Housing market in many countries is dependent upon what could be easily termed as loan economy. India is no exception. Right?
But have you ever thought whether housing loan is leverage or liability for you? Do you even understand the difference between leverage & liability?
Have you ever been taught to differentiate between good debt and bad debt? A good debt is one where you earn more with the borrowed money than the interest being paid.
On the contrary, a bad debt is one where the interest rate is higher than earning, if there is any. So, you have to pick wisely whether a debt is your ally or enemy
Does a house on loan have asset capacity to deleverage your financial obligations in the wake of an emergency?
Think again, if your home loan is just a function of your future earning potential. This could be a liability with potential to destroy your life in case of an emergency.
One question that I am asked at various forum is that whether one should buy a house on loan. Of course, this has reference to my public view across media spectrum that a home loan is more often than not liability and not leverage in India. I must admit here that seeking an answer to this question, most of the people asking this are already having an opinion on this. All that they need is a confirmation bias; something that they could justify to self and others with a statement of confirmation. Someone who understands the world of real estate and finance also said this. Right?
I have hence always maintained that there can’t be a one-size-fits-all answer to this. To each his own. There is a reason why the subject of money management has been called personal finance. It is very personal. Whether a home loan is a leverage or liability depends upon the borrower. It would be a very generic statement to say that a piece of property with borrowed money is a leverage. The same goes true with the generalized statement that housing appreciation being slower than interest paid makes a lousy financial choice. These are lazy answers to a complex problem.
Say for instance, someone having INR 1 crore in his investment portfolio that earns him 14% per annum takes a home loan at 8.5% interest rate. Now, with an interest arbitrage of 5.5% in earning and debt payment, this would qualify as leverage. But the same home loan at 8.5% interest could be a liability for someone if the given property is his only asset and the said property is appreciating at a nominal rate of 6-7%.
A lot of financial experts even believe that instead of paying 8-8-5% interest to bank, it would be prudent to stay on rent in the same house with 2-2.5% payment and the rest could be invested in high appreciating asset. This could enable the person to buy the same house without any home loan in the next 10-15 years, depending upon the returns. But that is a subject of discussion for some other day.
The game of leverage & liability is not limited to just the financial calculation. It is much more for an average salaried middle-class Indian. The cultural belief in this part of the world is that a house (read roof over the head) is the biggest social security. Right? But wait! If a house on loan is the only social security with you, this psychological security won’t help you in any given emergency.
Say for instance, there is a medical emergency in family that needs large capital after 4-5 years of buying a house on loan. Does your house have the asset capacity to bail you out? If you wish to liquidate the said property in urgency, it would mean a distress sale and would fetch lower price than the prevailing market price. Mind you, the EMI that you have paid to the bank in the initial few years of property acquisition is mostly the interest paid and not the principal amount. So, in your final calculation there could be a potential situation where you need to pay more to the bank than what the current selling price of the said property is. So, this kind of loan is a liability.
Does it mean that one should not buy a property on loan? Of course not! If you have a net-worth, and exposure to other liquid asset class that can take care of your emergency needs, then your home loan is a leverage. You are earning higher with your money than what you are paying to the bank for loan. More importantly, a piece of property is your risk mitigation strategy and you are not putting all your eggs in one basket – be it stocks, mutual funds, gold or real estate. In such a scenario, property being less volatile, compared to financial asset, is a prudent financial decision.
So, it all depends upon the profile of the borrower that defines whether a home loan is a leverage or liability. While it is a leverage for someone having a net-worth, it is definitely a liability for someone not having any financial back-up plan and having bought a house due to cultural conditioning in this part of the world. One slogs the initial ten years of his professional life to save the 20% downpayment amount and then further slogs for the next 20 years to repay it to the bank. Customer enablement with home loan is a smart strategy only for the banks and the builders.
This also raises a fundamental question as to who is an ideal candidate for buying a house on loan. In other words, who can turn loan as leverage? Well, in an ideal condition a person who can serve his EMI with the passive income generated from his other investments is the ideal case study of leveraging a loan.
Unfortunately, this is not the reality of a vast majority of Indians. Several studies have shown that 98% of urban salaried middle-class Indians don’t have any social or financial security. They are mostly living a pay cheque to pay cheque life; and more often than not are just one step away from a medical or legal disaster in life.
What makes the case of home loan borrowers even worse is the absence of financial education in this part of the world. Several studies have shown that most of the home loan borrowers don’t even understand the terms & conditions of the loan. They don’t understand that the banks mostly deduct the interest part first in the initial few years and keep the principal intact for the later part of loan repayment. Understanding of prepayment fee or penalty is also limited. Very few home loan borrowers even negotiate the prepayment fee, if they get some money to prepay the loan, and prepayment penalty is often as high as 6%.
I must add here that the statement of people falling into a debt trap with home loan is not 100% true, it nevertheless is a reality. Home loans are no doubt cheapest loan available in the market. And the whole argument of loan as leverage or liability is not black and white situation, it’s actually grey. But those who don’t understand the financial game of leverage and have just started earning, a home loan is not just a liability but a potential debt trap.
Ravi Sinha
X : RaviTrack2Media
Ravi Sinha is a journalist with over two decades of cross-discipline media exposure. He is the CEO of real estate thinktank group Track2Realty. He has been writing extensively on the real estate sector for more than a decade now. Evaluation of real estate brand performance is his core domain expertise and he has immense insight into consumers’ psychograph. He has conceptualised Track2Realty BrandXReport as India’s 1st & only objective & non-paid brand rating journal that is industry-accepted benchmark of brand equity & ranking of the Indian real estate companies.
Track2Realty is an independent media group managed by a consortium of journalists. Starting as the first e-newspaper in the Indian real estate sector in 2011, the group has today evolved as a think-tank on the sector with specialized research reports and rating & ranking. We are editorially independent and free from commercial bias and/or influenced by investors or shareholders. Our editorial team has no clash of interest in practicing high quality journalism that is free, frank & fearless.
Subscribe our YouTube Channel @ https://bit.ly/2tDugGl
