Photo by thinkpanamaThe following question was asked by Shashaank in the comment section of the post: 8 tax considerations to know before investing in property.
I have around 15 lacks in hand...is buying property with added loan the best decision, i pay around 40k income tax per annum apart from declaring 1 lack under 80c.My age is 25 and i am open to any other kind of investment.
Here’s the reply:
Shashaank,
Yours is a typical case of the classic dilemma (to buy or not to buy a house) faced by every young men with a bank balance of a few lakh rupees. Conventional advice is to buy a home early in life. But as usual I can only offer unconventional wisdom.
From what I can gather from your comment, all you have is Rs 15 lakh and you want to invest the entire savings to buy a house and financing the balance with a home loan. May be you think that property is a great investment (amazing returns without any accompanied risk) or, it might be that you want to avail tax breaks available on the housing loan in addition to saving rent (rent is a waste of money!) or probably the temptation is due to current low rates of interest (teaser rates) available on home loans.
Please don’t make such a mistake. You’re very young and I don’t think you should be in such a hurry to buy a house. Following points needs consideration before you arrive at a decision:
1. Return on property investments: A lot of people remain under the impression that property is a great investment just because land is the only asset with a limited supply on the earth and till we’re able to discover another habitable planet, the land prices can go only in upward direction.
Another related wider misconception is that property investment is lot easier (just approach a property dealer) and safer (no downside risk) than other asset classes like equities and mutual funds.
May be that they have never heard of US housing bubble. Understand that property as an asset class behaves in similar fashion to other asset classes like equities, gold and commodities. Put another way, real-estate market also moves in cycles (boom-and-bust) just like stock markets (what goes up must come down!).
2. Tax breaks on home loans will no more be available in future if DTC (direct tax code) is implemented in its current form.
3. Interest is an additional cost borne by you. Further, there are lots of other indirect costs associated with buying a house e.g., brokerage, loan processing fees, stamp duty and registration, municipal taxes, maintenance charges, repair charges, loan insurance charges and house insurance charges which significantly impact your true cost of ownership of a house.
4. Unlike other asset classes investing in property has long term implications.
5. Real estate is the most illiquid asset. Ask yourself following questions: What if there’s an emergent need for funds in the future? What if there is another recession and a salary cut? Or, what if you face a job crisis in future due to any other reason? What if there’s a significant drop in the real estate prices and the lender invokes “Depreciation of security” clause? What if interest rates rise and there is downturn in property prices at the same time? What if you have to change the city due to transfer or change of job?
6. You’ve not mentioned the value of the house and / or the amount of borrowing you’re planning. But let me tell you that excessive debt is not good. It is considered risky to borrow money to invest in stocks but not in property. Why? Isn’t it a case of financial leverage when we borrow money to invest in property? Don’t we also say that companies with debt on their balance sheets are more risky than the others? The point to note is that excessive leverage is bad irrespective of the purpose.
It is better to finance an asset out of your current savings rather than future income. Do you know the main cause behind US subprime crises? Although banks are ready to finance even up to 80-85% of the property value (in fact, lenders often encourage you to go for the maximum possible loan amount), it is always prudent to restrict your debt exposure to lowest possible level, in any case not more than 40-50% of the value of the asset and 50% of your net monthly savings (your take home pay less your monthly expenses). The purpose is to continue savings and investing to meet other financial goals and also keep a buffer for unexpected expenses & life style inflation.
Furthermore, as almost all banks and hosing finance companies are currently offering teaser loans so one has to also keep a safety margin for the imminent future increase in the EMI. So first understand how much loan you can really afford over a period of 20-30 years? You can calculate your loan affordability (& not eligibility) based on the maximum EMI you can afford to pay (as discussed in the previous paragraph) assuming a rate of interest around 2-3% more than the rate you are currently offered by using Loan affordability calculator.
No doubt, it is the dream nurtured by every young man to own his own house at the earliest. But as the above analysis shows it is better not to make this most important investment decision in a hurry and take adequate safeguards to reduce the likelihood of decision backfiring on you later.
Finally, it’s not about real estate vs. equities. In other words, the point of discussion is not whether investing in real estate is better than equities / other asset classes or vice versa. These are both different asset classes having their own pros & cons. The point is one should first have some investments in other asset classes, then buy a house for living (& not investing) as per your needs (& not wants), and after that even if you got some extra money, you might think of investing in real estate.
So Shashaank, first have some comfortable savings level. Your first priority should be to build a healthy investment portfolio by investing in debt (PF, PPF, NSC, Bonds, NCDs, Debt funds), equity (direct investing / diversified equity funds, index funds, ETFs) and gold based on your financial goals, risk profile and time horizon and then after some years you can go for your dream house. Remember—Buy in haste, repent in leisure.
In a nutshell, buy a right house at the right time and for the right purpose.
Do you agree? Please don’t forget to tell me about your decision.
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