A home is considered as ‘life’s biggest punji’ (prime investment) by most elders in our society. Traditional wisdom says that owning a home is a sign of upward social growth and class-status. The eyebrows of jealous relatives are raised whenever a youngster of another family ends up buying a house. Same traditional beliefs have given birth to today’s adage of ‘If you are a renter, you’re throwing money away’.
Is this true? Do these assumptions hold till date? Is the dilemma of owning a home or living on rent, is no dilemma at all?
Since time immemorial, there has been a huge emotional connect and psychological boost associated with owning a home. People say- ‘Bear the pain now, so you can rest later’, ‘These are the only times you can take risks’, etc. etc. But will buying a house, prove to be a smart financial decision or is it smarter to continue to live in a rented apartment?
Traditional assumptions of our elders
Times have changed- the world has become a highly competitive place to be in, private job market is very unstable, prices are skyrocketing, new generation likes the freedom and lack of commitment that comes with living in a rented home, and most of all, it’s not easy to get through the pressure which comes with mortgage period.
Let’s investigate if traditional assumptions of our elders have any solid grounding as such. Before continuing with deeper discussions in coming chapters, I want to level the dice between buying a house and living on rent by subjecting our stereotypes to acid test. This chapter will burst age-old myths which downgrade the decision of living on rent and over-hype the decision of buying a house.
My motive is not to persuade or dissuade anyone from buying/ renting a house. I want to disseminate unbiased financial knowledge in the simplest language possible to prevent this generation from becoming a prisoner of wrong financial decisions.
Myth #1: Rent goes towards expense, while buying a house builds equity (investment).
It is a most commonly used argument by real estate companies. According to the argument, the entire rent goes in the landlord’s pockets and contributes nothing to one’s equity (asset); instead owning a home contributes to equity which makes paying mortgage EMIs totally worth it.
Does it? Let’s see why the logic is flawed.
Things you OWN – Things you OWE = EQUITY
Have you ever wondered how much of loan repayment goes towards your property you own (principal) and how much of it goes towards paying what you owe (interest, insurance and tax)? The reality is, only a small chunk of your EMI contributes to equity, all else goes towards paying interest, taxes and insurance, especially in initial repayment phase. It is called amortization of loan. The picture below portrays it well. Please note that, the interest component in green is about multiple times that of the principal component in orange for more than a decade.
For example, if you buy a house worth INR 70 lacs by taking a home loan of INR 56 Lac @ 9.35% p.a. for 20 years, the interest and principal components will not come equal until at least 12.5 years of your mortgage period. So for more than a decade, you will not be investing a major part of your income towards building home equity rather you will be paying back what you owe.
In nutshell, your EMIs do not count towards equity until a long time in mortgage period.
Before taking any decision on buying or renting, consider once again, could you be invested in saving up resources in other investment sources with better returns?
Takeaway: Don’t oversimplify the big decision of your life of buying a house by claiming that it will build equity and thus buying a home is superior to renting or any other source of investment.
Myth #2: Rent is forever while mortgage stops one day.
It is a hook statement. The statement is not a myth but the ultimate aim which it aims to attain. It argues that a tenant will continue to pay monthly rent forever while monthly installments which go towards home equity will end one day. It is based on the arguments widely used by real estate advertising agencies. They say- ‘It’s high time to take risk and a little pain so he/she can rest later’. I ask two questions to them:
- Doesn’t a home require investments once mortgage period ends? What about maintenance costs, property taxes, utility bills, etc.?
- What if you are too old or boring to have fun after 20 years from now?
Certainly, the EMIs will stop, but there are lots of additional overheads which go in maintaining a property. I am not suggesting that be locked up in a rental loop for the rest of your life. I just want to burst this false argument and reiterate that don’t make a falsified premise the basis of your buying versus renting decision.
Takeaway: Weigh your priorities well and explore other investment avenues before jumping into anything based on hyped social sentiments.
Myth #3: Tenants do not benefit from rising real estate market prices while homeowners do.
This myth is often argued in social settings. Statistics suggest that long term real-estate returns are extremely overhyped.
A property can appreciate in two ways- via forced appreciation and market gains.
Forced appreciation is upgrading your house condition and renovating significant portions of your house so as to enhance its market value. But remember it is not about your personal whims and fancies. It is not limited to ‘having a beautiful marble floor’ or ‘expensive wooden doors’. It’s more than that. It takes a lot of skills and strategy to appreciate property value via forced appreciation.
Market gains are outside human control
Market gains are comparatively slow and outside human control. According to housing statistics, property prices do not increase substantially in value, they only keep pace with inflation. Real-estate market significantly underperforms the stock market most times.
So, a house that you bought in 50 Lac in 2009 may appreciate to 1 cr. till 2016. Yes, the initial amount has got doubled but due to appreciation in property prices, naturally the new property you wanted to buy would have increased in prices as well. Rise in your property prices may not even be adequate enough to be called a ‘benefit’ or ‘profit’.
One may argue that however less, at least buyers get some home equity at the end. Comparatively, renters have nothing.
Renters may not get any equity gains from appreciating property values, but remember they are neither paying for the ‘opportunity costs’ that comes with buying a house, i.e.
They do not tie their cash to EMIs,
They do not have to pay for maintenance charges, and
It is highly likely that they are paying less monthly rent than your EMIs.
So, with right financial knowledge, a tenant may invest the extra cash towards better investment opportunities. Not to mention that your lifetime cash tied up in home equity may just merely be keeping-up with inflation rather than giving you an upper hand over renting option.
Takeaway: Do your math before taking the rise in real-estate market for granted, especially if you are looking to sell your property after some years.
Myth #4: A house is the biggest investment.
For people in India and elsewhere, real estate investment is more of an emotionally driven decision than financially, especially if one buys with an aim to reside in it. Unsurprisingly, it leads to a great emphasis on buying a house and creates an impression that it’s the biggest investment. I hate to break it to you, but it is mere illusion, the ground reality is very different.
Experts say that your home should only be about 20-40% of your net investment worth. It’s not a good picture to end up with your house as your only biggest investment.
People counter-argue that it is better to own something than to own nothing. Well, it mostly depends upon-
Rent cost: if the rental costs are cheaper than EMIs, then you may consider investing your extra money towards better opportunities which can generate higher long-term returns;
House Down payment and Interest rate: Similarly to rental cost, you should weigh all pros-cons and opportunity costs (the loss of other alternatives) of investing this money in real estate market. Consider if property investment will generate better returns or something else?
Location: The place where you buy a property makes a big difference to highs and lows in housing prices. Some places are more sensitive to real estate changes and some are not.
Ultimately, do not forget even a small increase in disposable income significantly enhances the quality of life. It’s not an intelligent idea at all to live in a ‘hand to mouth’ situation and be left with nothing to enjoy life or exigency funds, just in order to acquire the so-called ‘biggest investment’.
Takeaway: Take a sound minded decision rather than emotionally drive decision while buying a house. Otherwise, it may lead to grave consequences and huge losses of your standard of life.
These assumptions are not based on mathematical calculations or sound financial knowledge rather the underlying sentiment of these myths is simply that it is beautiful to own a house because it’s an indicator of peace and a settled life.
The tradeoff between buying a home and living on rent is not an easy one. And to be blunt, it shouldn’t be. For a salaried person living in India, owning a home seems wonderful but wait until honeymoon period ends and the reality of EMIs, maintenance charges and home insurance hits you. Similarly there are qualms about staying on rent; mainly, managing landlord’s expectations, living with the skepticism that the landlord may ask you to vacate anytime; or the fact that you cannot entirely consume the utility of the space as per your ideas.
There are compromises in both, but it is important to make a fianncially literate decision absent of these stereotypes and with least risks involved. The question is which option will be optimum and allow you to live on your terms with happiness. The dilemma of renting or buying a home is worth pondering upon.
Let’s see how we can make an informed choice backed with strong financial reasons.