Those of us who tried buying a home in the past 18 months can easily identify with the experience of 32-year-old Rahul Mathur. For this Gurgaon-based senior consultant with recruitment firm Ma Foi, identifying his dream home was more like aiming at a moving target.
Mathur started his search for a three-bedroom flat in Gurgaon in June 2005 with a substantial budget of Rs 25 lakh (Rs 2.5 million). However, during the course of his search in the following months, he would find the property prices going up during every visit to this Delhi suburb. He finally managed to buy a house priced at Rs 32 lakh (Rs 3.2 million) in November 2005 -- Rs 7 lakh (Rs 700,000) more than his budget -- with the help of a 20-year floating rate loan from ICICI Bank.
Of course, there was relief from the success in acquiring what probably would be his life's biggest investment. By stretching himself on home acquisition, Mathur, however, had to make a compromise somewhere else.
"I would have bought a bigger car than the one I eventually bought had the prices not moved up so drastically," says Mathur.
Mathur's predicament is shared by most other home buyers. In the past 18 months, not only have real estate prices soared but home loan interest rates have headed north too, making a substantial impact on affordability of homes. In conditions such as these, should a home buyer go on to make the purchase and stretch his finances or should he postpone his purchase?
Clearly, it is not an easy decision to take, more so if you consider the following risks emanating from rising property prices and home loan rates.
The New Risks
For the sake of convenience one can categorise the new risks according to their sources, that is rising property prices and rising home loan rates.
Risks from rising property prices: On an average, property prices have moved up by 30-50 per cent in the past one year. In some areas, notably Delhi suburbs of Gurgaon, Noida and Faridabad, prices have doubled during the same period. This has exposed the buyers to new risks.
Increased financial vulnerability: This is the one of the major risks that you could face where you, like Mathur, could end up stretching your budget. Home finance companies typically finance 85 per cent of the cost of the property. This means that you will have to arrange for the balance 15 per cent from your resources.
In the backdrop of rising property prices, you run the danger of having to cough up more for the down payment should the prices increase substantially during the period of your home search.
Depending on the state of your finances, you could go through a period of financial difficulty. While Mathur had to compromise only on the car he bought, things could get even more difficult for others. Since you tap liquid funds during your home purchase, stretching your budget might leave you with very little liquidity to address emergencies, especially non-insurable ones.
Cascading effect on associated costs: There are additional costs linked to the cost of the property. Costs such as those for stamp duty payment, registration, builder transfer charges, legal costs and maintenance charges are all linked to the price of the property. For instance, depending on the property's location, stamp duty is 6-10 per cent of the cost.
Last but not the least, when you try to catch up with increasing property prices, you mostly have no option but to take a higher-than-anticipated loan amount. This translates into higher loan-related costs such as administration and processing costs.
Lower Returns: If one of the reasons for buying a home is to have an appreciating asset, you are likely to suffer from less-than-satisfactory appreciation, since you are buying at a high price. What makes the effective cost more is the fact that you are incurring interest costs. In fact, if you compare the current yields from various asset classes such as equity and debt with real estate, you would find the yield from real estate to be the lowest. At times, it may be even less than 1 per cent and post-tax, the figure would go down even further.
Risks from rising home loan rates: The interest rate on housing loan has descended from 13-14 per cent per annum in 2000 to touch a low of 7.5 per cent in 2004. However, there was a reversal in the trend since then and, currently, the home loan rates are quoting at 9-10 per cent.
This week, the RBI has again increased the short-term rates. ICICI Bank was among the first to hike the interest rate on home loans by 50 basis points. Though still below the historical averages, home buyers face a host of risks from this development.
Increasing interest costs: As interest rates are revised upwards by home loan providers, the number of equated monthly instalments (EMIs) and the interest paid out by buyers during the tenure of the home loan increases. Of course, this will be true for home loan products that have rates that are variable, like a floating rate loan, or the ones that have variable element, like hybrid loans that have floating rates for a certain part of the loan tenure. Mumbai-based Ashish Avasthy's experience illustrates the kind of additional burden that can come from home loan rate hikes.
Avasthy, a 30-year-old, who is an assistant manager, legal, at Raymond had been living in a rented apartment at Mumbai's Kandivli-East for one year. After his marriage in 2005, he finally got fed up of shifting his residence every 11 months when his leases expired.
In December 2005, he bought a flat in Wadala that cost him Rs 26 lakh (Rs 2.6 million). He took a 20-year floating loan of Rs 20 lakh (Rs 2 million) at an annual interest rate of 7.25 per cent. The interest rate on this loan has since moved up to 7.75 per cent per annum. While Avasthy's EMI amount has remained the same, the tenure for his loan has already increased to 22 years.
Deadly fine print condition: One of the risks that remain hidden from most home buyers comes from a fine print condition in most home loan agreements. This clause relates to the situation of the property price falling. While many experts rule out this possibility of a real estate price fall in the near future (See below: Bubble Trouble), you will do well to know that many home loan providers have a clause in the loan agreements, whereby they can demand you make good the fall in the value of the property.
"Any remaining balance would have to be borne by the consumer, since he or she is bound by the agreement to repay the debt. Also, if there is a guarantor or a co-applicant, the bank could make them liable," says an SBI official. Thus, more you stretch your finances for acquiring a home, more vulnerable you get to the risk from this clause.
How can buyers cope with the new risks from rising property prices and home loan rates? How does one decide what one can afford? Fortunately, the maze of options and pitfalls of buying a house can be navigated by keeping in mind three factors. We will now explain them in detail.
Strategy # 1: Check the EMI-rent gap
If you are staying in a rented house, figure out how much additional monthly outflow EMIs would entail when compared to your rent. The lesser the difference between your EMI and rent, the more sense it makes to acquire a home. From 2001 onwards, the low EMI-rental differentials were among the major factors that set off the current housing boom.
In the recent past, while property prices have breached the stratosphere, the silver lining is that the rents have not moved up. As a result, the difference between the EMI and rents too has increased. For example, the difference between the EMI outflow and the rents is as high as Rs 65,000-70,000 for some south Delhi properties.
"Such a huge difference between the EMI outflow and the rents is often an indication of a bubble in the market," says Abheek Barua, chief economist, ABN Amro Bank. Till what point is the EMI-rental differential acceptable? Experts say that the ideal difference between the rent and the EMI is not more than 30 per cent.
This is why the decision of Hemant Soreng, 33, a Bangalore-based IT professional, can be termed sensible. While living on rent, he was paying Rs 12,000 per month, while the EMI for the new house he booked in July 2004 and moved into in May 2005, is Rs 16,000. "Since the difference between the rent and the EMI was not much, I decided to buy a house of my own," says Soreng.
However, it is not always possible to conform to such thumb rules, especially when other factors come to the fore.
Avasthy paid Rs 5,250 as rent when he lived at Kandivli-East. For his house in Wadala, he is now paying an EMI of Rs 15,800. "Though the EMI is much higher than the rent, it has helped us improve the quality of our lives and gives us the time and energy to concentrate on our life and careers," justifies Avasthy.
"Staying on rent is an option if you feel that the market is overheated. Otherwise, it may be better to buy at today's prices. The reason being that once in a Bull Run, prices can rise to new highs. Thus, waiting will not solve your housing problem," says Veer Sardesai, a Pune-based financial planner.
Strategy # 2: Keep your EMI within prudential limits
Before you plan to buy a house, you need to know of the loan amount you can afford. Of course, the bank will analyse your repaying capacity. "Generally, the EMIs should be within 50 per cent of the net income of the applicant, subject to an overall limit of 85 per cent of the value of the property," says S.K. Mitter, CEO, LIC Housing Finance.
But financial planning experts suggest that you put a full stop much before that limit. "You should not exceed 30 per cent of your take home salary. In case you have other loan obligations, then your total EMI outflow should definitely not exceed this amount," says Sardesai.
However, there are other financial planners who are of the view that you can stretch the figure up to 40 per cent of your take home salary. Let's illustrate the EMI strategy with the help of an example.
If your take home salary is Rs 35,000, your EMI for the new house should not be more than Rs 10,500-14,000. Financial planners also advise to keep some funds as back up while buying a house. "You should ideally have three months of funds as a backup. This will include your EMI and other expenses," advises Rohit Sarin, partner, Client Associates. This back up helps you to meet contingency expenses.
There is another thumb rule that you need to follow for prudent borrowing. "Your total principal outstanding should not be more than 50 per cent of your assets," says Gaurav Mashruwala, Mumbai-based financial planner.
This means that if you book a property costing Rs 10 lakh (Rs 1 million), take a loan of Rs 7 lakh and you have assets worth Rs 4 lakh (Rs 400,000). You have total assets worth Rs 14 lakh (Rs 1.4 million). Under these circumstances, ideally your total principal outstanding should not be more than Rs 7 lakh.
This is so because in case of any eventuality like loss of job, it would be difficult for you to service the EMIs.You can only ignore the need for prudential borrowing at your own peril. The home buying experience of Kamaljeet Singh, 30, a Delhi-based IT professional will tell you why.
Singh, the only child of his parents, stays with them along with his working wife, who works in Jubilant Organosys. He bought a 324 sq yard plot in Mohali for Rs 37 lakh (Rs 3.7 million) in May 2006, with the help of a 15-year loan for which he pays an EMI of Rs 8,500. His next real estate investment in the same month, a Rs 20 lakh (Rs 2 million) four-bedroom society flat in Mohali, is all set to strain his finances.
If Singh hasn't faced the music so far it is because he has had to pay the deposit money of Rs 5 lakh (Rs 500,000) only. Once the construction starts, he will have to start paying an EMI of around Rs 12,000 on his 15-year loan. This means a total payout of Rs 20,500 on the two EMIs.
At that juncture, one income of either Singh or his wife would go in servicing the two home loans. Of course, Singh has a contingency plan.
"In case any problems arise in repayment of the loan, family's property investments will have to be sold," says Singh. Clearly, this is a case of going overboard. Contrast this with the case of Soreng, who has restricted his EMIs to 25 per cent of take home pay.
Strategy #3: Don't overdraw on your savings for down payment
You will need to organise at least 15 per cent of the cost of the property for down payment. This will give you an idea of how much you can spend on your property. For example, if you are planning to buy a property worth Rs 30 lakh (Rs 3 million), you will need to at least arrange for Rs 4.50 lakh (Rs 450,000). The down payment affordability varies depending on the disposable funds you have. The key lies in knowing which assets to tap for the down payment.
For starters, you can park money specifically saved for buying a house in very low-risk debt instruments like fixed deposits. "Apart from this, liquidate those investments that earn you less return than the rate at which you are borrowing," says Sarin.
This would typically be instruments like your bank FDs, under-performing debt funds, besides equity funds and stocks that have been under-performing for a very long time, with little prospect of future appreciation. Stay away from retirement funds such as your provident fund (PF) and public provident fund (PPF). "This is so, as once people take out money from these sources, they rarely replenish them," says Mashruwala.
Putting the strategies into action: To be effective, all the strategies, especially the EMI and down payment strategies, will have to work together. Let's see how. If your take home salary is Rs 35,000 per month, the EMI strategy tells you that you can have an EMI of up to Rs 14,000 or 40 per cent of your take home pay. If you are to take a 15-year loan at an annual interest rate of 9 per cent, the maximum loan affordable is Rs 14.21 lakh (Rs 1.421 million).
You can similarly arrive at an affordable loan amount from the stipulations laid down by the down payment strategy. Thus, if you can afford to make a down payment of Rs 1.5 lakh (Rs 150,000), the maximum loan possible is Rs 8.5 lakh (Rs 850,000). Clearly, the two approaches throw up two different property prices. Experts suggest that home buyers choose lower of the two figures. In this case, the figure works out to be a property of up to Rs 10 lakh and a loan of Rs 8.5 lakh.
Consider compromise options: What do you do if after adopting these strategies you find home options unaffordable? One option would be to postpone the purchase and wait for the prices to cool down. The other approach would be to buy a home that's affordable even if it means making a compromise on important parameters like the size, that is, settling for a two-bedroom flat instead of a three-bedroom. Many experts suggest that you go for this compromise option.
At a macro level, despite the rise in property prices and loan rates, homes remain affordable. In other words, home buying still makes eminent sense. The only caveat is that buyers need to tread with more caution than they did in the past. But what has not changed is the question that every buyer needs to answer: 'Can I afford this home?' Its relevance has only got heightened. Buyer would do well to remember that the pursuit of a dream home can no longer be a mindless one.
Bubble Trouble
Is there a bubble in the Indian property market? Like all other asset classes, even real estate passes through cycles, and in India, some experts believe, its having an extended run and is expected to rise further in the coming days. In the past one year alone, prices have moved up by 30-50 per cent and, in some places, prices have doubled.
Locations that witnessed unprecedented rise are Gurgaon, Faridabad, Noida and south Mumbai. Even prices of apartments in Bangalore moved up by 70 per cent in the past year.
The increase in prices is not restricted to big cities, but are also evident in Tier-2 cities. "Land prices increased by 150 per cent in some of the Tier-2 cities," says Joygopal Sanyal, business head, urban and infrastructure advisory, Trammell Crow Meghraj. These cities include Indore, Raipur, Siliguri, Bhubaneswar, Guwahati, Kochi, Coimbatore, Vishakhapatnam, Mangalore, Lucknow, Chandigarh, Ludhiana, Ahmedabad, Nagpur and Kolhapur.
There are many reasons for this upsurge. There is a shortage of more than 20 million dwelling units, both in urban as well as rural areas. Apart from this, easy availability of home loans, rising salaries, emergence of India as an outsourcing hub, companies shifting to Tier-2 cities to cut costs and the tax benefits associated with owning a house have been the major drivers.
But how long will the party last? "I think that the property market would continue to go up in the near future with a steady growth rate in almost all the markets," says Sanyal. Though not every one believes that the real estate market is a bubble waiting to burst, there are factors that can reverse the trend.
"Government intervention, rising interest rates and fluctuation in foreign investment in the sector can reverse the upward trend. Also, the last two year's boom has led to an excess of supply, which will ultimately result in stabilisation or even reduction in prices," says Major-General (Retd) Jayant Varma, executive director (North), Knight Frank India.
However, a possible correction may not lead to a crash in prices. Experts believe that it will only lead to a reduction in the rate of capital appreciation. Further, a recent Crisil report suggests that most rallies in home prices across the world end in soft landings rather than abrupt drops.
So how different is the present rally from the one that we saw in the mid-1990s? Experts believe that this rally is very different from the last one. In the '90s, an artificial demand was created and there was no supply to meet that demand -- this led to a crash in prices. In the current rally, however, the supply in new projects is aplenty as are genuine buyers.
