We all need a house to live in. However, the choice that needs to be made is whether one should stay in a rented house or buy it instead. In the present scenario, the cost of living in a metropolitan city is rather high. Also, the property prices and home loan rates are moving up sharply.
Given that both buying a house and renting it have their unique set of costs attached, one must evaluate both the options closely and then make an informed choice.
If an individual stays in a rented house, he could be paying a substantial amount as rent, depending on the location and the area of the property.
On the other hand, if he buys a house by taking a loan from a housing finance company (HFC), at the end of the stipulated period, he may find that the total repayments on the loan far exceed the actual value of the house. In this article, we conduct an evaluation to help you determine whether it's better to buy or rent a house.
Let's consider an individual (say Kumar) who lives in a metropolitan city (say Mumbai) and earns Rs 45,000 per month (pm) as salary. In terms of housing, he has two options; either live in a rented premise or take a home loan and buy a property for himself.
The assumptions for the purpose of this discussion:
1. Kumar gets a 5% increment on his salary every year and he falls in the highest tax bracket i.e. 30.9 % (including education cess);
2. There is no change in the tax laws during the period considered, i.e. 20 years.
Option 1: Live in a rented house
| Tenure of residency | Yrs | 20 |
| Rent per month | Rs | 13,500 |
| Annual rent | Rs | 162,000 |
| Initial deposit | Rs | 100,000 |
| Increase in rent (pa) | % | 5 |
| Result: | ||
| Total expenditure on rent (over 20 years) [A] | Rs | 5,356,685 |
| Tax benefit on house rent (over 20 years) [B] | Rs | 1,103,477 |
| Loss of interest on account of deposit (over 20 years) [C] | Rs | 366,096 |
| Total expenditure on rent after accounting for tax benefits (A-B+C) | Rs | 4,619,303 |
In the first option, Kumar stays in a rented house for 20 years and pays Rs 13,500 pm or Rs 162,000 per annum (pa) as rent. Besides the rent, he pays an initial deposit of Rs 100,000. The house rent increases by 5% pa.
Thus, over the 20-year period, Kumar will pay Rs 5,356,685 as rent (for the initiated, this is the future value of all the rent installments). However, as per Section 10(13A) of the Income Tax Act, an individual can claim tax benefits on the house rent allowance that he receives. Therefore, we estimate that Kumar gets a tax benefit of Rs 1,103,477 on his house rent over the 20-year period.
As mentioned earlier, Kumar pays an initial deposit of Rs 100,000 (refundable once he vacates the house). We have assumed that if this amount were to be invested in an investment avenue fetching 8% return pa, then, at the end of 20 years he would have earned Rs 366,096 on his investment.
Since the Rs 100,000 is inaccessible for 20 years (as a deposit); Rs 366,096, which he could have earned by investing the deposit amount, is an opportunity loss.
Taking into consideration all these aspects, i.e. his expenditure on house rent, the opportunity loss and the tax benefit he would receive, the net expenditure for renting the house would amount to Rs 4,619,303.
Option 2: Take a home loan to buy a house
| Cost of the house | Rs | 2,500,000 |
| Loan amount | Rs | 2,000,000 |
| Tenure of loan | Yrs | 20 |
| Rate of interest | % | 12 |
| EMI | Rs | 22,022 |
| Initial payment: | ||
| (a) Personal contribution (20% of property cost) | Rs | 500,000 |
| (b) Stamp duty (8% of property cost) | Rs | 200,000 |
| (c) Registration (1% of property cost) | Rs | 25,000 |
| Total initial payment (a+b+c) | 725,000 | |
| Result: | ||
| EMI outgo (over 20 years) and initial payment [A] | Rs | 6,010,280 |
| Tax benefits received from EMI (over 20 Yrs) [B] | Rs | 1,235,173 |
| Loss of interest on account of initial payment (over 20 years) [C] | Rs | 2,654,193 |
| Total expenditure after adjusting for tax benefits (A-B+C) | Rs | 7,429,300 |
Suppose Kumar decides to take a home loan and buy a house. The cost of the house is Rs 2,500,000. He takes a home loan of Rs 2,000,000 from an HFC for a tenure of 20 years at 12% rate of interest.
The balance amount will be paid as initial payment (HFCs finance around 80% of the total cost). Therefore, the total sum required as initial payment for the property is Rs 725,000 including stamp duty (8%) and registration charge (1%).
Based on the loan amount and the interest rate, his EMI (equated monthly installment) is Rs 22,022 pm. Thus, Kumar will repay Rs 6,010,280 (including initial payment) towards the home loan.
However, he can also claim tax benefits under Section 80C and Section 24 of the Income Tax Act on the home loan repayments (towards interest and principal). With this, we estimate he can claim a tax benefit of Rs 1,235,173 on the home loan.
If Kumar had chosen to live in a rented premise and not buy a property, he would not have made the initial payment of Rs 725,000.
Furthermore, he could have invested the same in an investment avenue offering 8% pa. At the end of 20 years, he would have earned Rs 2,654,193 on his investment. Effectively, this amount is an opportunity loss for Kumar.
After taking into consideration all the aspects such as total home loan repayments, tax benefits and the opportunity loss, the net expenditure on buying a house would amount to Rs 7,429,300.
On comparing the two options, one would find that over the 20-year period, the option to live in a rented house (total expenditure Rs 4,619,303) turns out to be much cheaper than buying a house on loan (total expenditure Rs 7,429,300). However, this cannot be taken as conclusive since there are other essential factors that also need to be addressed.
1. Although the option of staying on rent seems cheaper, individuals should appreciate that by buying a house they are creating an important asset for themselves.
2. While staying on rent would be a pure expenditure, buying a house should be regarded as an investment, as an asset is created for the home buyer. The asset's value is likely to increase over the course of time (a vital factor that we have not considered).
3. In our illustration, we have made some assumptions. Now, if any of these assumptions related to the interest rates, rent payable or tax laws were to change, they will have a significant bearing on the end result.
For example, if the home loan interest rate was 8%, then the net expenditure on buying the house (after adjusting for tax benefits) would be Rs 6,277,025 (as compared to Rs 7,429,300 in the current example).
Similarly, if the rent of the house were Rs 20,000 (instead of Rs 13,500; this is possible if the demand for rental properties were to increase significantly), then, the net expenditure on rent would rise to Rs 6,922,578. This clearly proves that a change in the assumptions can radically alter the end result. For instance, under the revised assumptions, buying a house would be more economical vis-à-vis staying on rent.
It should be understood that whether an individual buys a house or stays on rent is on one level largely a personal choice. There are factors, financial as well as non-financial (individual needs and aspirations), which need to be considered while determining the feasibility of options.
At Personalfn, we maintain that every individual must own property (for residential purpose), as the same has a vital role to play from an asset allocation perspective.
To that end, buying a property should be taken up on priority, and discretion can be used in terms of the location and size of the property.
By Personalfn.com, a financial planning initiative. It can be reached at info@personalfn.com. Personalfn.com also publishes a free-to-download financial planning guide, Money Simplified. To get a copy of the latest issue -- Real Estate & You - please click here.
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