Rent vs buy house decision explained with an Online calculator

Rent vs buy a house decision is a dilemma that majority face while buying first home. It is one of the tough decisions of life. Why?

Because when common men decide to buy a house, they are actually making a decision to lead a less-abundant lifestyle. Hence, along with money, buying a house also needs a lot of willpower and motivation.

In some cities of India, residential property has become so expensive that some people decide to continue living on a rented apartment. They just cannot afford to buy a decent home. Check home affordability calculator.

While people are living in a rented apartment, they make a decision, to buy their own home. Paying rent is a lot easier than paying an EMI. How? Let’s see this with an example. But before that, let’s use a calculator.

Home Affordability Calculator

Data Input		Remarks
Net Salary (Rs/month)		This value should be the average "MONTHLY SALARY" credited in your bank account in Last 12 months. This is not your CTC. If you are entering a value of Rs.1,00,000 - it means Rs.12,00,000 (=Rs.1,00,000x12) was credited into you salary account in last 12 months
Rent (Rs/month)		Indicate the average monthly rent you are expected to pay in next 12 months
Other Loan EMI (Rs/month)		If you have multiple other loans EMI, kindly enter the cumulative value of all EMI's here.
Asset Size (Rs.)		You must enter here the total value of savings plus investments (cash, FD, mutual funds, stocks, gold, etc.)
Expected Home Loan Interest (%)		If you will avail a home loan, what is the expected interest you will be charged by the bank/lender
Loan Tenure (Years)		What will be the period for which you are expected to take the loan (7,10,15,20 years?)

Purchase Price of Home	Value	Remarks
Your EMI Affordability (Rs.)		This is the maximum value you should pay per month as your home loan EMI
20% Downpayment (Rs.)		This is the minimum downpayment you are expected to pay to avail a home loan. Zero (0) value indicates you've enough asset to buy the property without any loan
Value of Home (Rs.Lakhs)		This is the maximum you can spend to buy a home with your net income (or Asset size)

Note

Rent Vs EMI load

Suppose there is a real estate property in Bangalore. Its present market valuation is suppose Rs.50 lakhs. Let's see how the decision unfolds if one takes a decision to buy or rent this property:

• Rent: If one decides to live in this property on rent, the immediate cost to the tenant will be approx Rs.15,000 per month. This cost will increase after lapse of every 11 months. Read more about where people spend money in India.
• Buy: When home is purchased on home loan (20% downpayment, 80% Loan), it will cost Rs.35,000 per month as EMI (@8.6% for 20 years). Paying EMI is almost 2.33 times that of rent (per month). Moreover, a lump-sum amount of Rs.10 Lakhs would be needed as a downpayment (self-contribution). Read more about buying a first home.

For a middle class person, paying EMI's is a huge burden. Hence, buying a house is not an easy decision to make.

So does it mean that paying rent is wiser than paying EMI and owning a home? Not at all. To get more clarity, we will've to develop a perspective on the alternative approach.

What is the alternative approach?

The alternative approach will be to stay on rent, and save the extra cost.

Example: For a newly married couple, the cost difference of 2.33 times is too high. They would rather save those differential Rs.20,000 and downpayment, by staying on rented house, to lead a more lavish lifestyle.

This proves why majority people delay the purchase of their first home. But the question remains, is this the solution to our problem? What is the problem? Buying a house for self.

No this is not a right solution. Why? Because the property prices are increasing at a fast rate. "If we'll not buy them today, tomorrow it will become even more unaffordable".

I'm sure you must have heard this cliche from people around you. But in this article, we will also see the maths behind this saying.

Why the alternative approach is not wise?

The point is, the cost difference between rent and EMI will always be there. It is not that after few years, EMI vs Rent ratio will come below 2.33. In fact, it is more likely that the EMI vs Rent ratio will increase with time.

In cities like Mumbai, New Delhi (NCR), Bangalore, Hyderabad, Pune, Chennai etc this ratio has only increased. The property within the city is becoming more and more costlier. The affordable properties get pushed on the suburbs.

This phenomenon is more predominant in above cities. But a subdued version of the same thing can be seen in Tier-II cities of India as well. Hence, it becomes essential for people to know how to maintain a balance between their lifestyle and buying a house.

Why people buy a house eventually?

Why eventually everyone starts living in a self-owned property over a rented house. There must be some reason why people eventually buy their own house.

The EMI payments that is looking costly now, how it becomes a viable option when years pass by? One big reason is, with time people become wiser and also gather more control on their spending’s.

Yes, buying a home for self, over a rented apartment, is a wiser choice. You may say that before even starting this article, we have already reached the conclusion. Sorry, but this is a fact.

No matter whatever a financial calculators say, buying a house for self EARLY, is the best financial decision one can take in their life. But still, let's try to play with some numbers and logic to substantiate this claim.

• Psychological Reason: Paying rent sucks. Rent payments are more like a burden and a self-inflicted pain. When these people meet their friends and relative who own their own home, the demon of living in a rented house becomes even bigger. In childhood, we've lived in OUR HOME. Then, there was no landlord. But here, there is a landlord who often acts as the boss. With time, this emotion becomes so severe that some people impulsively buy a home. Emotionally there is a huge pride associated with living in a self-owned house. Read more about how to build assets.
• Feeling of ownership: Once the rent is paid, it is like money spent forever. What it gives us back in return? One month of shelter. Paying EMI has a dual benefit. It gives us one month shelter, plus is also increases our proportional ownership in the hose. Consider EMI as a rent which eventually (say after 20 years), makes you the owner of the property. Read about preparation required for home loan application.
• Financial Reason: This is where the whole mathematics portion of Rent Vs Buy house decision will be explained. I'll try to use examples to make the conclusion more logical. Let's read more...

Financial Calculation Behind Rent Vs Buy House Decision

Let’s consider a hypothetical example of two friends, Jacob and James. Both are 30 years of age. Let’s assume that both Jacob and James lives in a rented house. Both of them pay a rent of Rs.15,000 per month. The house in which they live has a market price of Rs.50 Lakhs.

Jacob decided to buy a similar house in which he is living. He took a loan of Rs.40 Lakhs, @8.6% p.a., for 20 years. While James decided to continue living on rent. His approach was to save the cost of loan, and invest the saved amount.

The decisions of Jacob and James has been explained in the below flow chart:

Though this flow chart is self explanatory, but I'll still like to take a moment and explain the logic and numbers.

You can also use the online calculator prepared in Google Sheets here.

1. Explanation of James's Decision (Staying on Rent)

What is the decision of James? He has decided to continue living on rent, and save the extra cost incurred in buying a home. What is the extra cost of home purchase? EMI's and Downpayment. Let's see how the decision of James shapes up.

• Lump sum Investment: The downpayment for the house is Rs.10 Lakhs. As James has decided to stay on rent, he can invest this amount in say an index fund which can pay 12% p.a. returns. Why only 12%? Because it is better to keep this money safer for future use. Read more about how to invest 10 lakhs in lump sum.
• Monthly Investment (SIP): The cost saved in paying rent (vs EMI), is also used for investment through SIP route. As James has decided to stay on rent, he can invest the differential amount (EMI minus Rent) in say a large cap mutual fund which can pay 14% p.a. returns. Read more about mutual funds SIP's. [Note: Rent increases with time. Hence savings also reduces accordingly.]

Let's see the above theory as calculations in an excel sheet. The idea is to show how much money can be made by James by deciding to stay on rent.

P.Note: What I've considered here is an exceptional case. Why I say so? Because I'm assuming that James is judiciously investing each and every penny saved (from not buying a house) for 20 years at a stretch.

Practically speaking, people are not generally as disciplined. Hence, the chances of building a Rs.2.26 Crore corpus by James in 20 years is remote. As per my assumption, the actual value will be much lower.

2. Explanation of Jacob's Decision (Buy a Home)

What is the decision of Jacob? He has decided to buy a house for self, and move out of the rented house. By doing this, he has bought a property for self. The value of this property will also appreciate with time. Moreover, as home loan has been taken, it will also save him some income tax. Let's see how the decision of Jacob shapes up.

• Property Price Appreciation: The market value of house at the time of purchase was Rs.50 lakhs. By the end of the loan tenure (20 years), I've assumed that the property price will appreciate at an average rate of 10% p.a. It means, a house which is priced at Rs.50 lakhs today, will be worth Rs.3.36 Crores after 20 years. Read more on How much salary can buy homes in top Indian cities.
• Income tax Savings: As per Indian tax laws, the interest portion of home loan can be claimed as deductions (max of Rs.2.0 Lakhs). Assuming that Jacob is currently in 20% tax bracket & will remain here for next 4 years. After fourth year, his tax bracket will be 30%. In this case, his total tax savings in 20 years will be Rs.9.5 Lakhs. Read more about effective income tax paid on salary.

Let's see the above theory as calculations in an excel sheet. The idea is to show how much Jacob can save on Income Tax (due to home loan), and what'll be his property worth after 20 years.

P.Note: There is a difference between how wealth has been created by James and Jacob. To build Rs.2.26 Crore, James has to be extremely disciplined and committed towards his investment.

But for Jacob, as soon as he bought the property, the wealth building goes on an autopilot. Income tax Savings, and property price appreciation will happen anyways.

Why to buy a home?

People who defend staying on a rented apartment are all filthy rich people. For a common man, the wisest decision will be to buy a home for self as early as possible. Here are four reasons why one must buy a home (and stop living on rent):

1. Home is an asset: From the above calculations, you can see that Jacob has build more wealth than James. How? By simply buying a home for self. How one can build wealth? By owning an asset. Jacob has decided to own an asset in the form of a home. Read more on how to build assets.
2. Forced Savings: Arranging for downpayment is one of the biggest hurdle in buying a home. Hence, a person who has decided to buy a home, will save more to arrange for the downpayment. I've seen people using innovative ideas to arrange for the downpayment amount. Read more on tips & tricks to save money.
3. Learn Affordability Analysis: We often overspend our money because we do not seem to understand what is affordable for us and what is not. Buying a home early in life, can teach one this skill. How? Buying house is a good thing. But it must not happen that one ends up buying a very expensive house. How to know one’s affordability? Suppose Jacob's salary is Rs.1.5 Lakhs per month. If he pays an EMI of Rs.35K per month, he is utilising only 23.5% towards EMI. As a rule of thumb, if can keep the EMI/Income ratio below 30%, it is considered great. Read more about what is a debt trap.
4. Future Savings: Buying a home triggers another set of money saving avenue. What is it? Savings in the form of prepayment of ones home loan. Buying a property, and prepaying one loan (say 5 years early) can save one lakhs of Rupees. Read more about loan prepayment.

I personally consider that, buying home is not just a monetary activity. The whole process of buying, and maintaining the house makes us a fuller person.

If my child ask me for one financial advice, I'll tell him to buy his first home in early 25, and then finish-off the loan by the time he is 35 years of age.

Conclusion

Rent vs buy a house is a debate which is continuing since ages. But not buying a house today, is like not delaying your gratifications for living a more abundant life. This is not a wise choice.

Move out of rented house to your own house as soon as possible. Yes of course, there are conditions where people cannot buy house immediately. Those are one-off cases.

There are people who do not have job security. Such people cannot afford to commit to a home loan. Also, people who work in a city they don’t like. Such people may not like to buy home immediately.

There are also people, who buy home for self only after their retirement. This is a wilful decision, not taken in ignorance. Such people get huge retirement benefits which they can divert to buy a house for self. One such example is, high ranking people retiring from Indian Defense Services. These are examples which is not applicable to majority.

Not buying a house today, and staying on rent is an individual’s choice. But if there are no big bottlenecks, it is always better to buy a house for self than to live in a rented apartment.