Sunday, 6 November 2011

How much home loan can I get? (Part I)

Buying a home in India, or for that matter anywhere in the world, is a big decision for most people.  It is most likely the single biggest purchase you will ever make in your lifetime.  Gone are the days when one used to save for a lifetime, before finally being able to afford a small home towards the end of your career.  Today India is growing by leaps and bounds, and the average home buying age in India is dropping every year.  The Associated Chambers of Commerce and Industry of India (ASSOCHAM) estimates that the average age for home buyers in the 1980s was 55-58 years in India.  In stark contrast, since 2000, the average age for first time home buyers for personal use has dropped to 30-38.  Many first time buyers are either just married, or many times choose to buy a home even before marriage.

In most Tier1 cities in India, the trend I see these days is that once a person graduates from college and begins working, the first big ticket purchase they consider is a car, and the second one is a house.  In most Indian families, even after the children start working they typically continue to live with their parents and siblings.  After a few years of working when they are 25-28 years of age for boys, and a couple of years younger for girls, the thoughts turn towards owning a home.  Guys typically prefer to buy a smaller new home (maybe a 1BHK) just prior to getting married, so they can move in as soon as the wedding is done.  The other alternative is to buy a bigger new house (upto a 3BHK) so the newly weds can have their privacy, while still living with their parents.  Girls on the other hand might typically wait to get married, and then right away begin the search for a home, since the joint income of the husband-wife couple is more than enough to afford a good home.  Many times the quality and size of home you currently live in, or plan to buy soon, can be a critical factor in influencing the choice of life partner, with families preferring to create marriage alliances with their social and financial equals (as measured by the size and quality of their dwelling!) 

Buying a home in India can also be a very emotional decision, heavily influenced by family, friends, peers and the unique social environment we live in.  Peer pressure plays a big role here as you see your friends and colleagues purchasing homes.  There is also a desire to show that you have "arrived" and the best way to do so, is buy purchasing the biggest house you can afford.  A nice upscale colony, with a fancy clubhouse, tennis courts, gymnasium, walking/jogging track etc helps in setting the bragging rights, even though you may have to pay a stiff monthly maintenance fee for several of these amenities that you probably never use!

Of course we always rationalize to ourselves that surely we deserve the best house we can afford.  We want to provide the best living conditions for our parents given that they have sacrificed so much for use.  We want our kids to have the best amenities, and access to swimming pools, tennis courts, basket-ball courts, play areas, etc, since we did not have that luxury when we were growing up.  The list of reasons is endless, and I am not debating right or wrong.  I had the same thoughts while we were trying to figure out where to buy a home ourselves.

Let us take the example of 29 year old Gaurav who is married for a couple of years now to Sneha and is soon planning to have kids and start a family.  This is of course a fictitious example, but helps to illustrate my point better.  Before Gaurav and Sneha decide to have a child, they would like to purchase their first home.  They would like to go for a 3BHK, since 3 bedrooms would give the family enough space and privacy once they have a child.  Since both Gaurav and Sneha are salaried employees, they expect one set of parents (either Gaurav's or Sneha's) to stay with them almost throughout the year, to help with taking care of their child.  A good apartment complex near the upcoming outer peripheral road would be a good place to invest in a home, since there are several new developments happening in that area.  Good schools are expected to come up there soon, and both their offices are also within a 10Km radius.  The first thing Gaurav does is search online for how much home loan can he get given their combined joint monthly income.  Gaurav and Sneha are very disciplined and do not spend extravagantly.  They do not have any personal loans or student loans and pay off their credit card bills promptly.   Their joint monthly take home income is Rs 80,000.  Gaurav and Sneha approach a leading bank to negotiate a pre-approved home loan so they can decide on the budget for their dream home purchase.  The bank informs them that they typically sanction a maximum EMI of 45-50% of the net take home salary, and encourages them to jointly apply for the home loan to maximize the total loan amount.  Also since they dont have any other personal loans, or credit card debt, and their credit rating is impeccable, the bank agrees to extend the eligible monthly EMI to 55% of their take home pay.  This means the bank estimates that Gaurav and his wife can comfortably pay a monthly EMI of Rs 44,000.  After all the bank manager also has home loan disbursement targets to meet, and a young couple with a strong employment history is an ideal customer for the bank. 

Gaurav decides to maximize the tenure of the loan to further bump up his overall loan eligibility.  The maximum term with this bank is for 25 years.  The home loan interest is a floating rate of 10% per annum.  Based on these parameters, Gaurav is eligible for a home loan of Rs 44 Lakhs (I used the home loan EMI calculator available here at ApnaPaisa) Since the bank will only fund upto 85% of his loan, his maximum budget can be Rs 52 Lakhs with the 15% margin money of Rs 8 Lakhs being Gaurav's responsibility.  Gaurav and Sneha are overjoyed by this and sign up for the pre-approved home loan.  They can now buy a flat of their choice upto a maximum budget of Rs 52 Lakhs.  This is a fairly conventional storyline, and is repeated hundreds of times across various banks in India. 

So what is wrong with this story?  Well nothing much, if you are counting on a conventional financial plan, with traditional milestones of marriage, family, owning a home, working hard till the age of 60-65, and finally leading a happy retired life.  But this does not work for early retirement aspirants.  In my next post we will dissect this case study from an early retiree's perspective, and see why this plan cannot co-exist with thoughts of early retirement. 


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