When it comes to home - it is an emotional thing for all of us.
Our parents worked very hard and bought a home when they were close to retirement.
We know the pain they went thru.
So we try to attain that goal as soon as possible.
Also if there is no own house, getting married becomes a big question mark in many lives.
The first question they ask in bride/groom alliance is whether you own a home.
As if this pressure is not enough, there is peer pressure as well.
Everyone around us own a home.
If we don't buy it, it makes us feel guilty of missing out on something.
Is owning a home really that better than renting a home?
There are many benefits in owning a home.
It gives emotional strength. No one can ask us to leave the home in 2 months.
No house owner can discriminate us based on caste and religion.
There are many benefits like that.
But we are not going to look into those.
Just from purely financial perspective, is it a good decision to own a home than renting is what we are going check out in this episode.
Generally speaking, we assume that the rent we pay for home is a waste of money.
But is it true?
Are we paying for an useless thing? We definitely need a place to stay.
So it is an necessary expense.
We are not giving the money useless. But we are giving it for a purpose.
But why we do we think that we are wasting our money by paying the house owner?
If we have owned this home instead of renting, the rent would not have been a waste is our thinking.
What is the mistake in that logic?
No one is giving us a "own home" for free.
We are buying it either with our own money or by borrowing.
That means we could have invested that money somewhere else.
But instead we locked that money by buying a home.
This is what is called as "Opportunity Cost".
that is, by buying a home with our own money, we are losing the opportunity to use that money to be invested somewhere else.
That is why we are calling it as "Opportunity Cost".
I can hear you saying, "So what? This is also an investment".
True. But, how can we evaluate whether it is right investment?
For that we will use this "Buy Vs Rent" calculator.
The link for this calculator is in the description below.
You can use it by copying to your account.
This is not a calculator created by me. Some smart and blessed one created and shared this calculator in Fatwallet Finance forum a decade ago.
All credit to that blessed one.
Lets see how we can use this calculator.
All yellow colored fields are input fields.
We should input depending on our situation.
All other fields are calculated fields.
There is no reason for us to even touch it.
It already has formualas in them.
They get updated based on the input fields.
Lets check out an example calculation.
Purchase price - this is the price we paid to buy the home.
Lets assume that we are buying a 3BR home for Rs. 70 Lakhs.
Down Payment - the money we are putting in home from our hand.
Lets have it as 20% - Rs. 14 Lakhs.
Interest Rate - this is the interest rate that we are paying for the home loan. Lets have it as 10%.
Principal Amortization - this is loan's tenure.
We have to enter the period length of the loan here.
Lets have it as 30 years for our calculation.
Property Tax Rate - this is different for different towns.
Lets assume it as 0.25% for our calculation.
Annual Maintenance - we should include the general repair cost here.
Generally we can expect 1% of home's value for maintenance.
So lets have it has Rs. 70,000.
Annual Insurance - this is home insurance cost.
Not sure how many have home insurance in India. If you are planning on having it, fill it in here.
Assumed Annual appreciation - how much are we expecting the home price to appreciate every year?
We have to enter that here. 3% is reasonable.
It is OK to even have it as 7% to match the inflation rate.
But as your real estate friend suggested, if you are expecting a growth of 25 to 50% every year, feel free to enter that here.
This is your calculation. You can enter your expectation here.
But we will use 3% for our sample calculation.
Marginal Income Tax Rate - based on our income tax rate, our tax savings will change as well.
Looks like upto 3.5L can be deducted for tax in India.
Lets assume 20% as tax rate for our calculation.
General Inflation - we have to enter the average inflation rate.
We are using this inflation rate to calculate the present value of our future savings.
We will enter India's average inflation rate 7% here.
Monthly Mortgage Payment - this is a calculated value.
This shows how much we have to pay the bank every month for our loan amount.
Cost of renting similar home - We have to enter the rental cost for the similar home if we are renting here.
We will assume Rs. 15,000 for this home.
Rental Price Inflation - how much are we expecting the rent to increase every year?
We have to enter that here. Lets assume that it is 3%.
Assumed annual return on cash - what would we have done with the downpayment cash Rs. 14Lakhs, if we have not bought this home?
Remember the opportunity cost? What is the return we would have got for that opportunity is what needs to be entered here.
For fixed deposit - 7%, for stock market - 12% - like that we have to enter the return we are expecting from our investment.
We will use 10% for our calculation.
That is all the data entry. Lets check out the results below.
Lets check out the buying scenario first.
House - 70 Lakhs. Debt - 56 Lakhs.
Equity in home - that is, our share in home - 14 Lakhs.
This table is showing us the break down of how our cash flow would be for each month.
We are paying Rs. 49,000 every month right? How much of it is going to interest? Rs. 46,600.
Just Rs. 2500 is going to principal.
Not many realize this.
In the beginning of a loan period, most of the payment goes towards interest.
Because the loan balance is big. And so the share of interest from our monthly payment is big as well.
As the loan balance gets smaller and smaller, more share from our mortgage payment goes towards principal.
Lets see how our monthly payment is split in 10th year.
Lets scroll to the right and get to 120th column.
Out of 49,000 - 6,000 is going to principal in 10th year.
42,500 is going to interest.
Lets check out how this looks in 20th year.
We have to go to 240th column for that.
18,000 is going to principal and 31,000 is going to interest.
By the end of the loan period, as part of the last payment - just 400 is going towards interest.
The rest of 48,700 goes to principal.
Because by the end of the loan period, the balance will be very less. And so the interest paid for that balance is very less as well.
This monthly schedule is called as "Amortization Schedule".
By looking at the amortization schedule, we can check how much our loan balance would be for a specific period.
For example, the beginning loan balance of 56 Lakhs would have been 51 Lakhs by end of 10th year.
As we did not enter home insurance and house association fees, they are blank here.
As the maintenance cost is 1% of house price, it is increasing every month along with the house price.
Then property tax expense.
Then the tax advantage we are getting from loan interest.
For our assumptions, the total cash outflow for the first month is Rs. 47,000 if we have owned the home.
If we have rented the same home, our cash outflow would have been just Rs. 15,000.
The 15,000 we pay as rent looked like a waste of money. But the 46,000 that we are paying to bank as interest is useful?
Something to think about.
Next, lets check out the renting scenario.
Instead of buying a home, staying in a rental and investing the downpayment is this scenario.
Not just the 14 Lakhs downpayment, but also the money we are saving by renting is also being invested.
So for the first month, Rs. 47,000 would have gone out of our hand if we have bought a home.
But if we rented, Rs. 15,000 would have gone out of our hand.
So because we rented, the difference Rs. 32,000 is savings for us.
We are investing that savings Rs.32,000 for 10% return.
Assuming that we are investing that Rs.32,000 every month for 10% return along with 14 Lakhs,
the monthly investment balance is shown in "Savings when renting" row.
We can see the summary of the results below.
This summary is showing how the situation will be if we are selling the home after 10 years.
After 10 years, the house price would have been 94 Lakhs.
Debt would have reduced from 56 Lakhs to 51 Lakhs.
In the 59 Lakhs that we paid as loan in this 10 years, only 5 lakhs went towards principal.
The rest 54 Lakhs would have been paid to bank as interest.
What? Out of 59 Lakhs payment 54 is interest?
Are you thinking that there is something wrong in the calculation?
There is nothing wrong. You are looking at it right.
This is the reason I said that owing a home will be a big drag for our financial growth in "Building Wealth" series.
Home Equity after 10 years - our share in the home.
It would have grown from 14 lakhs to 43 lakhs.
Because the home has appreciated 24 Lakhs.
Then 5 lakhs from our paid principal. A total of 43 lakhs.
This calculator is assuming 6% as the transaction cost for selling the home.
6% is normal in US. If it is cheaper in India, update the calculator accordingly.
So finally, the cash that we will have on our hand if we sell the house by the end of 10th year is Rs. 38 Lakhs.
But instead of buying a home, if we have invested the difference, we would have had 1 Crore 4 Lakhs in hand by the end of 10th year.
So for these assumptions, staying in rental home would have saved 1.04 Cr - 38 Lakhs = 66 Lakhs for us.
Present value of that 66 Lakhs is 34 Lakhs. 56th row is showing that.
So for these assumptions, we can clearly see that renting a home is far better than owning a home.
There are 2 important assumptions here.
one is "Annual appreciation rate". Another is "Annual return on cash".
I have conservatively assumed the annual appreciation rate as 3%.
You can use what makes more sense to you.
We can go upto 7% to match the inflation rate.
Expecting the house to appreciate more than that is over expectation in my opinion.
I have also assumed the return of cash as 10%.
If you say that you are not familiar with any other investments other than Fixed Deposit, change the return rate accordingly.
US folks can use the same calculator as well.
I have entered some of the default values in the second tab "USA".
Change it depending on your situation.
One thing to note is, as most of us are using standard deduction during tax filing, we cannot deduct mortgage interest in tax.
So I have left out the marginal tax rate.
If you use Itemized deduction in your return, update this field for your needs.
Generally in market, to quickly identify whether it is better to buy a home or rent a home, "Price to Rent Ratio" is used.
If the value of a home is 65 Lakhs, and if its monthly rent is Rs. 15,000
then the yearly rent is 1.8 Lakhs.
Price to Rent ratio is the ratio between these two numbers.
that is 65 Lakhs / 1.8 Lakhs = 36 is the rent ratio.
If this ratio is less than 15, we can definitely buy the home. No need to think.
If it is between 1 and 20, we have to evaluate and then make a decision.
But if it is over 20, it is better to avoid buying the home.
In Chennai, as of now, the price to rent ratio is over 35.
That means, renting a home is way cheaper in Chennai.
I can hear you saying, "What do you mean cheap? Rent is Rs. 10,000 to 15,000".
When compared to the price Rs 65 Lakhs, 15,000 is cheap.
The way we should see this is - lets say that we need a storage place for our business.
If the rental price for that storage place is Rs. 15,000 and if the buying cost is Rs. 65 Lakhs,
would we buy it or would we rent it?
We would definitely rent it.
Because, instead of locking down that 65 lakhs in that storage place, we can invest that in the business expansion.
Same concept applies to buying home as well.
But here its not pure business.
There is emotional part and also other intangible benefits.
So there is nothing wrong in buying a home. We can definitely buy for other reasons.
But buying a home as investment is a questionable decision.
The purpose of this episode is not to discourage buying home.
But to clarify that renting a home is not a waste of money.
If anyone is hesitating to give bride/groom because you do not own a home,
share this video with them.
Or if your parents or in laws are forcing you to buy a home as investment,
share this video with them as well.
Hope this helps. Good Luck.
We will soon meet again in the next video. Thank You.