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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Some thumb rules for house and car

Posted by Muthu on January 9, 2016

1) In a fair market, the rental yields are close to cost of borrowing. If cost of borrowing is 10%, rental yield also need to be around 10%. Then only it makes sense to own a house.

2) Another thumb rule is that the value of the property should not be more than 3 times one’s annual income. If your annual income is Rs.24 lakhs, your house purchase value should not be more than Rs.72 lakhs.

3) The house price to rent ratio should be around 15. If a house cost Rs.1 Crore and the annual rent is Rs.3 lakhs; the price to rent ratio works out to 33, which is very expensive. Going by the thumb rule, if this ratio is above 20, then the cost of owning is considered higher than cost of renting. This means you would be better of paying rent. In other words, the minimum rental yield should be 5% to justify owning a property.

4) Make it a point to save atleast 50% of the property value as down payment; till then live in a rented place. 10% down payment means you work rest of the life for welfare of the bank.

5) Home loan EMI as a part of your income (debt to income ratio) should not exceed 30% (i.e.) EMI should not exceed 30% of your take home pay.

6) The maximum you can pay for the car should not be more than 5% of your net worth. So if your net worth is Rs.2 crores, the car should not cost more than Rs.10 lakhs.

7) Makes more sense to buy a new car. But you should drive it for not less than 10 years.

8) 20/4/10 rule: If you decide to borrow for your car, you should at least put 20% down payment. The repayment tenure needs to be not more than 4 years. The monthly transportation cost should not be more than 10% of your take home salary. Transportation cost includes EMI, fuel and insurance.

9) The best rule: If you can save money and then buy a house and car by making full payment. No debt is the best option. Debt is slavery.

19 Responses to “Some thumb rules for house and car”

  1. I am not able to understand this rental yield theory. In the last roughly 1 year, I have seen such comments or blogs by all kinds of finance professionals and experts that the rental yield in India is very low and concluding that property prices are very high. To my opinion, this is a rubbish argument as of now in India. The problem is that these theories have come from western countries which have a completely different real estate market scenario than in India.
    In India, no body would give you a rent equivalent to 10% of the property value. The actual average rental yield in India for residential property is around 3% and for commercial property it would be around 4 to 5%. Simply because real estate price appreciation is much more in India than in western countries.
    In India, if you take a longer period (don’t take last 2 years price rise as benchmark) of say more than 10 years, roughly property price appreciation has been more than 12% to 15% CAGR. Do you find such kind of price appreciation any where in these western countries from where these theories have been imported.
    If you take property appreciation at 12 to 15% and add rental yield of 3%, then overall appreciation comes to 15% to 18% which is absolutely fair in a high growth economy like India (which country witnessed more than 7% GDP growth in the last 20 years and had rental yield of more than 10% – I don’t think any country).
    In western countries also where rental yield is more than 10%, property price appreciation is in the range of 3% to 6% (you take last 20 years figures for these countries and these markets), and therefore they also get overall 13% to 15-16% return from their properties.
    To me, this is a bogey being created in India in the last more than 1 year, clamoring that since rental yield is low, therefore, in turn property prices are high and therefore in turn property prices should come down.
    Whether property prices are higher and builders are not able to sell their inventory and each city and mega city has huge unsold inventory is a different problem and has to be looked at differently and not from rental yield point of view and comparing rental yield in India with rental yield in western countries.

  2. Editor said

    Super. Thanks!

  3. Editor said

    What a calculations! Awesome!

  4. Editor said

    Home loan can be good debt. Car loan can be bad debt.

    Example: I have 1 crore rs. I bought a house of 70 Lakhs. After 10 year it is 2.5 crore rs. with 15% appreciation.
    But, if I buy house on loan with 30% return stock investment. Every year I paid back from stocks. In this way after 10 year I can get around 5 crores.

    So house is a good debt!

    But, car in the same way will cause 20% depreciation and after 10 year it is losing value. So car is a bad debt!

    What is your view on this?

  5. Kashi said

    I agree with you @Kamalgarg – it’s like using dividend yield for evaluating equity gains.

  6. Taking housing loan is always a great idea, even if one does not need it, simply because your post tax interest cost is roughly 7% ( 10% minus marginal tax rate). And second most important point is that you are taking ‘loan’ for a ‘value appreciating asset’. Whereas if you take a loan for any consumption item (say a car or TV or worse a foreign trip), you are taking a loan for a ‘value depreciating or value evaporating asset’.

    • Joseph said

      A house for own use is a consumption expenditure. The “market value” of such a realty asset is useful only if one can find a buyer. Since not all “speculators” like you would be able to find a greater fool (due to the shortage of greater fools), you cannot generalize and say for sure that a house is always a value appreciating asset. It becomes a sinkhole with no returns. If one is going to be stuck with an asset that can be sold only at a meagre CAGR profit at any point of time, he/she would be better off paying rent for a fraction of the EMI & investing the surplus in some other instrument.

      As long as one can afford a house without sacrificing other financial goals, it is an acceptable “consumption expenditure”, thats my stand… but these days, this is rarely the case.

  7. Editor said

    You are Genius & Helping the Needy! You require one Award!!

  8. Why don’t you initiate one.
    Ha Ha!!!
    I do not know how to forward this post with all the comments to my group of well wishers. I have tried the button “Share This” and “Email”, but it does not work.
    Can you please guide me.
    Can you please arrange to at least send the entire post with all the comments on my email : kamalgarg279@gmail.com
    Thanks & regards
    Kamal Garg

    • And if you further take into account, inflation, then may be your cost of fund from a HFC/Bank would be almost nil (as illustrated above, 7% after taking into account tax benefit to an individual – which is general inflation rate in India.
      So inflation adjusted cost of taking a housing loan is almost nil in India as tax laws stand today.

  9. Dr joshi said

    Super idwas and suggestions

  10. Kumar S said

    Hey Muthu….. I have a car loan of 4.5 Lakhs. I’m paying EMI of 7600 a month (term 7 years). Now I have received some bonus of 50K. I’m wondering if i use it for part payment of loan amount or invest in MF/Specific stock. By paying car loan, I will instantly save 39000 in total interest. I have paid 10 months of loan so far. Please advise

  11. Sagar said

    Question about point#7) Makes more sense to buy a new car.

    Why is this so please explain as I understand that a new car’s value depreciates the moment you purchase it.

    • Muthu said

      Finding a good used car is always a challenge. New car would be more fuel efficient and also can be maintained almost freely for first 4 years by going for an extended warranty.

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