3 Questions to ask before buying a second home

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Things to consider before purchasing second home

Introduction

In the previous blog, we discussed the things one should consider before making a purchase of housing property for primary residence. However, it is quite common in India to purchase a housing property from investment point of view. Let us discuss a few things one should consider before buying a second home.

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3 Questions to ask before buying a second home

1. Is the property value appreciation more than the interest rate of home loan?

  • Most of the people prefer buying second home on loan. In this case there is a tax benefit associated with the interest payment of home loan.
  • For example – if a couple applies for a loan of INR 40 lakh at 8% p.a. Considering they appear in the top tax bracket of 30%, they are eligible for the tax benefit of (8%*30%) = 2.4% on interest payments.
  • Thus, their effective interest rate for home loan becomes 8%-2.4% =5.6%.
  • Here, one should compare if the property will appreciate at a rate higher than the effective interest rate of 5.6% or not, and accordingly take a decision to buy a second home.
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2. What will be the Rental Yield on the second home?

  • Here, rental yield is given as [(Monthly rental income*12)/Original price of the property]*100
  • Lets understand rental yield with the help of an example. Considering a property worth INR 1 crore in any tier 1 city will fetch a rental income of ~INR 20,000-25,000 per month. This sums up to the annual rental income to the tune of INR 2.4-3 lakh. Thus, here the pre-tax rental yield is given as [(2.4 to 3 lakh)/1 crore]*100 = 2.5% to 3%.
  • However, if we consider taxes at 30%, here the rental income reduces to INR 2.1 lakh and further reducing miscellaneous expenses like maintenance costs, etc the rental yield comes ~1.5% -1.8%.
  • However , it is advisable that one should consider buying a second home only if the post-tax rental yield for that property is to the tune of 3%-5%.
  • Currently the post-tax rental yield in majority of the tier 1 cities is ~2%, which is not very attractive from investment perspective.
  • Usually , once the effective rental yield goes up ~5%-6%, the property is considered more lucrative and it marks the beginning of another bull run in real estate.
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3. Are you ready to bear the financing liability (EMIs) for buying second home?

  • If one is buying second home by taking a loan, it comes with the commitment of paying EMIs.
  • Also one needs to note that buying a real estate comes with one-time lump sum down payment along with EMI commitments.
  • Many people tend to compare EMIs with SIP. However, SIP is a discipline while EMI is a commitment. One can always choose to stop/reduce their SIPs, however the same is not the case with EMIs.
  • Thus it is suggested that one should take a note of all the financing liabilities that come with buying a second housing property and then take a decision prudently.



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