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Renting vs Buying: To buy a house or rent it?
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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Note: Please treat the opinion expressed here as a broad suggestion. Please consult your financial planner / investment advisor before making any investment decision.
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Oct 05, 2008
Thanks for your inputs.
I agree that the assumptions may or may not be entirely correct - these are the things that I see as likely, and you may differ.
and depending on our assumptions, the result can vary.
That's why I have provided the spreadsheet that contains the analysis - once you download it, you can change the various assumptions and can see how it turns out, and can decide for yourself!
Again, thanks for the input. Its always nice to see another point of view...
Nice article, but have you considered the total repayments made including the interest on the principal that you would pay back to the bank?
For eg, If a loan of 20 Lakhs is taken at lets say 10%, for a tenure of 20 years, the total interest and principal payments made to the bank at the end of the 20th year would amount to around 46.5 lakhs.
Can you try including this aspect in the calculation (ie, lets say on a condition that it gets invested elsewhere at around 12% rate of return), then it would be really great.
thanks for all your efforts,
Ajai
In the calculations, I have considered the total payment, including the interest paid.
In the "renting and buying later" option, I have considerd investing the difference between the EMI and the rent. Since, the EMI includes the interest payment, it is automatically included in the amount that can be invested every month.
Thanks for the prompt reply. My mistake, I Shouldnt have rushed to post that at the end of a long day!!
Did the calculations once again, its true that there would be a shortfall of 11438342 at end of 20 years if your investment earns 12%. But if you manage to get even 2% more (14%) on your investment, the tables turn in your favour. Then the value of your investment will grow to 52066378 giving you a positive return of 1610128. (Calculations as per the excel sheet on the website)
Instead of calculating the impact of investing the downpayment money seperately, if you start with that in the beginning of the calculation (thats what happens inreal world, you first make the downpayment and then the monthly EMIs) and add the yearly additions to that amount and keep calculating, then your investment will fetch you around five lakhs more at the end of the 20th year if you can manage a 13% return..
Now the question is how many of us have the discipline to invest the surplus amount and more importantly manage our money so that it can fetch you anything above 13% CONSISTENTLY.
Very good analysis! The excel sheet is meant exactly for that - people can fill in the details as per their individual case, and try out the various permutations and combinations.
I agree with you - if we increase the returns expected, the result definitely tilts to the other side! So, if you think you would be able to earn 14%, then yes, your conclusion would be different from mine.
And earning 14% is not impossible - in the long run, stocks return beteen 12% to 15%. As you have pointed out, the kep is to be disciplined and not get swayed by sentiment, and remain invested for the long term!
(Please check Equity Investment is Risk Free Here's the Proof and Stocks - The winning bet for the long term to see how equities give great returns over the long term)
In my calculations, I have generally remanined conservative - thats why I have assumed that house prices increase by 10% (when it can be upto 15%), and rent increases by 6% (when it can be anywhere upto 15%).
So, in the same way, I have been conservative in my expected returns - and have assumed 12%.
Downpayment money: Although it is listed at the bottom of the table, I have assumed that it would be invested from day 1.
Again, I have assumed that it earns 12% per annum, so that it grows from Rs. 11,25,000 to Rs. 1,08,52,080 in 20 years.
I would like to have a list of guidelines that need to considered before availing a loan to secure financial stability. It could be factors like
Having required margin amount
Insurance cover
In current tough economic times, how much money should be kept aside for payment of EMI so as to take care if one were to lose his job. This could be like money to pay 3 EMI's or 6 EMI's
Do you have that published somewhere?
Regards,
Vinayak Bhat
You can check out the articles "An introduction to home loans and factors to consider" and 7 factors you should consider before buying a second house.
If you want personalized advise on your investments and for creating an emergency fund, you can avail of the "My Financial Plan" service. Please check out more details here.
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The article however gives some food for thought. Thanks
ravee.