Determining if you are financially ready to buy your first house If you own multiple properties, only one will be considered as self-occupied
Ravi N Rao, a software engineer from Hyderabad got married 5 years back to Swathi Rao, a banker. Ravi andSwathiarenow 34 and 31 years old respectively. After two years of their marriage, they decided to buy a house. The house cost them ₹54 lakh and they took a joint home loan of ₹45 lakh to fund it. At that time, their combined salary was about ₹ 1.1 lakh (₹ 65,000 and ₹45,000 respectively).
Fast forward to now and the couple is expecting their first child in afewmonths. Swathihas decided to take a back seat in her career andwill be astay-at-home parent to take care of the child. But it’s not going to be an easy road ahead. As they transition from a double income no kids household to single income household with a child, they are worried about servicing the EMI, which is about ₹42,500.
“At the time of buying the house, we did not think about such a situation. We exhausted all our savings for the down payment while buying the house,” said Ravi. The couple is not an aberration; owning real estate is considered a proud purchase by many households which is normally funded through loans. House is one of the biggest investments you make, but it may not always be the best investment. You need to assess this asset class on the metric of affordability and future serviceability of any loan you take. Here are few factors that should help you decide if you are ready.
ANALYSING YOUR FINANCIAL LIFE
Unlike financial assets that are liquid—you can redeem your mutual fund units and realize the money in a few days—real estate is not liquid. It can take days to months to find a buyer and the ensuing hassle to sell off the property really makes it a sticky asset. Any financial plan starts with ensuring a solid emergency corpus that will take care of any unforeseen circumstances. “Oneshouldensurethat they have at least 6-9 months of emergency funding in liquid options,” said Varun Girilal, co- founder and executive director, Mitraz Investment Advisors. Then comes the shortterm goals that you may have and think about how it may impact EMI payments. Say, having a new born may change priorities and that may impact income of the household. However, the home loan EMIs will continue to accrue; so have this discussion now rather than later. “The first thing one needs to do is to estimate the liquidity, contingency and funds for nearterm goals,” said Suresh Sadagopan, founder, Ladder7 Financial advisories, a financial planning f i rm. Make a l i st of your expenses—both monthly and annual. Also, note down the near term (up to 3-5 years) goals and funds you need for these goals.
Whether you can afford the loan or not is a serious question you need to ponder upon. Your current financial position without touching your emergency corpus or disturbing your other financial goals—short- and longterm—should allow you to make a decent down payment. “One needs to see whether they have the 25% upfront amount. Ideally, the higher this amount the better,” said Sadagopan. You will be more comfortable if you can afford to make the contribution of 40% to 50% of the property value as down payment. Then comes the EMIs. A good thumb rule is to ensure that your EMI should not take away more than 40% of your take home salary. You need to figure out how you will be able to service the loan in case of emergency like a job loss or increase in expenses. “A stretch of up to 50% of one’s posttax monthly income in EMIs for the first 1-3 years is manageable provided one makes up in building liquid financial assets in later years,” said Girilal. Besides taking the huge loan, the other mistake that Raomade wasmaking pre-payment of home loan as and when the couple had some funds.
LIVING IN THE HOUSE
Then comes the ultimate question of whether you will actually use the house to live in. “This is important as people these days are mobile and they go to other locations nationally or internationally in pursuance of the career,” said Sadagopan. If they are not certain, it may not make much sense buying a house—for they will have a home in one city and they may move to another and will have to rent out, added Sadagopan.
If you are not planning to live in the same city at least for another 5-7 years, it is better to stay on rent. “If you feel that there is a strong chance of relo- cating , then factor how you would be able to bear the rental cost in the new location and EMI servicing together,” said Girilal. Selling the house and again buying another housein the newcity would not be feasible as it involves lot of efforts; transaction cost—stamp duty, registration fee and brokerage—is also very high.
If you decide to let out the house, “you may not always be able to get a tenant immediately. Most housing complexes have high maintenance costs and one should factor that into monthly cash flow planning,” said Girilal. It could also be very time consuming to maintain a house in another city.
Buying a house can’t come at the cost of other important goals like your child’s education and your own retirement neither should it impact your lifestyle significantly. “Home loan EMI is one of the biggest breakers of passions such as travel, entrepreneurship and other interests. Buying a home should not mean having to work in a highly unsatisfying job or missing out on investing for your kids only because of the EMI pressure. It can also set off your time to retirement by a large number of years,” said Girilal. So, besides servicing the home loan EMI, one should have enough savings to invest for other goals and expenses. A lot of people still prefer to invest in real estate as compared to other financial assets, and people who can afford it end up with multiple properties.
While some people have a house in the city of work as well as in their native place, there are others who buy one house for regular stay and invest in a weekend or holiday home in another city. Then there are others whobuyinasecondhousefor rental income and investment purposes.
However, if you have multiple houses, remember that there are tax implications on all the houses you own, except one. Irrespective of whether the houses you own are used by you or your family, either regularly or occasionally, from the income-tax point of view, only one house can be considered as self-occupied.
While there is no tax to be paid on a self- occupied property, income from other houses or the annual value of the houses is taxable.
Here are the income-tax rules for a self-occupied property and other properties you may own.
According to income-tax rules, a self-occupied house is one that is occupied by the taxpayer throughout the year by her and her family. In case of a self-occupied house, income chargeable to tax under the head “income from house property” is considered either nil or negative (in case the taxpayer has taken a home loan for the property). Income tax Act, 1961 allows deduction of up to ₹ 2 lakh in respect of interest on housing loan in case of a self-occupied property, under Section 24(b).
However, in case the taxpayer owns only one property but does not use it for residential purposes owing to her employment, business or profession in another city or location, where she stays in a rented accommodation, the property she owns will be considered self-occupied if she does not let it out at any time during the year or derive any other financial benefit from it.
DEEMED TO BE LET OUT
If a person owns and occupies more than one property for her residence, then one property of her choice can be considered as self-occupied, while all other properties will be treated as “deemed to be let out”.
Even if the other properties remainvacantfor the entire year and do not provide any financial gains to the taxpayer, they will be considered as deemed to be let out and tax will need to be paid on its annual value.
According to Section 23 of the Income- tax Act, the annual value is “the sum for which the property might reasonably be expected to let from year to year”. In other words, annual value is the potential rent that the property would have fetched if it was rented out. To calculate the annual value, you need to consider factors such as standard rent in case the property lies under the jurisdiction of Rent Control Legislation or rent based on the municipal value of the property or the rent equivalent to the rent other similar properties are fetching in the same locality. The higher of these will be considered the annual value of the property.
Once the annual value is calculated, you may be allowed to claim few deductions such as on taxes paid to the municipal department, standard deduction and interest paid on home loan that was taken for the purpose of purchase, construction, repair, renewal or reconstruction of the property.
If youownmultipleproperties and find it difficult to calculate the annual value or tax liability, it is advisable to contact a tax expert or chartered accountant.
TO CALCULATE THE ANNUAL VALUE, YOU NEED TO CONSIDER FACTORS SUCH AS STANDARD RENT
Buying a house can’t come at the cost of other important goals like your child’s education