Home Loans Vs Renting - Cost of Ownership

Should I buy a house and spend the next 20 -25 years of my life worrying about an EMI or should I just live as a Tenant?

This question seems to have as many answers as people you choose to ask. The fact is that there are aspects of this deal which are hard to pin down in numbers and most people tend to justify the decision that they have themselves made. I have seen many articles written on this but I think that rather than presenting a conclusion, what is really needed is to have all the aspects listed out so that people are provided with something that they can try and figure out for themselves.

This link has a spreadsheet(Loan_Feasibility.xlsx) that I have shared and can be downloaded. I will, in the following paragraphs describe how this works along with the assumptions that have been made. I hope this is useful for all those who are in the midst of taking this decision.

Listed below is a screen shot of how the spreadsheet looks like and the section by section explanation of the various fields follows

Input  Paramters:

Property Value: This is where you need to enter the current value of the property you are after

Own payment: This is the amount that you can pay up front for the property
Loan: This is auto calculated based on the above listed inputs
Loan Interest Rate: This is an Input parameter and you can plug in the expected ROI for your loan
Loan tenure(months): Self descriptive input parameter. Should be < 300 months (25 years)
Annual Inflation: This is another input parameter that is a critical factor to be considered
Rent: This is the monthly rent that you would expect to pay if you stay in a SIMILAR property.
EMI: This is auto calculated based on the loan amount, interest rate and tenure provided.

All the rest of the fields are auto calculated based on the inputs and the following sections describes how these are being calculated. You can play around with the excel to factor in additional details if needed. There are no macros in the spreadsheet, just cell formulas, which are easy to manipulate.

Owned Apt Cost:

Loan Repaid: This is the total amount of loan repaid (EMI*tenure)
FD loss (own Payment): This is the amount that you would have had if you had invested in a FD instead of paying the down payment for the property. Assumed annual cumulative return@Inflation for duration of the Tenure
Tax Savings (30%): The current 1.5L rebate on income tax is factored in here. Assuming a tax bracket of 30%

Rented Apt Cost:

Rent paid: This is the total amount that will be paid out as rent over the duration of the tenure. The assumption here is that the rent increases@Inflation every year.
EMI Savings: This is the savings that would accrue for you if you go in for rent rather than paying an EMI. The calculation also accounts for the fact that the savings is invested and earns interest@Inflation for the relevant duration i.e for a 20 year tenure, the savings of the first year earn interest for 20 years,the savings for year 2 accrue interest for 19 years and so on. Also note that with the rent increasing @Inflation every year it will get to a point where rent becomes higher than the EMI (which is fixed) and hence at that point, the savings become negative. This has also been accounted for.

Conclusions:

 Difference b/w Ownership Cost and Rent: This is the difference between the two costs i.e cost of ownership - cost of renting.
Current value of Asset: This is the current value of the asset.Assumption is that the appreciation was @Inflation
Net Worth(Ownership): This is the price of the asset minus the cost incurred

Net Worth (Rent): This is the amount expended when living as a tenant

Difference: This is your perceived net worth after the end of the tenure

*Points to Ponder

1) The difference between the EMI and the rent that you would have to pay for a SIMILAR property has a significant bearing on the outcome so validate this assumption. Saying that the property price is 90L for a 3 BHK and then comparing it against paying a rent of 10,000 is illogical simply because if you are actually planning to buy a property worth 90L then it has to have the amenities/environment etc that should command a higher rent.

2) The rate of Inflation is being used to calculate the returns on FD, increase in Rent as well as appreciation in property price. This is realistic but honestly speaking  it is a convenience to make such an assumption but for the calculation intended here, it should suffice.

3) The final asset value also has a huge bearing on the outcome. Be realistic about it. The calculation assumes appreciation @Inflation for the tenure of the loan. This will never happen in the long run so adjust this accordingly. Over the last 5 years however, this logic seems to have held good.

4) Try and keep your EMI to be around 40-50% of your take home salary. Its a safer bet.

5) One obvious thing that is not factored in here is the part prepayment possibility as that is difficult to estimate. However, this too can have a very significant bearing on the total amount you dish out for the loan.

Please play around with the spreadsheet and try out different combinations of the Input paramters to see the effect on the outcome. My favorite calculation was to first decide on a property price/loan details and then play around with the rent parameter to bring the Difference b/w Ownership Cost and Rent as close to Zero as possible. This would give you the "equivalent" rent.

Example:  

In the snapshot given above, the Property price is 90L,down payment was 30L for a Loan Tenure of 20 years@11%. Inflation is at 8% and Rent is 25K.

Overall it shows that the net worth of the person owning the property would be 87L higher then a Tenant.

If you play around with the Rent parameter then the equivalent rent in this scenario will turn out to be 

Rs 41155

Happy decision making!!! Ending with a few lines by a great man

"Ownership has a cost but also brings joy

Leverage your credit, don't be coy

Or chill for a while, pay the rent

Maybe the Earth will expand and you wont repent"- Samrat (A tormented EMI payer) :-)

The Monty Hall Paradox

Over the years, one fact has been very subtly revealed to me by chance. That fact is..that there will always be a finite probability that I do not understand probability. That was recently underscored by my chance encounter with the Monty Hall Paradox, a seemingly obvious problem with a not so obvious solution. For folks who have come across this and still have a niggling doubt about it, I have laid out all the permutations in the below diagram along with the associated explanation. Needless to say, I had to do this to convince my self first of all.

Prerequisites for reading further:

1) What is the Monty Hall Paradox? Why on Earth do we have wikipedia? Please go here -> Monty Hall
2) An interest in Mathematics and/or
3) Extreme Boredom :-)

Ok, since you are already here, lets get to the solution. Here are the scenarios

 Explanation:
 Lets take the first three rows from the above snapshot. Here, the prize is behind the first door and the three rows list out the three possible choices that the player can make.
The player's choice is mentioned under the "Original Choice" column.
The next column shows the final outcome provided the player decides not to switch while the subsequent column shows the result in case he had decided to switch.
Taking the second row as an example, the prize is behind Door 1, the player chooses Door 2, the host then opens Door 3. The player has the option of sticking with his original choice (Door 2) and lose or switch to the only other remaining door i.e Door 1 and consequently win.

The overall success probability for all the scenarios is listed below and as counter intuitive as it may seem at first, the results speak for themselves.

The life lessons I gathered from this are
1) Your first choice is likely to be the wrong one
2) If you get the chance - Switch :-D

Shillong Lajong is one of the well known Football Clubs from the North East of India and recently they had invited submissions for their club anthem. I wrote a few lines and had it sent to them but they were looking for a composed song and not just the lyrics so I didnt get in. Nevertheless, here is what I had written down and all the best to the club! Proud to be a Shillongite. Khublei Shibun!

The Lajong Song

 Our hearts beat, longing for a story

One of victory and everlasting glory,

Dreams, faith, hope and desire

And a will to win, forged in fire;

The path laid by two,

Is not a dream but true

We walk, we play, so say the wise.

It may rain today but the sun shall rise.

We play for victory, we play for you,

We play for dreams, we play for the view,

We shall win and do no wrong

 We are, we are, Shillong Lajong!!