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 decides to buy house, they are actually taking a decision to lead a less-abundant lifestyle. Hence, along with money, buying a house also needs a lot of willpower and motivation
While people are living on a rented apartment, they take 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.
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):
- 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.
- 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.
- 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.
- 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.
From a pure investment vs the ROI perspective, you forgot that the EMI is the investment that have gone for 20years something (loan tenure). You missed that by the time you, end up the loan tenure, you have paid 2 times the original loan amount. Moreover, the amount invested in SIP/Mutual funds is pure returns, however, all investments (including home loans) need active watch for ups and downs to make a shift (sellout and buy more depending on market conditions).
I feel assets are those which make money for you. What’s the point of value of the house if you don’t Cash it.
My pov is if you are staying in the house that’s on a loan is a liability vs an asset.
Thoughts?
Buying a house on loan and staying with EMI’s for 20 years is not advisable. Prepayment of loan must be considers. The idea should be to at least reduce the tenure by 5 years. Till the loan balance is zero, a house is not an asset.
I feel that this article is biased, not used practical numbers and real life scenarios.
Owning house great for anyone but the downsides such as high EMI’s should not bother ones life and needs.
EMIs should not be greater than 40-50% of ones monthly salary, if any excess could burden the middle class family.
I truly believe that having a house is an essential part of attaining financial independence. I’ve left my job at 40. Had I been still living on a rented property (or paying EMI’s), life post achievement of this milestone would not have been as seamless.
Hi the way you have expressed the article is really great. Super easy to understand. But i would like to address few points here.
1. The rate of price appreciation you have assumed is quite high i believe. It should have been 7-8 percent.
2. Also the property value at the end is on paper. I mean when you are going to sell the property, first of all there is a high chance that you are not going to get that price mentioned on paper (reason explained below). There would be other costs involved like costs of advertisement, brokerages etc.
3. Generally people sell their investment when they are in the need of money. So in case of mutual funds, it takes one click and the money gets transferred within 2-3 days. But in case of selling the property when you are really in need, it’s really difficult to get the price quoted on paper.
4. If you live in a different city you have visit the place where you have the property. This costs time and money.
5. Taxes are on higher side. As when you sell the property, it will be treated as your income and taxes would be as per income tax slab. While in MF, taxes would be lower.
So my friend, buy buying the house early you are not only reducing your effective income, you are also adding a burden because of its liquidity.
Having said that, i am not saying we should not buy a home. What i am trying to say is buying a home for investment is not a great idea.
Thanks for expressing your views.
The article is heavily biased towards buying. Points to ponder
1. We speak of capital appreciation. If i am buying a house and i am going to live in it is capital appreciation a point to consider? Like a equity stock i am not going to sell it as i live in it so the figure of 3cr odd is pointless
2. What about opportunity cost of downpayment? Also assumption is house cose of 50lakh. A house in even outskirt of mumbai like thane of navi mumbai cost nothing less that 1.3cr
3. What about costs of maintainence, and other repair costs time to time
4. What about unforseen events like some1 loses a job atleast i am hedged againts a long term emi burden.
5. Y not stay on rent and invest that additional saving which would have gone into emi to invest in a mutual fund. Just because we have lived all our life as a kid in a own house doesnt mean it makes sense now. Also the narrative on landlords being bossy etc is little too melodramatic. I have lived under multiple landlords and all have been amicable as long as rents are paid on time and property is taken care off.
Its like fools build homes for smart people to live in it. Happy to have a discussion on this.
I hope you will walk the talk (..”stay on rent and invest that additional saving which would have gone into emi to invest in a mutual fund…”). In long term this strategy will build good wealth. But there are several if’s and but’s in this strategy (practically).
I wish you good luck.
Hi Mani after 20 years the apartment will become like booth bungalow.
🙂 If so then the owner has the luxury of selling the property.
Hi,
Buying a house with your own money (not loans) is the best thing to do.However in todays world its not practical and hence people take loans.
The second best thing would be to save enough over a period of time so that we can close out the loans early there by saving interest.
Regards,
Mahesh.
the
Suppose I take a loan amount 25 lakhs for twenty years. After twenty years I will pay principal plus interest =50lakhs. Is it possible after 20 years that property value will refund me 50 lakhs? It is easy to spend a rental life. And if anybody invest little amount to gold, then gold will fulfill all dream.
If the person invests judiciously for life, probably living on rent may look be profitable. But I personally do not agree that buying a home is less convenient.
I have read this article very carefully.And after that I realized that buying a home is one kind of invest and above all a security for living.But on the other hand there is a question that is EMI. Actually it is said that what amount will you take the same will repay to bank as interest.So,if you have no roof then you have to invest but if you have home and you living another state for your job then it is wrong idea.You can invest your money for gold. you can easily sell this gold,and gold will give you better refund than land.
Your idea has weight. But reconsider “gold” as an investment option.
Thanks for your deep comment.
Everyone wants to buy a house but you need crores to buy a good flat in a decent locality in Mumbai therefore I feel renting is wiser and it has become very difficult to sell flats today.
I want to elaborate, I didn’t mean to say that you missed the point. You make many good points in your article, I just wanted to add a few more on why renting may be a better option. Good stuff tho!
I think you completely miss the point on how much of a financial burden this creates on an individual. Rather, you can acquire multiple assets at various levels of risks and could possibly meet the same net worth. By renting, you are so much more financially free, where you can enjoy the luxuries around you and be happy. I know people who have taken loans and are super depressed because, 80% of their income goes towards paying a loan for the next 20 to 30 years (provided their salary hikes, but the net effect of inflation would probably match the ratio anyways, due to floating rate loans).
By Renting a house, you also have the freedom and power to change your house at any time, whereas by buying the house with a loan, you might not be able to quickly find a tenant and, if found you would typically always get an amount lower than your EMI and plus have to shell out more money on renting another place. By renting you are also able to control all the legal risks associated with the property.
There is also the question about liquidity. It is not easy to sell many properties. The higher the market value of your property, the more difficult it is for you to sell. I know many people who put up their properties for sale, but the sale ends up happening after 2 to 3 years. If it does happen within a year, then great! and typically the amount realized would be lower than the market value.
There are many more reasons, but according to me people should only buy a property loan-free, or their EMI’s are not more than 20- 30% of their incomes.
You are right, buying a home which does not compliment income will create a financial burden.
Nicely presented – most of things in this article are covered, but i like to mention some missing things in calculation part such as monthly society maintenance charges & yearly corporation tax which landlord have to bear. Also the fact that most of metro cities property prices are not growing @ 10% p.a. or you can that this type of growth in Affordable housing sector 50-60 lacs & not in mid size segment where property prices are beyond 1 Cr
You are right, maintenance and property tax charges are additional for the owners.
I think, property price growth @10% in long term is not a bad guess. You are right, prices may not be growing now, but as the Indian economy evolves, the price will catch up. This is an estimate for ‘very long term horizon’.
But leaving aside the mathematics, I hope you would not like to miss the bigger point of “the necessity to buy a house for self – as early in life as possible”.
If some age is touching 50 and EMI is around 50 percent of monthly income than should he go for buy. Secondly initially buy it and during possession or after some time say 5 user sell it and enjoy the difference. Please advise.
Hi Mani, thanks for the article but the numbers are far from reality. Firstly let’s talk about metro cities, a decent 2 BHK house today cost 1cr which entails down payment of 20 lakh and EMI of ~75k-80k, now what do you expect a person in early 25 year old to earn, max 1.5- 1.75lakh per month, so first of all from where he will bring 20 lakh down and how he will afford 80k EMI
You are right, this is one of the big disadvantage of living in a city like Mumbai. But the point that this blog is trying to make is that, ‘buying a home for self early in life is better than living on rent’. Why? Because the price of houses will probably rise faster than our income.
The matter of affordability is a separate issue. If one cannot afford buying a house for self in their city – as there it is too expensive, then I think following can be done:
– Buying a rental property in other city (affordable) can be a good compromise.
– Buying a rental property in the same city but of smaller size.
– Buying a house for self on the outskirts of city (with decent connectivity to work etc).
I’m sure theorists can put forth many such ideas. These ideas may work for some, and may not for others. Keep thinking of your own new ideas and you’ll surely come out with something.
HI thats a good read. I have one query.
I have just done the math and found out that, if I borrow loan of say ₹33Lakh at an interest rate of 8.85%, for 20 years, the EMI I have to pay is ₹29,373. which means after 20 years I would have had paid ₹7049520 to the bank despite the loan amount of ₹33Lakh. So here I paid more than double the loan amount. So I am feeling skeptical about borrowing a loan. I also learned that the whole home loan banking works on this very system. So If people took a loan for 20 years they are paying twice the amount, how this is profitable.
Also If I reduced my loan tenure to half i.e., 10 years still the total amount comes to around ₹49Lakh which is still far more than what i had borrowed.
Please can you throw some light on my question and explain your thoughts. Thanking you in anticipation 🙂
Buying house is a necessity of life. One can delay it today to buy it tomorrow at a higher cost. Now the question is that, is it worth a delay? Try to answer the following questions for self, and I think you will see the point. For me, buying house as early in life is beneficial (financially):
– What is the cost of loan for next 20 years? 8.85%.
– What is the assumed growth rate for next 20 years? 6-10% (say).
– What is the expected growth rate of price of a residential property? 8-12%.
What does these numbers? If a house is not bought today, it will be prove more expensive tomorrow.
Good article, I see a fundamental flaw in the calculation, Assuming both Jacob and James are equally intelligent, James would invest the initial down payment amount and the remaining amount after paying rent in an oridinary mf with 10 percent returns, he is better off after 20 years.
Thanks for your deep comment. I can understand your point. I’ve reinvented the whole article based on your comment. I hope now the conclusion has more clarity.
Hi,
Its great to go through the article. But I have a little different view. If James put the down payment in the index fund and do a SIP in the same for the amount he saves instead of paying EMI, he will have more wealth than Jacob. Because the return of index in long term is 14% and it will continue to give the same in long term. Secondly the rents will not go beyond certain limits as you are projecting 8% YOY. For the last 6 years I am paying the same rent and no increase. So I feel this assumption is not correct. It may increase and may be doubled over this period of 20 years. Request your views on the same.
Your are right, but picking investments based only on returns is not always correct. A real estate investor (or a home buyer) thinks differently than an equity investor.
Regarding same rent for last 6 years, I must say you are very lucky 🙂
How a real estate investor different from equity investor?
Good question. The concept of investment is same, the only difference is in the asset. Equity as an asset needs to handled differently than a real estate property. Though the concept of intrinsic valuation can be applied to both.
Hi..what is your opinion on someone buying a smaller apartment and renting it out while staying in a bigger apartment on rent for convenience?
If goal is income generation, buy a property and put it on rent.
If goal is protection, buy a home for self.
Alternative, do your math. The option which is yielding better returns should be preferred.
Yield:
– Income Generation – (Annual Rent / Investment).
– Protection – (Rent Saved / Cost of Home).
Hi ,Its very helpful info you have provided in this article.
Thank you so much.
Thanks for your comment. The please is all mine.