Should you buy a home or invest in mutual fund? This is one question that almost all millennials grapple with, more so, during these inflationary times when prices of homes are skyrocketing. While the latter is comparatively a new entrant in our financial scheme, the former has always been the most important thing in the financial plan of people. All of us would agree that in our country, buying a home is an emotional decision. All of us have heard our parents advising us to buy a home as it ensures the much-important roof over our heads. Having a home of one’s own is really a big deal in our country. Nevertheless, this emotional wisdom-cum-advice should be taken with a pinch of salt.
Home is not really an investment
This is not to say that you should not buy a home. Neither does it mean that a home is not important. A home is fairly important and you should buy one but only if you have to live in it. It is not prudent to buy a home with the motive of investment because it does not make sense from the point of view of investment in the current times. All this despite the numerous claims of home owners saying that their home is an asset which, it is not, in reality. Reason? To qualify as an asset, an investment should give cash flow i.e. regular income which is not the case with a home bought on home loan. The home is actually consumption because you pay interest on the home loan.
Many people would counter this fact with the theory that the value of the home bought through loan rises after a time period and hence, it becomes an asset with the potential to yield profit. For ex, a home worth Rs 1 crore becomes worth Rs 1 crore 80 lakh after five years resulting in a net appreciation or rather profit of 80 lakh. Well, here is the catch. The interest on the home loan (payable at 8.5% with tenure 25 years) for this very home turns out to be Rs 42 lakh in five years only (the interest is higher in initial years). If you deduct this amount from 80 lakh what you get is an amount with a return of 6-7% which is quite lesser when compared with mutual funds that give an average return of 12%.
When to buy a home
The above example makes it amply clear that a home is not really an asset in the real sense of the word but it does not mean that you should not buy a home. The important question is when to buy a home. Well, when it comes to deciding between buying a home or deciding to live in rented home, you should be clear that you are buying the home for living. Secondly, you should take into account your monthly income to determine if you can afford the EMI of the home loan. A good rule of thumb is that you should go for the home loan only if the EMI is less than 30% of your monthly income.
Another equally important guideline you should follow is the home price to home rent ratio i.e. home price divided by annual rent of the home. If the ratio comes out to be less than 15 then you should buy a home. If it hovers between 15 to 20 then you should take into account some important factor such as locality, budget, EMI, affordability, etc. If it is more than 20, you should stick with the rented accommodation. For ex, a home worth Rs 1 crore has a monthly rent of Rs 20,000 which turns out to be Rs 2,40,000 for one year. So, the ratio is 41 in this case which is more than 15 and hence, rented accommodation is the ideal option.
So, if you are hounded by the dilemma of buying a home and investing in mutual funds then you should follow the important rules described above. Most importantly, you should buy a term insurance plan of the equivalent amount of your home loan.
Make sure to make an informed decision as it will prove to be the best investment for your financial health. The right assistant is here and now! For professional assistance talk to Dr. Finance, through Facebook, Skype, or Google who will answer all your financial queries. Visit Findvise or download the app today to plan your loan and calculate your correct life value.
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