Decision for buying a house
This topic is very close to my heart as it has paved the way for my financial literacy. Also, house is a basic necessity of life and everybody has a need for it. For most, it is the biggest purchase of their life. There are 2 aspects in this decision - Financial and Emotional.
Emotional - A house where a family plans to live creates wonderful memories during its life span. Memories of your kids and watching them grow everyday and eventually flying out of the bird's nest. Also, you can design your home as per your aesthetics and beliefs which are not possible in a rented apartment.
Financial - Below is the list of Financial aspects while buying / selling a house
1. Purchase Price compared to Affordability (Recommended - 2-3x of your annual salary max)
2. Interest Rates - At what interest rate do you plan to take a mortgage loan. At 10% interest rate, you would end up paying double the purchase amount to the bank in 10 years
3. Liquidity - House is an illiquid asset or a liability depending upon whether you are debt free or the house is still under mortgage. It would generally take 1 year to sell the house at prevalent market price in the area. If you plan to premium sell - you have to wait longer. If you plan to discount - you might sell quicker
4. Maintenance - Depending upon how old is the house, you would end up having low / high maintenance cost of the house + maintenance fees of society / neighborhood i.e. HOA.
5. Brokerage - When you buy or sell, you end up paying 1-2% as brokerage fees
6. Taxes - There are Capital Gains Tax when you sell, annual local government tax
7. Insurance - Every house requires insurance.
8. Appreciation - In general if the overall economy is going good, then housing market goes up. Coupled with leverage, appreciation makes your equity sky rocket and leverage remains same.
e.g. $100k house, bought with $10k equity and $90k mortgage loan. If the value of the house goes up to $200k, then your equity value jumps to $110k, bank loan still remains same at $90k or goes down. So you would create $110k with $10k of investment in few years. In MBA parlance, it is called as Leverage Buy Out (LBO) when Investment Bankers buy companies using 10x-20x leverage.
9. Tax Benefit - Depending upon country you would get tax benefit on the interest paid. Its a benefit on INTEREST PAYMENTS (not principal amount OR principal + interest amount). So if you have paid $10k as interest to the bank, you might get $5k as tax benefit. Still it is net $5k loss of your hard earned money per year.
If point 8 turns out to be true, you end up creating lot of wealth for yourself. It it doesn't, you end up paying for the points from 1-7. Points 1-7 are 100% going to happen. Point 8 - 50% chance that it can happen and 50% chance that it may not happen. Plus the appreciation may not be doubled in 10 years. It is your vision / predictability and how things turn out in 10 years based on your predictability.
All the cited above, over a long period of time (10 years at least) - I guess it is a huge huge COST / Liability. Also, when you buy a house you are confirming nothing would happen to your job for next 5-10 years at least. Below is what happened in my life in last 10 years
1. Completed MBA
2. Got married
3. Got kid
4. Left job and changed country (not city / state or region)
5. COVID 19. It is very unfortunate that millions of people lost their lives / jobs / savings in this situation without any fault of theirs.
So how one should buy a house. Here is what I believe one should do.
1. Defer the purchase of a house by few 5-10 years.
2. Instead of paying EMIs to the bank, pay those EMIs as an investment in an Index Fund / Mutual Fund
3. Use the appreciated money, to pay 50-75% down for the house - keeping your leverage down.
4. Pay off the remaining mortgage loan asap - it is bliss to live debt free.
I have learned all the above - hard way. Be smart and learn from others mistakes. Life is too short to keep learning from your own mistakes.
Take care, stay home and stay safe in this COVID 19 environment.
Regards,
Sushil
Emotional - A house where a family plans to live creates wonderful memories during its life span. Memories of your kids and watching them grow everyday and eventually flying out of the bird's nest. Also, you can design your home as per your aesthetics and beliefs which are not possible in a rented apartment.
Financial - Below is the list of Financial aspects while buying / selling a house
1. Purchase Price compared to Affordability (Recommended - 2-3x of your annual salary max)
2. Interest Rates - At what interest rate do you plan to take a mortgage loan. At 10% interest rate, you would end up paying double the purchase amount to the bank in 10 years
3. Liquidity - House is an illiquid asset or a liability depending upon whether you are debt free or the house is still under mortgage. It would generally take 1 year to sell the house at prevalent market price in the area. If you plan to premium sell - you have to wait longer. If you plan to discount - you might sell quicker
4. Maintenance - Depending upon how old is the house, you would end up having low / high maintenance cost of the house + maintenance fees of society / neighborhood i.e. HOA.
5. Brokerage - When you buy or sell, you end up paying 1-2% as brokerage fees
6. Taxes - There are Capital Gains Tax when you sell, annual local government tax
7. Insurance - Every house requires insurance.
8. Appreciation - In general if the overall economy is going good, then housing market goes up. Coupled with leverage, appreciation makes your equity sky rocket and leverage remains same.
e.g. $100k house, bought with $10k equity and $90k mortgage loan. If the value of the house goes up to $200k, then your equity value jumps to $110k, bank loan still remains same at $90k or goes down. So you would create $110k with $10k of investment in few years. In MBA parlance, it is called as Leverage Buy Out (LBO) when Investment Bankers buy companies using 10x-20x leverage.
9. Tax Benefit - Depending upon country you would get tax benefit on the interest paid. Its a benefit on INTEREST PAYMENTS (not principal amount OR principal + interest amount). So if you have paid $10k as interest to the bank, you might get $5k as tax benefit. Still it is net $5k loss of your hard earned money per year.
If point 8 turns out to be true, you end up creating lot of wealth for yourself. It it doesn't, you end up paying for the points from 1-7. Points 1-7 are 100% going to happen. Point 8 - 50% chance that it can happen and 50% chance that it may not happen. Plus the appreciation may not be doubled in 10 years. It is your vision / predictability and how things turn out in 10 years based on your predictability.
All the cited above, over a long period of time (10 years at least) - I guess it is a huge huge COST / Liability. Also, when you buy a house you are confirming nothing would happen to your job for next 5-10 years at least. Below is what happened in my life in last 10 years
1. Completed MBA
2. Got married
3. Got kid
4. Left job and changed country (not city / state or region)
5. COVID 19. It is very unfortunate that millions of people lost their lives / jobs / savings in this situation without any fault of theirs.
So how one should buy a house. Here is what I believe one should do.
1. Defer the purchase of a house by few 5-10 years.
2. Instead of paying EMIs to the bank, pay those EMIs as an investment in an Index Fund / Mutual Fund
3. Use the appreciated money, to pay 50-75% down for the house - keeping your leverage down.
4. Pay off the remaining mortgage loan asap - it is bliss to live debt free.
I have learned all the above - hard way. Be smart and learn from others mistakes. Life is too short to keep learning from your own mistakes.
Take care, stay home and stay safe in this COVID 19 environment.
Regards,
Sushil
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