Accordingly, nothing from his savings would be diverted towards tax savings instruments (from financial year 2010-11 onwards), as the housing loan repayments would help him counter the same.

Managing cash flows

Ramesh’s personal expenses total Rs 58,800 per year. His current post-tax salary income is sufficient to meet his personal expenses, rental payments, PF contribution and still save for his goals.

Ramesh expects his salary to rise by at least 12% year-on-year. His personal expenses have been projected to increase at the rate of inflation (6%) yearly.

On purchase of the house, the payments towards his house rent would end.
The proposed housing loan would entail a repayment of Rs 2,40,000 p.a. (For 20 years from April 2010). The cash inflows that year would be sufficient to meet the repayment schedules, too and also provide him with savings to the tune of Rs 1.5 lakh.

Key concern

Ramesh would not be able to invest to exhaust the limit laid under section 80C of the Income Tax Act and would therefore pay additional taxes on his income during the three years. The additional tax outgo for these years is the price paid for fulfillment of his goal.

Conclusion
Ramesh will certainly not be able to purchase his house within the next year, but as it is said, patience is the plaster for all sores.

If Ramesh has the patience to wait for the next 3 years, his planned cash flows will certainly be able to help him realise his cherished dream. In other words, time is money for Ramesh.

The author is a certified financial planner working as chief planner, Dreamz Infinite Financial Planners. Views expressed are his own and do not necessarily represent those of FPSB India. Feedback may be mailed to myplan@fpsbindia.org.