The decision to buy a house is one of the most important and impactful financial decisions of a person’s life. Important because it signifies putting down roots and visualizing a concrete (pun intended) future for yourself. And impactful because financially, it requires you to set aside a big chunk of your money, creating an asset that isn’t as liquid as say a mutual fund or a fixed deposit. The latter is what often begs the question – Does it really make sense to buy a house, or are we better off renting?
The first thing to understand is that the answer to this question isn’t as simple as it seems. It is layered, and depends on various factors. Factors that are both monetary as well as non-monetary. Consider this post a guide to help you with your own rent versus buy decision.
Looking at it from the monetary perspective
For the short to medium term, renting is definitely the better option. Let’s take a closer look at why.
When you rent a house, the expense that you incur is the monthly rent you pay as reduced by the tax benefit you get in the form of a House Rent Allowance exemption (a common allowance provided by employers to employees). The other outflow is a one-time zero-interest refundable deposit which can be as low as 1-2 months’ rent in cities like Delhi and Hyderabad, and as high as 10 months’ rent in cities like Bangalore. And because you’re renting, the amount that you would otherwise have put in for the down payment to buy a house is being invested elsewhere, fetching you a return.
On the other hand, when you buy a house, the expenses that you incur are the cost of the property, the interest cost (considering you take a home loan), property taxes and money spent on the upkeep of the house. You also get a tax benefit on both the principal and interest components of the home loan.
Now, to compare renting with buying in purely monetary terms, we would need to calculate the net benefit in both cases. After entering the data what one will notice is that over a period of say 15 to 20 years, renting works out to be the more financially viable option. Take a look at this sheet for detailed calculations. (Courtesy investor and entrepreneur, Ankur Warikoo).
That dream of owning a home doesn’t look so rosy now, does it? But don’t take those spectacles off just yet, because this net benefit calculation is not the only factor to consider. Let’s dive into the other, lesser talked-about factors in the rent versus buy decision.
Net Worth
Buying a house should neither wipe out all your financial assets nor give rise to liabilities that you cannot afford to pay off. In other words, the house you own should form a part of your total net worth, and not your entire net worth. It also should not increase your liabilities to such an extent that all your income goes towards servicing the home loan. No more than a third of your income should be directed to the EMI.
But when to buy?
Ideally, you should consider buying a house only when you have built your wealth up to 50% or more of the value of the property. This is in case of home loans, of course. If you wouldn’t want to be tied down by a loan, ensure you build your wealth up to over 150% of the value of the property.
No matter what stage of life you’re at, liquidity is important. It gives you the freedom to pursue your goals without having to worry about your finances.
Life and Career Goals
Speaking of goals, flexibility is essential in the early years of our careers. This is the time we are figuring out the best route for us and what we envision for ourselves. At this stage, buying a house can take a back-seat.
Based on your career choice, you may want to explore opportunities beyond your city, state, or country. If this is the case, owning a house at this point in time wouldn’t be logical. It would simply be a drain on your finances.
There is no right or wrong age as to when you should buy a house, but I’d say it’s that sweet spot between being content with where you’re at, and having a sense of where you want to be for the better part of your life. For some, this sweet spot can come early on, for others, much later.
As we get older, most of us would like to be in a position to not have to move around too much. Uncertainty isn’t novel anymore, and stability takes center stage, which is when owning a home makes more sense.
Psychological Satisfaction
Picture yourself moving houses every few years. Initially it can be exciting. But after a certain point in time, setting up home over and over again can leave you craving for something more permanent. Right from having the freedom to renovate your home as you please, to knowing that you are not at the mercy of a landlord, to simply feeling a greater sense of peace. The psychological satisfaction of owning a house cannot be valued in monetary terms. And in the long term, this is the biggest benefit of owning your own home.
As well-known financial advisor, Dave Ramsey, says of home ownership, “Do it right, so that your home becomes your safe haven and not a point of stress on your finances, your marriage or your belly.”
Real Estate as an Investment
Many of us might also have considered putting in our money into real estate purely for investment purposes. Apart from the stress of maintaining more houses, what we tend to overlook is a concept known as “rental yield”. Rental yield is the amount of rent earned in comparison to the cost of the property. Let’s say you buy a property worth ₹60 lakhs and give it on rent. You may earn a rent of ₹15,000 per month. This means the annual rent is ₹1,80,000. So the annual yield is (1.8 lakh/60 lakhs) 3%.
In India, 3% is considered good. The average yield is anywhere between 1-3%. In addition to this, there is capital appreciation, which is basically the rise in property prices. This varies across the country and can be anywhere between 4-6%. This capital appreciation though, is notional until we sell the property. Put together, the return on real estate isn’t at par with other investment avenues.
Recent statistics show that the ratio between buying real estate for own-use versus buying real estate purely as an investment is 74:26 post-COVID. During the pre-COVID period, this ratio was 59:41. As a financial coach, these numbers make me happy. Real estate has never topped our list of investment avenues. It is only when one buys or builds a house for residential purposes that pouring money into real estate makes sense. And of course, after considering all the factors above.
P.S: – In 1977, the film Gharonda explored the reality of builders cheating home buyers, running away with their money. With the Real Estate (Regulation & Development) Act coming into force in 2016, real estate transactions have become more transparent than ever before. Having said that, it’s always wise to do your due diligence when zeroing in on any property.
