So you want to buy a house? Here is a formula which I have arrived at after a long time as a finance professional. Most of these rules were part of the mortgage business in the 1980s and even 1990s.
However, as the greed of the lender (and the borrower) increased, these rules were forgotten. Let this serve as a reminder.
If you follow this rule, you may buy a smaller house (or in a more distant suburb - the price depends on location as we all find out in life) but you will surely have a more peaceful possession and live a life of less stress. That is a guarantee. Many people realised recently that their house was too big a commitment - and a car only added to the misery.
So the formula is 3/20/30/40, but what are the rules? “3” in the rule stands for the total cost of the house. It should not exceed 3x your annual income. So for a person earning say Rs 10 lakh, the cost of the house should not be more than Rs 30 lakh.
Of course, it is very difficult to buy anything in big cities. However, if you do not have anything to sell - like equity shares, property, and do not have financial support from your parents, then you should get a place on rent, till your income increases or you shift to a smaller city /location where you can buy a house for Rs 30-35 lakh.
Assuming that one spouse is earning Rs 9 lakh and the other is earning Rs 5 lakh, then the budget can go up a little - but it means both of you cannot leave the job till the loan is repaid. If both are earning equally, then try to live on one person’s income, and use the other person’s income for quick repayment of the loan.
The next one is “20” - keep your mortgage to 20 years or less. The lesser the better - you pay less interest if the loan is smaller, and for a shorter period. If you can afford the EMI for a 17-year loan, so be it. The only exception is if you are a good and disciplined investor. In such a case you could take a 30-year loan and invest aggressively and smartly. In the long run, this could be rewarding.
The next is “30” - make sure that the EMI that you pay (including all other EMIs for your car, personal loan, etc) is about 30 per cent of your total income. So for a person earning say Rs 7 lakh per annum, the annual instalment should be worth around Rs 2,10,000, which equates to Rs 17,500 per month. This means this individual could take a loan of about Rs 20L for 20 years.
Of course, if you are seeing all these figures in Mumbai or Delhi, you might be wondering where such flats are available. Well, it has to be beyond Mira Road or Ulwe. Best, is to rent till you have accumulated enough money to buy a house. The last number in the rule is “40” - the minimum down payment that you should make while buying a house should be 40 per cent of the house’s cost.
Mortgage companies will tell you that the minimum requirement is 10 per cent. Ask them what was the rule in 1984. So once again, for clarity, here’s the rule in its entirety - maximum 3 times, maximum 20-year loan, maximum 30 per cent of CTC should be the EMI, and minimum 40 per cent should be the down payment.
P V Subramanyam Author and CEO: Subramoney.com