Consider this case where
- Cost of a real estate: Rs. 100 lakhs or 1 cr
- Own contribution – 20 lakhs
- Loan – 80 lakhs
- Rate of interest – 10.75%
- Loan tenure – 20 years
Here are the questions for you:
- What is the EMI?
- How much interest will you end up paying over the tenure of the loan?
- What is the real total cost of your apartment?
Now the story.
I was visiting the capital city a couple weeks back and met a friend who was my ex colleague as well.
After the catching up was done, I slid into my role. (Compulsive disorder, you see).
How are your investments doing?
“Oh, I just bought a new commercial property, six months ago!”
I was taken aback ( I knew his background).
How did you fund it?
“I got a loan from XYZ bank at 10.75% for 80 lakhs. I withdrew some money from my mutual funds to make the downpayment. Kar liya manage (I managed it somehow).”
So, my friend now pays Rs. 81,000 EMI every month and will do it for the next few years. Along with the other EMI he is servicing, the total burden on the take home income is over 50%.
Strange as it may sound, while he said, “I bought a commercial property”, he should be saying, “I bought a loan”.
The asset remains a myth as long as the loan and its interest nibble away your asset’s value.
The money lenders at your door
As long as you have enough take home income and the lender doesn’t find you risky, it will be willing lend you more.
Why not? It gets to earn interest from you, very predictably. More steady income, more profits for the lender.
As for you, you behave like the good borrower. Fear of a downgrade in CIBIL reports ensures that you pay on time, regularly.
You bloat your ego with the fact that you bought an asset that will never go down in value.
It may not yield you enough and make your portfolio significantly illiquid but that doesn’t concern you.
Frankly, you need to rethink.
Is what you bought on loan – an asset or a liability?
Here are some pointers I gave to my friend. You may want to use it too.
- When you take a loan, you pay interest. The interest is a COST and should be added to the total cost of the investment. The basic cost of real estate is 100 lakhs, the interest that you pay is about Rs. 30 to 40 lakhs over the years. Without taking into account time value of money, your total cost is Rs. 130 to 140 lakhs.
- When you compare the market value and start bragging about your returns, take into account this total cost and not the base price. Shocked?
- When you buy an asset on a loan, you may want to show the Rs. 100 lakhs as your asset value. In that case, please also note the current loan value of Rs. 80 lakhs on the liability side. The net worth is only Rs. 20 lakhs.
- What about productivity or returns? You pay a lot but your returns are measly. On residential real estate, for example, the rental yield is about 2% (pre tax, pre maintenance). On commercial, it could be 1% more. Count in some appreciation of the asset. Then compare with the REAL cost. Where do you stand?
- When you pay interest, it diverts resources from one kind of investment to another. You may in effect be altering your asset allocation or worse, putting a most of your eggs in one basket. Does that present a healthy financial position?
Think and I ask you.
Where do you stand?
Do share your views and experience.