Investing in real asset

Realty scores over most asset classes. But don’t buy a second house based on the rise in valuation of your first property.

B. Srinivasan | Print Edition: November 16, 2006

They are prepared to discount future earnings today. Any individual with a steady source of income can take a home loan and buy property. What he would save in rent and taxes could go into paying the equated monthly instalment (EMI). Both rent and taxes are actually expenditures which do not create any value addition to an individual’s finances, whereas repayment of home loan creates an asset.

For instance, a two-bedroom apartment rents for between Rs 6,000 and Rs 10,000 a month in any middleclass area of a metro. Principal repayment of up to Rs 1 lakh a year and interest payment of up to Rs 1.5 lakh every year are tax deductible, which roughly translates into a monthly tax savings of Rs 4,000. The monthly savings in rent and tax together take care of about 60% of the EMI for a Rs 20 lakh loan for 20 years. A 25-year-old single person with no other immediate commitment can even go to the extent of putting 75% of his disposable income into servicing a home loan EMI. Assuming the individual has an annual income of Rs 6 lakh, he needs to save Rs 1 lakh under Section 80C and another Rs 1.5 lakh towards interest expenses to claim the maximum tax benefit.

A Rs 20,000-25,000 EMI, along with the mandatory provident fund deduction, ideally provides for both. By the time he marries four or five years later, the additional cash-flow in the form of future salary increments will take care of additional expenses. However, there would be problems if the individual is already in his 40s or 50s and is yet to buy a house. At that phase of a person’s life, other financial goals such as a child’s education and marriage get priority and everything else is put on the backburner.

Also, at this stage one cannot opt for a long-term loan. Housing finance companies and banks want that a loan should conclude before a person retires. So, one will have to go for a shorter tenure and fork out a higher EMI at a time when several important goals demand his attention. Besides, one has to be very choosy about the location where he intends to buy the house. After all, he will settle down in the same house after retirement. It is common for people to purchase a second house even before they finish repaying the loan for the first. Individuals must assess their ability to take another liability and whether they would be able to service another EMI before taking such a step. Many people prefer a long-term loan of 20 years on the premise that the EMI is lower.

But they forget that the major part of the repayment in the initial years goes only towards interest repayment and not the principal. The total interest outgo on long-term loans is very high.

Keep in mind asset allocation, which not only reduces the risk of an individual but it enhances his ability to take additional risk and leverage his finances prudently. As a tangible asset, real estate definitely scores over most other asset classes. But try not to base your decision to buy a second property on the rise in valuation of your first house.

Having said that, I must add that a home loan helps develop a compulsory savings habit. Any other avenue allows investors to either stop investing or withdraw the savings. On the other hand, your home loan EMI forces you to build an asset over the years.

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