The buying v/s renting debate is among the vigorous debates in personal finance, and is influenced equally by logic and personal choices. It goes without saying that the society pressure also plays an important role here.
Buying is an obvious choice for a lot of people. In fact, in India, renting a house is viewed as a sorry situation wherein the renter is viewed as someone who is ‘poor’ and ‘unable to afford’ a house.
Owning a house is considered as an investment by most people. It may give financial returns in the following ways – rent and capital gain from appreciation in house prices. It is a safe option, and one doesn’t have to worry about losing his job or incurring losses in business as one owns the house.
The common assumption is that since the population is increasing, and we can’t make more land, the real estate prices are going to increase by default. However, many economists and financiers warn against the assumption that the capital gain from appreciation will be more than the loss of real value due to inflation.
Let’s assume for the sake of simplicity that Mr X is considering buying a house by taking out a loan and comparing it with the option of renting it out.
Here are the financial implications of the same.
- Down payment – Mr X has to pay a down payment of 20% the principal amount of the loan. This means that if he is going to buy a house worth INR 1 crore, he will have to pay INR 20 lakh as the down payment.
- Payment Period of Home Loan – The maximum repayment period offered by most housing finance companies is 20 years, but it is ideally inadvisable to carry on a loan for this long. Most people either pay it off or renew it after a maximum of 7 years. (This is a fairly common practice since there are no pre-payment charges.)
- Other costs – There are certain costs involved in taking up the ownership of the house – stamp duty registration is one of them. These costs are a significant amount, and must be accounted for before making the decision.
- Overhead costs – One is going to most likely want to make a few changes in the house – renovation costs, and some basic repair and maintenance costs are bound to follow. These costs add up to the already high pile of expenses involved.
- It is a common Indian practice that the on-paper cost of the house is much lower than the actual cost which has to be paid to acquire it. This is, of course, illegal, as there is black money involved in such a transaction and it’s best to avoid getting into such a transaction.
On the other hand, renting a house would imply the following.
- Let’s assume that Mr X has two options. He can pay INR 20 lakh as down payment and take out a loan, paying INR 40 thousand as EMI. Or, he can rent a house and pay INR 30 thousand per month.
The opportunity cost of buying the house is equal to amount Mr X would have earned by investing
a) The downpayment, INR 20 lakh, and,
b) The difference between the EMI and rent, INR 10,000 (40 thousand – 30 thousand)
- House Rent Allowance – Salaried professionals are entitled to HRA – House Rent Allowance. If they rent a house, this amount is non-taxable income. The tax exemption for HRA is 50% of an individual’s income. This means that if Mr X’s income falls in the 20% tax slab, he won’t have to pay the tax for that portion of his income which he pays as rent, as long as this amount is equal to/less than 50% of his income.
- Mobility – There are other advantages to renting as well, and the most important among these would be mobility. If Mr X gets transferred to another city, or willingly moves, he would be stuck in a position where he would still have to pay the EMI for the purchased house and rent for a house in the city in which he shifts.
- Liquidity – By renting a house, Mr X can keep his liquidity intact. In case of emergencies, one can’t sell ‘a room’ of the house, but one can withdraw the amount invested in mutual funds or break an FD in order to provide.
One must not, however, turn a blind eye to the disadvantages of renting a house –
- You don’t ‘own’ the house, hence you are not free to make changes to the house. At the end of the day, the house belongs to someone else and you can’t do anything without the owner’s permission.
- The process of shifting houses every now and then can become tedious, as you would have to shift as soon as you settle down in a place.
- If you find yourself without a job, you will find yourself without a place to live in.
To sum up,
Advantages of buying a house
Disadvantages of buying a house
1. Financial security for life.
2. Possible gains from appreciation in house prices.
3. Potential rental income.
4. Freedom to make desired changes.
1. Significant portion of the net worth gets tied up.
2. Lack of flexibility and mobility.
3. Vulnerability to economic cycles which may bring down the cost of the house.
4. Lack of liquidity in funds invested.
Advantages of renting a house
Disadvantages of renting a house
1. Mobility and flexibility.
2. Ideal for those in transferable jobs.
3. Opportunity cost of the money not invested in buying a house.
1. Lack of freedom to make changes in the house.
2. Too much shifting can be emotionally taxing.
3. Risky if one loses his/her job.
Concept of House Poor
The concept of house poor has become extremely common in recent times. One becomes house poor when one invests his entire net worth in buying the house and as a result, can’t make his ends meet. It is very important to analyse your financial standing properly and make sure you don’t end up becoming house poor.
One must remember that at the end of the day, it is an individual choice. One must decide what one wants. There are many buy-v/s-rent calculators out there ( Magic Bricks and Sulekha) which are pretty useful, but they don’t account for the individual preferences.
Mr X and his wife decide to do some number crunching and see if they should buy a house or rent it. The calculations suggested that they should buy the house if the rent was over INR 30,000 per month. Their rent was INR 35,000 per month. Hence, on paper, buying was the right thing to do. However, when they think logically and bring their personal factors into the equation, they realised that if one of them would lose his/her job, they would be in trouble because apart from an emergency fund, they didn’t have much savings. Hence, they decide to postpone buying.
This proves that calculators and number crunching and guidance is not fool proof. It is an individual decision and nobody can make it better than you.