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Business News/ Money / Personal Finance/  The math behind the right-sized loan

The math behind the right-sized loan

  • Banks may be willing to give you a bigger home loan. But there’s a catch
  • The home loan amount that one can get from any lender goes down as interest rates go up. The vice versa is also true in this case

File photo of an affordable housing complex, in Naigaon, outside Mumbai.

MUMBAI :

Scene 1

It’s 6pm. The sun has just set and the sky turned maroon as it often does on random evenings. Pooja has been watching the sun set from her rented flat, in the central suburbs, while talking to her mother-in-law or Mummy ji, on the phone.

Scene 1

It’s 6pm. The sun has just set and the sky turned maroon as it often does on random evenings. Pooja has been watching the sun set from her rented flat, in the central suburbs, while talking to her mother-in-law or Mummy ji, on the phone.

“Do you remember Chintu?" Mummy ji asked.

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“Do you remember Chintu?" Mummy ji asked.

“Yes," she replied. “Your younger sister’s elder son."

“Yes," said Mummy ji. “He bought a 3BHK in Bengaluru in January."

“But didn’t he get fired after that?"

“Yes, but he still has the flat," replied, a rather irritated Mummy ji. “And my sister reminds me of that every time she calls."

Scene 2

Later, the same evening. Around 9pm. Pooja’s husband, Rahul, has come back from work.

“So how was your day?" he asked.

“It was spent trying to fine tune my PhD topic further," she replied. “Also, your mother called in the evening."

“And?" he asked, as always, slightly apprehensive when she spoke about his mother.

“She wants us to buy a flat."

“Nothing new there."

“Yes," she said. “But she was rather emotional today."

“Hmmm. So, what are you suggesting?" he asked. “Should we buy one?"

“I mean there is no harm in doing some basic thinking," she said. “Any way, it’s not a decision that can be made overnight."

Scene 3

Early morning the next day. Around 7am. Pooja has a serious look on her face and is staring into her laptop. Her husband has just made coffee.

“Did you sleep well?" she asked, as he handed over the cup of coffee to her.

“Yup."

“I couldn’t sleep at all. The conversation with Mummy ji has been really hassling me."

“That’s not good," he replied.

“Anyway, I got up and did some basic research."

“And?"

“So, I figured out the math behind taking a home loan."

“While that’s not the conversation I want to have first thing in the morning," he replied, “but now that you have started..."

“First things first. I have taken a break from working to do a PhD. So, I don’t have a regular income and that limits the total amount of loan that we can take."

“Hmmm. Of course, two incomes go a longer way than just one."

“I looked at your salary slip. Your take home salary is around 2 lakh per month."

“Oh, is it?" he asked. “You know I have no idea about these things."

“So, given our expenses, I think we should be comfortable paying an EMI of roughly around 70,000 per month."

“That makes sense."

“If we are ready to pay an EMI of 70,000, we will get a home loan of 80.7 lakh at an interest of 8.5% to be repaid over a period of 20 years."

“My my, that’s impressive," he said. “You have already figured out the math."

“It’s pretty straightforward if you know the right functions to use on a spreadsheet," she replied.

“Hmmm. What if we aren’t able to get a home loan at 8.5% per year, but get a loan at 9%, what happens then?" he asked.

“At 9%, an EMI of 70,000 over 20 years can repay a loan of 77.8 lakh, which is around 3 lakh lower than the loan we can get at 8.5%."

“Interesting. So, the loan amount that one can get goes down as interest rates go up."

“Yes. And vice versa is also true."

“Vice versa?" he asked.

“Like if we had managed to take a loan early last year when the home-loan interest rate was at 6.5%."

“What would have happened then?"

“At 6.5% interest, a tenure of 20 years and an EMI of 70,000, we could have taken on a home loan of around 93.9 lakh, which would have been around 13 lakh higher than what we can take on currently."

“Oh damn!"

“Also, home prices have risen in the last one year."

“That’s a double whammy!"

“Not really," she replied.

“How?"

“Because interest rates have risen in the last one year, so the benefit of low interest rates wouldn’t have lasted that long. Of course, prices have risen too and one can’t do anything about that."

Scene 4

Early afternoon, the same day. Pooja is staring into her laptop and wondering if she should really be doing a PhD, given that everything else has taken a backseat because of this one decision. As she was lost in her thoughts, her mobile started to ring. Mummy ji was calling.

“So, done with the cooking beta?" asked Mummy ji.

“Mummy ji," she said, “you know na Rahul cooks in the evenings."

“Oh yes, my son is a great cook," replied Mummy ji, never dropping an opportunity to praise her son. “But you should also learn to cook his favourite recipes."

“Which he is already doing Mummy ji," she replied, ignoring the barb.

“Did you guys talk?"

“About what Mummy ji?" she asked, trying best to hide her irritation.

“About buying a home."

“Oh that," she said. “I have started a conversation."

“Good to know that," replied a rather happy Mummy ji. “Rahul is just terrible with money decisions."

Scene 5

Same day, late night. The husband and wife are just about ready to go to sleep.

“You know Pooja," said Rahul, “I spoke to my colleague Ashish today."

“And?"

“He said we were being very conservative."

“Not liberal?" she asked, trying to get in a poor joke.

“Pooja yaar…"

“Okay, okay. Conservative about what?" she asked.

“At my salary level, banks and housing finance companies will give us a bigger home loan than just the 80.7 lakh you worked out. And that we can easily stretch it a little more. And that one has to take some amount of risk while buying a house given that incomes generally tend to go up."

“Which is true. I have been Googling and checking out home eligibility calculators across the websites of various banks and home finance companies."

“And?" he asked.

“There is a rule of thumb going around and it says that banks and housing finance companies are comfortable giving out a home loan of up to 60 times the monthly salary."

“Hmmm."

“Which means that at your take-home of 2 lakh, we can possibly get a home loan of 1.2 crore, which is nearly 50% more than the home loan amount of 80.7 lakh that I feel comfortable with."

“So, what’s the catch?"

“On a home loan of 1.2 crore at 8.5% per year to be repaid over 20 years, the EMI works out to 1.04 lakh. At 9%, it works out to 1.08 lakh."

“I see where this is going."

“I am currently not earning any money. At 1.04 lakh, more than 50% of our monthly income will go towards the EMI. It will really stretch us and we will have to cut down on many of our other expenses. Also, we will be saving next to nothing and I don’t like that."

Scene 6

Around 3pm, the next day. Mummy ji calls but her daughter-in-law is taking an afternoon nap and ignores the call. Mummy ji immediately calls her son, who is getting a dressing down from his boss, for having failed to meet last month’s sales target. Mummy ji throws her phone on the bed and goes off to make a cup of tea. Nothing irritates her more than her kids not taking her call.

“I don’t know why they do this to me," she cries out in frustration.

Scene 7

Late evening, the same day. Rahul has come back from office early. Pooja is out for a jog. Just as Rahul is about to make himself a cup of coffee, the doorbell rings. Pooja is back. They look at each other and immediately know that they have had a tough day.

“Are we in a position to take on a home loan of 84 lakh?" asked Rahul.

“Theoretically yes," replied Pooja. “At 8.5% and a 20-year repayment period, it would mean an EMI of slightly less than 73,000."

“Hmmm. I have come to know of this nice one BHK in the neighbouring building. The owner wants 1.1 crore for it. But the agent I am talking to is Ashish’s friend and can get the owner to knockdown the price to 1.05 crore."

“Hmmm."

“Of course. We will have to pay stamp duty and also pay a commission to the agent. So, net net, the total cost should work out to 1.15 crore. With a loan of 84 lakh, a down payment of 21 lakh, we can buy that flat. And we would need at least another 10 lakh for other expenses."

“The thing is that we will need at least around 31 lakh from our savings ( 21 lakh down payment plus 10 lakh for other expenses)," she explained.

“Yes, that’s true," he replied.

“Our total savings amount to 40 lakh. This means exhausting a good portion of our savings and I don’t really like that."

“But Ashish did say that we will have to stretch?"

“Well. Ashish doesn’t know our finances, na!" she replied, slightly irritated. “We are paying for the flat, not him."

Scene 8

Late night, same day. Rahul and Pooja are ready to call it a day when Rahul’s mobile rings. Ashish is calling.

“Good time to talk boss?" asked Ashish.

“Yes," replied Rahul.

“Okay. So, my brother-in-law is looking to sell a one BHK flat that he had invested in. He wants 90 lakh and is unwilling to budge."

Rahul had put the phone in the speaker mode, so, Pooja was also listening. He looked at her and raised his eyebrows and head slightly to ask what did she think about this. Pooja gestured that he should keep talking.

Scene 9

A few weeks later. Rahul and Pooja have bought the flat. They have taken on a loan of 75 lakh and made a down payment of 15 lakh. They had to spend a few lakhs more to pay the stamp duty and to pay for the other expenses of moving into a new flat. Their savings were down to around 18 lakh. The savings situation was better than where they would have ended up if they had gone ahead and bought the flat in the next building, which would have cost them 1.15 crore. Also, the EMI on a loan of 75 lakh was around 65,000 and almost 8,000 lower than the EMI on a loan of 84 lakh. Nonetheless, they had to cross the creek and live further away from the city.

“So, Mummy ji should now be happy," said Pooja.

“Yeah," replied Rahul. “We have finally done something that should make her happy."

“And she will now finally have something to talk about, when her sister talks about her son Pintu."

“His name is Chintu," replied Rahul.

“Same difference," said Pooja.

Scene 10

Rahul and Pooja have moved into their new apartment. Mummy ji is visiting. Rahul has gone to pick her up. The doorbell rings. Pooja goes and opens the door. Mummy ji rushes in and quickly checks out the new flat. Thirty seconds later, she rushes out into the living room with a disappointed look on her face.

“This is even smaller than the servant’s quarter my father’s government bungalow used to have," she said. “And it’s just a one BHK… Now, what will I tell my sister? Her Chintu has a three BHK."

Pooja gives Rahul that look.

(The example is hypothetical).

Vivek Kaul is the author of Bad Money.

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