Let us take an illustration.
Assumptions:
- House rent Rs 10,000 per month for a house costing Rs 60,00,000. Rent increase by 6% every year.
- Home Loan EMI at 9% interest rate is about Rs 45,000 per month.
You stay on rent and save the spare cash into a diversified equity Mutual Fund scheme. You invest in the Direct Plan of the mutual fund. The fund gives you 15% per year over next 20 years. There are many such funds which have done so in the last ten years.
Following table is the cash flow in both options on an Yearly basis.
The summary is that you Value of MF holdings after 20 years becomes ₹ 3,77,73,665 whereas the value of the House after 20 years is ₹ 1,92,42,813
Benefit of MF over House = ₹ 1,85,30,853.
We are assuming the monthly surplus is invested in one lumpsum at the end of the year. MF value will be higher if the surplus is invested each month.
Here is the bar chart view of how the Value in any given year changes over time.
One may argue that MF returns of 15% are very high. If you change it to 12% (very reasonable), then the surplus is 68 lakhs. And if you drop the 20 year return on Mutual Funds to 10% the surplus is still 11 lakhs.
Conclusion #1: Clearly staying on rent is better as far as the numbers speak.
Impact of broker commissions:
If you do NOT invest in Direct Plan Mutual Funds, then broker takes about 1.5% commission. In such a case the surplus reduces from 1.85 crores to 1.21 crores. This means broker commissions are as much as Rs 64 lakhs!
Conclusion #2: Investing in Direct Plan Mutual Funds is far more profitable (to you, not the broker).
What about the Sentiment and Emotion?
Of course one needs to weigh this with the emotional and sentimental reasons of owning a house vs renting. It is hard to say no when the heart wants to stay in “Your Own House”. But keep these other factors in mind too:
- Are you somewhat of a nomad in your early career years, or
- Want to go back to your home town, one fine day
- Want to go retire at a farm house or a hill station
- Wish to keep moving to a ‘bigger house’ every 5 years,
In such cases it makes sense to stay on rent and invest the surplus. When the time comes, you can buy a nice house in your choicest locality, after having explored the world!
Conclusion #3: It is a battle between the head and the heart.
Read more:
3 Reasons to Switch to Mutual Fund Direct Plans – Jama
Note (updated):
- I am ignoring LTCG for now, the impact will be minimal even if one withdraws the entire corpus in a single year. The MF gap over the house value would still be abbot 1.5 crores. LTCG exemption limit may likely be raised from 1 lakh to an inflation adjusted amount in 20 years.
- Home loan is also partly exempted from income tax upto a cap of Rs 2 lacs. This doesn’t change the math significantly.
- Assuming a lower return on MFs say 12% will still bring down the gap to Rs 67 lacs. Long term i.e. 20 yr investments need to compared with equity class.
- Renting a house for long term may involve costs of shifting every 3–5 years to a new house (part of the adventure!). For some their employer may cover such relocation costs.
