Rajiv and Meenal, a newly wedded couple, visited my office to discuss the Investment options to save for their house buying. Both of them were salaried and currently living in Rajiv’s parents house, and thus had a nice disposable income with them, which they want to put into productive use, with an idea of buying their own home as soon as they can.
But me with my financial planning mind , always start with the risk side and want to understand the other investments and liquidity already in place.
Since it’s been only 6 months of their wedding, it was a kind of honeymoon period going on for them, so expenses are totally out of hand. And due to the wedding expenses they have also withdrawn all their old savings done till date. Thus almost zero liquidity. Read more: Budgeting – Be aware of your expenses
So, how much would you like to pay as a down payment and what’s your budget for the new house, i asked them. To this they replied that they will take loan to the maximum extent their cash flow could support the EMIs. They want to get organized and would like to control the expenses to pay for this loan payment. But they want their own house sooner than later.
Of course, when they are so desperate to buy a house, they have already visited many different projects and numbers are ready in their hands.
So my next question to them was, if you have already decided and know that your cash flow could support the EMIs, what made you visit me? What are your questions to me?
Rajiv replied that they are a bit confused. While what they want desperately is a house but still don’t know if that would be the right decision considering the other goals they have. Today the decision looks feasible to them and they can manage the cash flow easily but what about the future…will they be able to pay the EMIs well. Read More: Home Loan Repayment Strategy: Is it Better to Increase the EMI or Tenure?
What should be the right choice for them and why? From financial planning, financial health and financial hygiene point.
Making your first investment decision is a pivotal moment in your financial journey. For many, the choice often comes down to buying a home with an Equated Monthly Installment (EMI) or saving money for long-term goals. Sometimes it comes from Society or Peer pressure and many times it comes from an emotional side.
Both options have their merits, but it’s essential to consider your unique financial situation. To help you make an informed decision, let’s delve into the practical considerations surrounding this choice.
Of course there could be Positives in the financial situation like good surplus income, parental support, stable job etc. Still, house buying is a big decision which involves a lot of financial considerations. Thus along with positives, let’s look at the other side too, like Job loss, Parents and their own health situation, economic slowdown, unforeseen expenses etc.
So, before taking a 20 year loan decision, it’s wise to consider the unexpected situations too and better to plan them first by keeping and maintaining a decent Emergency fund. This should be at least 6 months of your monthly expenses (including EMIs and Insurance Premiums) Also Read more: Keeping emergency fund – first step in financial planning
As a second step, one should be having adequate insurance coverage to manage the “What Ifs’ ‘ due to death, health or disability scenarios. The lender will also take care of this part and offer you the life insurance coverage while giving the loan, but it’s wise to understand your requirements and cover yourself accordingly. Read more: Review your Health Insurance Portfolio – Are you covered of all Risks?
Please do not depend on the employer provided insurances too and take separate covers for self and family, and better to stay away from Investment linked Insurance Policies.
Now after having these foundational arrangements in place next steps are to understand the impact on the financial health.
Always strive to pay at least 40%-50% of your new house value as a down payment. This will help in 2 ways. One while saving for the down payment, you get to know the pressure the EMIs may bring into your cash flows and if you are comfortable with the same or not. And Second this will ease out the future burden of EMIs and thus low interest outgo.
Just be aware of these financial ratios to keep your financial health in check
Debt to Income ratio : It is calculated as Monthly Debt Servicing Commitment / Monthly Income
This is an indicator of the individual’s ability to manage current obligations given the available Income.
I know we are only talking about home loans at this time and in the specific case of Rajiv, the cash flow permits EMI. But going forward he may like to add a new car, new furniture, new appliances..and all are available on EMI these days. So Financial Health needs to be in check.
Leverage ratio: This is a measure of the role of debt in the asset build up of the investor. It is calculated as Total Liabilities/Total assets
Higher the leverage, the more risky it is for the Individual’s financial situation. Ratio Greater than 1 indicates that the assets will not be adequate to meet the liabilities. (Read: Why Real Estate is Riskier than Equity?)
The ratio is likely to be high immediately after a large-ticket asset like Real estate is purchased with debt. Over time as the asset value appreciates, the ratio will also moderate.
But here please understand, that though you may take your own home as Asset, in actuality it’s an expense, which may not result in any income yield.
Besides the current numbers, be aware of your near term and future probable expenses
Like in the case of this couple, they are newly married and when they move on a family way, the expense structure is going to change in a big way. And then there will be addition of new goals which will also ask for decent savings. Plus Retirement or Old age Income Planning will also take away a major portion of your savings. Read More: Why is Retirement considered to be the Most Important Goal?
I have seen in the Indian Scenario, there is a clear clash and overlap among these 3 long term goals – House, Kid’s future and Retirement. First 2 are emotional goals , and also for the first 2 there are loans available, but not for the Retirement, which in the young age looks quite far.
By the time you reach 40 you start looking for Financial Freedom and Early Retirement, which may not be possible to achieve easily if your finances are not in a good shape. Also Read More: Early Retirement – Planning for your Second Innings Beyond Money
Conclusion: Buy Home or Invest for long term
So, there’s no clear answer to this. Every personal profile, Individual circumstances, and financial standing is different. Yes, there are important and practical considerations which let you decide the course of action.
There is no harm even in living on Rent. In fact in India, this sometimes is a more financially wise approach due to the lower rental cost/yield. Read more: Rent or buy a house? – This is how you should Plan
For Rajiv and Meenal, it comes down to their desire for homeownership and their ability to manage the associated costs. If they choose to buy a home with EMI, they should be prepared for a long-term commitment and the responsibilities of homeownership.
On the other hand, if their long-term goals are diverse and they value investment flexibility, saving for those goals through Path B might be the better choice.
It’s wise to give time to such decisions and always follow the financial prudence
Dear Readers, hope you find the thoughts shared useful. Do share what are your views and experience on this question?