Till about 4-5 years back owning a home was a dream for many of us. The real estate prices were fairly steep as compared to our income levels. Finance, though available, was both cumbersome to avail and quite expensive.
Since then and at least till last year, the scene in the real estate and home loans have been nothing short of dramatic. While the real estate prices were subdued, the average income levels rose sharply, making purchase of a home quite affordable. And, so called adding fuel to the fire, was the home loan bonanza - sharp drop in the interest rates, increased tax benefits and easy availability. This has resulted in a huge growth in the purchase of property.
But the scenario seems to be changing. In last one year or so, while the real estate prices have gone up quite appreciably, the home loans interest rates are also rising. Therefore, the situation today warrants exercising caution.
Real estate
The supply of housing has not kept pace with the demand. Also, in the interim the prices of steel, cement etc. have also increased leading to higher construction costs. This has resulted in a jump in real estate prices from anything between 20-100%.
The question one is, therefore, forced to ask is – Is this a bubble? Will it burst soon? Where are the real estate prices headed?
While the local factors – city to city, location to location - will be important to look at, it can reasonably be assumed that with the continued good economic growth, the demand is likely to remain strong. But the prices have already run-up sharply, which can affect the demand. Hence, while it may be difficult to comment on how much further the real estate prices can go up, the likelihood of any significant reduction in prices look doubtful.
To a getting caught on the wrong foot, we need to first decide on the need for investment in real estate – Is it for personal use or is it an investment?
In case the home is to be purchased for personal use then it is more important to look at whether you can afford it or not. Since the prices in the near future do not seem likely to come down, the decision to buy or not will be more governed by ‘need’ and ‘affordability’, rather than the future price trend. As long as one has to stay in a particular house, it doesn’t really matter if its’ price is Rs.1 lakh or Rs.1 crore.
However, if the purchase is purely from the point of view of investment, it is important to do a thorough analysis. Have the prices in the area already increased appreciably? Is any development expected in the future which may increase/sustain the demand and hence the prices? Etc. This analysis becomes more critical if home loan is being taken to finance the purchase. Fall in real estate prices, together with increasing home loan rates, could put one in a spot of trouble. It is important not to be tempted by the past price increases or overextend oneself on the home loan.
Home Loans
And how does the interest rate scenario on the home loans look like? Should one go in for a floating or fixed interest rate? How much loan should one avail?
Is it still cheap?
While the home loan interests have started moving up, they still are quite affordable. And the tax benefits make it still more attractive. Further, though the monetary situation today indicates that the interest rates may move up, the increase is not likely to be very steep.
Fixed or floating?
It is difficult to take a call on the interest rate scenario beyond a year or so. But on the other hand a home loan is of typically 15-20 years tenure. Therefore, it will not be correct to base one’s decision to go in for a fixed or floating option, solely on the developments of the last 6 months to 1 year.
Let us decide on the issue from a slightly different perspective. The fixed interest rates today are around 8-9%. In a best case it could go down to say 5-6% depending on how the monetary situation pans out over the next 10-15 years. But, if things go bad, it could increase to say 12%, may be even 15%. Who knows? Therefore, while the benefit from the downside movement seems limited, the upside movement in interest rates can prove disastrous.
Hence, a person should opt for a floating rate interest if (a) his financial position is such that he can afford to bear the interest rate volatility and (b) he is in a position to prepay the loan out of his investments if the interest rates become too high.
If you are a fairly affluent person then you could go in for a floating rate home loan and invest your own funds in options where you can earn much better returns. This way one is in a net surplus situation. The day this situation reverses, one can pay off the loans.
But, on the other hand, if someone is not in a position to pay higher interest charges and not comfortable with the interest rate fluctuations, he may be better off locking himself in a fixed rate option.
How much is enough?
As regards the maximum loan amount one should avail, financial prudence suggests that the annual EMIs + Property Tax + other costs should not exceed 30% of the annual income, even though one may be eligible for a higher amount.
Today, there is no one solution applicable to all and each one of us has to weigh the pros and cons very carefully and see how it meets one’s individual profile.
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