As far as your home is concerned, you have two options: You can either buy a house now, and pay EMIs for many subsequent years, or, you can rent a house for a lesser amount, and buy it at a later stage.
Which option is financially better? Should you rent your home or buy it?
| I have strongly advocated that buying a house is a must for everyone. It is even more prudent for young people to buy a house in their early years. (For more, please read “Settle early in life – buy a home when young”) |
But how does it compare to renting a house? Does it make financial sense, or does it just give a sense of security? Let’s find out.
The two options
Let’s spell out the two options that we are going to compare:
Option 1: Buy house today
You buy a house today. You make the down payment, and for the remaining amount, you take a home loan for 20 years.
You pay the Equated Monthly Installment (EMI) for 20 years, and at the end of these 20 years, you fully own the house.
Option 2: Rent house today, buy it later
You rent your house. The monthly rent you pay is less than the EMI that you would have paid. You invest this difference regularly, and grow it over 20 years.
At the end of 20 years, you buy a house from the investments that you had made.
What do the numbers say?
Fair enough? Now let’s crunch some numbers by going through an example!
(Download this spreadsheet that has the detailed calculations for this buy v/s rent illustration. You can change the parameters and assumptions to suit your need, and find out the figures for your exact situation)
(You need to be logged-in to download the spreadsheet. For free registration that takes less than a minute, please click here. To know the benefits of registration, please click here.)
Let’s consider a 2 bedroom apartment in a Western suburb of Mumbai: A 2BHK apartment, measuring around 1000 sq.ft.
Buy house now
The cost of the house today would be about Rs. 75 Lakhs.
You would get a loan for 85% of this. Thus, you would make a down payment of Rs. 11.25 Lakhs (15% of Rs. 75 Lakhs), and take a home loan of Rs. 63.75 Lakhs.
(To know more about home loans, please read “An introduction to home loans and factors to consider”)
The rate of EMIs being around Rs. 1025 per Lakh, you would end up paying Rs. 65,344 every month as your EMI.
You would pay this amount every month for 20 years, and at the end of the 20 years, the house would be yours.
(Download this spreadsheet that has the detailed calculations for this buy v/s rent illustration. You can change the parameters and assumptions to suit your need, and find out the figures for your exact situation)
(You need to be logged-in to download the spreadsheet. For free registration that takes less than a minute, please click here. To know the benefits of registration, please click here.)
And what would be the value of this house at that time?
Historically, real estate investment has given a return of around 15% a year over the long term.
(To get an introduction to real estate investment, please read “Real Estate Investment”)
Even if we assume a very conservative 10% return, the value of the house after 20 years would be Rs. 5.06 Crores!
You would be a proud owner of a house costing a whopping Rs. 5.06 Crores!
Rent house now, buy it later
If you rent the same house, you would be able to rent it for around Rs. 22,000 per month today.
Now, what you would do is that you would invest the amount you save by not paying the EMI. Thus, you would be able to invest Rs. 43,344 every month. (The EMI would have been Rs. 65,344. So, investment = Rs. 65,344 – Rs. 22,000 = Rs. 43,344)
But would you be able to invest this amount every month for 20 years?
No! Remember, unlike the EMI, the rent increases every year, just like the price of the house!
Let’s assume the rent increases by 6% every year – again, a very conservative assumption.
Thus, you would pay an increasing rent every year, and therefore, your monthly investment reduces every year.
In fact, you would be able to invest only till the 19th year – in the 20th year, the rent is more than the EMI! (The rent is Rs. 66,563 per month in the 20th year)
(Download this spreadsheet that has the detailed calculations for this buy v/s rent illustration. You can change the parameters and assumptions to suit your need, and find out the figures for your exact situation)
(You need to be logged-in to download the spreadsheet. For free registration that takes less than a minute, please click here. To know the benefits of registration, please click here.)
And how much would all these investments over the 20 years fetch at the end?
Since you are investing for the long term (in the range of 20 years), you can invest in the stock market for superior returns.
(Please read “Stocks – The winning bet for the long term” for more on the benefits of long term investment in the equity markets)
Let’s assume a return of 12% from your investments – since you would be investing for the long term, this is achievable.
At this rate, your investments would grow to Rs. 2.82 Crores at the end of the 20 years. Well, thats quite short of the Rs. 5.06 Crores that the house costs now!
But wait – let’s not forget the down payment of Rs. 11.25 Lakhs that you would have paid had you bought the house.
When you rent the house, you also save that amount. Assuming you also invest it for 20 years, and earn a 12% per year return on it, this amount would grow to a tidy Rs. 1.09 Crores.
Thus, you would have a total of Rs. 3.91 Crores at the end of the 20 years. Unfortunately, even this is far less than the cost of the house!
The verdict
Buying a house right now wins hands down!
So, go ahead and buy a house as early as you can – you would build an asset that keeps appreciating in value. And buy the house irrespective of the price – in the long run, it would always prove to be a good investment.
(Download this spreadsheet that has the detailed calculations for this buy v/s rent illustration. You can change the parameters and assumptions to suit your need, and find out the figures for your exact situation)
(You need to be logged-in to download the spreadsheet. For free registration that takes less than a minute, please click here. To know the benefits of registration, please click here.)
Note: The impact of income tax has not been considered. You save income tax when you pay EMIs, and you also save tax on HRA when you pay rent. So, income tax should have a similar impact on both the options.
Similarly, the deposit you pay (which can be a couple of Lakhs) when you rent a house has also been ignored for simplicity. When considered, it would further strengthen the case for buying a house.
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- Home Loan / Mortgage Insurance – What to Buy, How to Buy
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- All you wanted to know about Senior Citizen Savings Scheme (SCSS)
- When “at-par” is not so good: New Fund Offer (NFO) versus existing MF schemes
- Not Cash, Not Travellers Cheques: Use Travel Card
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