Buying a House

Buying a house is one of the first things on your mind after you get a job. Part of the reason is that a house is a major source of security, stability and status. This is probably the biggest financial decision taken by most people. Yet, as the housing crises all over the world shows, this is a decision that is easy to get wrong.

Emotional Factors

Many of the mistakes that are made while people are buying a house are because of "emotional" factors associated with it. So I will address those first.

1. Status Symbol: Owning a house certainly is a status symbol. But you need to ask yourself how much are you willing to pay for purely the status part of it as a fraction of your salary. While the number will vary for different people, it should not be more that 10-15% of your take home salary. In any case, asking yourself this question and writing down a number will help you take much better decisions.
2. Convenience: Sure, it is much more convenient to not have to change a house every year or two. Further, you can decorate / customize your own house to an extent that nobody will allow someone staying on rent to. But you need to ask yourself when will these important enough - before marriage, after marriage or after having kids. On the other hand, do remind yourself that buying a house reduces a lot of flexibility. I know a number of people who bought a house and then in a few years switched cities because of their job. Many wasted several months in a dead end job because they did not want to change cities / the new offer was too far off. As a rule of thumb, you should buy a house only if there are a large number of opportunities nearby or if you plan to stay in your current job for 3-4 years.
3. Marriage: Few people openly talk about it but that fact is that in arranged marriages (and increasingly otherwise as well) owning a house is a big plus point. To be sure, a house is a sign of stability - and it is relatively more polite to ask if the prospective groom has his own house (and ask to see it) rather than asking what is net worth is. I would like to emphasize that one should concentrate on education, job, basic savings and house in that order and that you are probably better off not marrying someone whose priorities are significantly different.
4. Pressure: A number of people, especially bachelors buy houses not because they see any major benefit but just because their parents of relatives pressure them to. Spending a few hours trying to figure out your life plans will help a lot. If you have just got a job then typically you will not know what you want to do with your life; purchasing a house will be a major decrease in flexibility.

Financial myths

I now look at a few common misconceptions regarding housing.

1.  House prices never decrease. Not true. They decreased in Mumbai in the 1995-2003 period. Search on the internet for proof.
2. If you want to buy a house for self use anytime is a good time. Again not true. It should be common sense that if a decision does not make sense for one class of customers (i.e. the investor), it will not make sense for another class (i.e. the end user).
   This myth is probably spread to get more end users to buy in the current slow market. The justification probably derives from the efficient market hypothesis which says that a market cannot be timed (i.e. you cant be sure that if you wait prices will fall, no matter how insane they appear). Unfortunately, housing market in India is very far from being efficient. Besides, even if a market is efficient, the ideal way to invest is systematically (i.e. a small amount every month) so that temporal risk (i.e. the risk that price will suddenly change in a small period of time) is avoided. Unfortunately, that is not an option in India currently.
3. Rent is wasted money; it is better to pay EMIs. It is a surprisingly common myth that I have seen. Somehow people forget that the interest that you pay is as much a waste.
4. Returns on property are high, especially if you take a loan. This is partly correct to the extent that there are tax benefits on interest repayment. However, the bulk of high return is due to leverage - the fact that you are borrowing money to invest. As long as price appreciation (+ rent) is above interest rates, leverage will magnify returns; however if prices remain event flat for some time, returns will become significantly negative. Basically increasing leverage increases risk so the returns should not be directly compared.

In my next post, I will talk about setting a budget to buy a house.