In the last two weeks I have had three conversations with young folk looking to buy residential property on loan. There is emotion involved, there is some amount of self-worth and status involved and there is always an element of trying to please elders involved.

What nobody considers upfront, is the real cost of debt. They are aware, they need to take a loan and consider that loan amount as the cost. It is not. People will also talk about how the loan is really for an asset and the value will go up. It may, but there is no certainty. Moreover, if the property is meant for investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains..., as in, you are going to put it up for rent, it important to consider rental yield rather than capital gain alone. In Indian cities, rental yield is around 2.5%-3.5% per annum whereas the loan interest rate is roughly 8.5%-9.5% per annum. There itself the investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... case for residential real estate taken on a loan is negated.

What you also need to understand is that banks will front end interest cost within the monthly EMI or monthly payment. Sample this: for a Rs 54 lakh loan at 8.5% per annum for 20 years, the monthly repayment instalment works out to Rs 46,862. For a 20 year loan period, you will end up paying a total interest cost of Rs 56.46 lakh.

In the first ten years, the total amount paid as EMIs would be Rs 56.23 lakhs, 79% of this is interest repayment and only 21% is principal repayment. Which means that at the end of ten years you still owe the bank about 80% of the principal amount you borrowed. Roughly Rs 44.35 lakh is interest amount paid to the bank in these ten years.

Now if it’s an under construction property, the rental income won’t even start soon to offset against this kind of high cost. So, really, the math of this entire transaction doesn’t really workout well. Capital value gain for the property may happen, but there are too many variable to take into account like, location, developer, quality of the construction, permits allotted, neighbourhood and so on. Plus, there are other costs like registration and stamp duty, municipality charges, maintenance costs, loan processing charges and so on.

The alternative is to invest this money regularly in another growth asset, equity. Take the amount of EMI and just start a regular monthly investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... in a simple equity fund for the next 5-7 years. Grow your investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... and savings pool, accumulate that and then use it to buy a house without a loan or with a small sized loan, if you must.

Practically speaking this would make more sense. Even if you are not planning to take a loan, consider that the annual rental yield can be low and the capital gain uncertain.

But then as we said at the start, buying a house is almost always an emotional decision. When it comes to fighting this emotion in favour of the practical, rational choice. Think of this: the elder you are trying to please, will be pleased but will not be able to share the monetary weight of your decision to take a large sized home loan. Your life circumstances are not the same as your parents’ and the conditions under which they bought a home have changed significantly for you. The real cost of debt shows up in the emotional strain of repayment, in your inability to negotiate job change or career leaps because of the sword of EMI looming just above. It shows up as the emotional strain of having to show restraint in upgrading your lifestyle because you have debt to repay and it shows up as dissatisfaction because you are chained with this one task of paying EMI and unable to move forward till the time the loan is repaid. Some people do get lucky or move forward in leaps professionally; money comes in sooner than expected and home loans get paid off well in time. But these cases are fewer than those where home loans drag on to a point where it becomes a heavy burden to carry.

If you are buying a house to live in it, it’s not an investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... and the economics doesn’t really matter in terms of the rental yield or the expected appreciation in value, but the burden of the loan will still matter. Yes, owning a house is a beautiful dream and you must go ahead, provided you can afford it. Taking a 90% loan value to buy that house is not the same as being able to afford it. So, please think long and hard before making this crucial decision and do the math or ask for help and then do the math. But surely don’t rush into this highly critical money decision of your life.