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Buying versus renting a house: 5 home truths you must consider

Buying the first house is perhaps the biggest decision for a salaried individual. It's also a decision that has to be financially prudent because one wrong step and you might be saddled with a huge debt and an illiquid asset.
Here's what you must consider before deciding to buy a house:
  1. Returns: The return on your investment should decide if you should keep your hard earned money in a bank or invest in a house. Here are some of the tools that can help you.

    i) Price-to-rent ratio: This is a commonly used tool in the US that can be calculated by dividing the cost of the house by the annual rent. If the ratio is below 15, you should buy else rent the house.

    ii) Risk analysis: Property prices rise exponentially because in a developing country like India, prices can be artificially kept high over a long period of time. But, rental income grows at a more realistic rate because they are a true function of demand. Most rent agreements have a clause for 10 per cent annual hike, but property prices generally double every five years in a metro. But, even stock markets might give you a return in excess of 20 per cent. So, do a risk analysis before buying.

    iii) Cost-benefit analysis: Online calculators are available free of charge that will do a cost-benefit analysis, incorporating various tax advantages, and other investment avenues.

  2. Financial strength: Your financial position should be the guiding force behind your decision to buy a house. If you earn Rs 1 lakh per month, you are entitled for a loan of Rs 40-50 lakh for tenure of 20 years. However, your monthly expenditure should be less than your salary minus equated monthly installment (EMI) towards the home loan. That's not all. You will have to shell out 20 per cent of the cost of the house upfront, which for a Rs 50 lakh house is Rs 10 lakh. Ideally, you should set aside four-six months of salary (Rs 4-6 lakh) as contingency fund. Finally, you should have some surplus after you pay the monthly EMI and household expenditure. This surplus will cover your investment needs and any immediate rise in interest rates. Only when you fulfill these minimum conditions, you should buy a house. Else, renting is a good option.

  3. Income stability: Home loans are for long tenures, typically, 20 years or more. Banks do not give home loans without thoroughly checking your employment record. But as a prospective buyer, you should be confident about your job stability, especially if you are in the private sector. Loan agreements generally come with an in-built insurance, which takes care of your outstanding loan in case of death. However, if you leave your job, you can get a reprieve for only three months. Also, before buying a house, you must take into account the salary hike you expect over the next few years because your EMI may rise sharply when rates go up. So, it’s better to rent if you are not sure about your employment prospects.

  4. Economics: It is difficult to predict economic cycles. But, buying when the economy is turning around gives you a buffer of four to five years at the least. So, look out when the job market starts picking up and stock markets are on the rise because equities are a lead indicator of the economy. Also, look at the interest rate cycle closely because that is an uncertain component in your EMI. If you are uncertain about the economy, it is better to live in a rented accommodation.

  5. Ease of disposability: It is difficult to dispose a house quickly because of the large amount of capital employed. So, it is always better to invest in areas with basic infrastructure in place. Good roads, schools, parks, and malls - also ensure appreciation in your property. If your budget can get you a house without adequate infrastructure, it's better to live on rent than be stuck with an illiquid property that is difficult to dispose.

Story first published on: September 20, 2012 07:43 (IST)

Tags: renting vs buying, buying vs renting, home loans, property prices, EMI

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