What Is The Ideal EMI To Rent Ratio?
Ever wondered whether it is better to buy or rent? You are not the only one. This is one of the most common financial dilemma that young investors face. While most western countries place, the EMI spend anywhere between 30-35 per cent, in India it varies between 25-40 per cent. It is good to get over with the burden of EMIs as soon as possible but watch out before you commit too much that may lead you into walking on thin ice.
Let's consider a few cases. Jayant Biswas is a 32-year-old IT professional. He is unmarried and lives with his parents. Two years back, he invested in a 3BHK unit in Noida and 30 per cent of his net income goes out as EMIs. Perfect situation! Biswas hasn't got a lot of responsibilities at hand as of now and his finances keep him well-placed. He gets to save and puts his Demat account to profitable use as well.
Even in case Biswas had been paying a rent to his parents, he could get some tax benefits on it if his parents declare the amount that they received as an income otherwise the tax departments usually do not take it kindly.
Consider Jayant Biswas in a different situation now. He moved away from the city he grew up in and is now working in a different one. He lives in a rented accommodation and has recently invested in a real estate unit. For a long time to come, he would be having an additional burden of having to pay rent as well as EMI, both of which he cannot overlook. He can save taxes if he wants to claim HRA benefit.
Under Section 24C and Section 80C, Biswas can claim some tax benefit too. However, both are available only from the financial year in which the house is acquired or construction is completed. Even under Section 24, for availing maximum benefits, the construction of the house must be completed or the house must be acquired within 3 years from the end of the financial year in which the loan was taken.
By the time, you consider Biswas married and responsible for a household- rent, family outings, childcare expenses, social gatherings, medical checkups, school fees etc., EMI would necessarily be a demonic pressure on the income. Nevertheless, most people save and manage. However, managing it the right way does matter.
How to do it right
Consider the total cost of owning a home in a certain location. This includes, mortgage principal, interest, property tax, insurance, dues, memberships, brokerage costs, PLC, handling charges, maintenance etc. Now consider the cost of renting a home- actual rent, security deposit, brokerage, maintenance etc. What looks more profitable?
The price to rent ratio is calculated by dividing the average list price divided by the average annual rent. If the ratio is less than 15, it is ideal to buy.
There are many Rent versus Buy calculators available online which tells you whether it is a better decision to buy or rent. A simpler way is not to exceed the comfortable threshold of 30 per cent of your net income.
Outgoing Rent and EMI
Project delays have hurt real estate sentiments like never before. When it comes to tenants who are looking at occupying a house in a defined, pre-agreed time, the burden of EMIs and rent in the interim period weighs heavy on most. The only way out is if you buy a ready to move in property. But suppose, that is not what you want, how does your EMI and rent balance? If the Rent plus EMI means zero savings for you, it can get worse if the construction is delayed. In case of rate changes, lenders usually extend the loan tenure or if you already have a very stretched tenure, monthly EMIs go up disturbing your finances.
Take this case, A is living on rent, paying Rs 20,000 per month. His EMI's come to Rs 25,000 per month. He needs to pay this amount for at least the next 2.5 years till the project is scheduled for delivery. His monthly income is Rs 75,000. This is not an ideal scenario as over 50 per cent of his take home is cash outflows. What makes it more pressing is the fact that A has a car loan and a few other expenses to take care of. Hence, an ideal ratio is when your monthly expenses are less than your EMI plus rent.
Most analysts believe that 50-60 per cent of your gross income could be put into paying off your loans given that your salary also increases over a period. However, only you can decide how much you want to put in your saving's kitty. There are developers and banks willing to let you avail of the EMI sharing benefit. You may want to read about it here.
Renting to Pay Off Your EMI strategy
Naturally the positive aspect of this strategy is known to all. If your investment helps you pay off your debts, nothing like it. But this is what you should bear in mind:
- Rental income is usually in the range of three to five per cent. Therefore, suppose you are investing into a Rs 50 lakh home with a loan amount of 80 per cent, EMIs over a 20-year period at 10 per cent interest will come to Rs 39,000 per month. Now if the property is rented out for Rs 20,000 per month, you still must manage an extra cashflow of Rs 19,000 per month because that is above the rent you are getting. In this case, the ideal scenario would be if you can restrict your loan to Rs 20 lakh and then the EMI will match the rent.
- If the rent is your only way to pay off your EMI's consider times where the property may be unoccupied- say for two months in a year or even six months.
- In grave situations, you can even sell off your property. However, do keep in mind the time needed for that transaction.
Property prices in Indian cities
Bengaluru, for example, continues to be favourable for renting than buying even though average property rents have increased. In Chennai, too, renting is affordable given that while property prices increased, it had a negative impact on rental values. Delhi is expensive, renting and buying will be equally heavy on your pocket while the NCR cools that tension for you. The most affordable in the list is seemingly Hyderabad for both buying and renting, like Ahmedabad. It is estimated that those with an annual income above Rs 9 lakh can buy a house easily. Mumbai property prices are out of reach for even those who earn up to Rs 25 lakh per annum. Pune has a similar trend across rental accommodation and property prices and for the floating population, renting is a viable choice. Kolkata is also on buyers' cards because of affordability.
Before making any decision, take into consideration the stability and growth of your income, expenses to sail through unforeseen circumstances, economic instability as also your willingness to shrink your expenses.