Rent vs Buy a Home in Depth Financial Analysis
Say you are staying in rent and want to get a clear idea to decide whether to buy a similar home/apartment or stay in rent. We are going to do the in depth financial analysis with all the areas covered practically with future values as well.
If you buy the property, you no longer need to pay rent, which is increasing at 8% per year. This is a significant factor to consider, as rising rent costs can make renting more expensive over time. Let’s revisit the analysis by incorporating the increasing rent cost and compare it with the cost of buying.
1. Rent Increase: Rent increases at 8% per year.
— Starting rent: ₹15,000 per month.
2. Buying Costs:
— Property price: ₹65,00,000.
— Down payment: ₹13,00,000 (20% of property price).
— Loan amount: ₹52,00,000.
— Mortgage interest rate: 9% per annum.
— Loan tenure: 20 years.
— Monthly EMI: ₹46,785 (calculated earlier).
— Monthly maintenance: ₹4,000.
— Monthly property tax: ₹500 (₹6,000 yearly).
— Tax benefit on interest: Up to ₹2,00,000 per year (₹5,000 monthly tax savings).
3. Investment Returns:
— If ₹65,00,000 is invested in mutual funds, expected return is 12% annually.
4. Property Appreciation:
— Property appreciates at 6% annually.
Step 1: Calculate the Total Cost of Renting Over 20 Years
Rent increases at 8% per year. We need to calculate the future value of rent payments over 20 years.
Formula for Future Value of a Growing Annuity:
FV(rent) = P * ((1 + g)^n — (1 + r)^n) / g — r
Where:
- P = Initial rent payment (₹15,000 per month or ₹1,80,000 per year).
- g = Rent growth rate (8% or 0.08).
- r = Discount rate (opportunity cost of investing, 12% or 0.12).
- n = Number of years (20).
However, since ( g < r ), we can use the formula for the present value of a growing annuity and then calculate its future value.
Present Value of Rent Payments:
PV(rent) = P * (1 — ((1 + g) / (1 + r))^n) / r — g
PV(rent) ≈ ₹34,57,350
Future Value of Rent Payments:
To find the future value of these rent payments, we compound the present value at the discount rate (12%):
FV(rent) = PV(rent) * (1 + r)^n
FV(rent) = approx ₹3,33,00,000
So, the total cost of renting over 20 years (including rent increases) is approximately ₹3.33 crores.
Step 2: Calculate the Total Cost of Buying Over 20 Years
Total Mortgage Payments:
- EMI: ₹46,785 per month.
- Total EMI over 20 years: ₹46,785 × 240 = ₹1,12,28,400.
Maintenance and Property Tax:
- Monthly maintenance: ₹4,000.
- Monthly property tax: ₹500.
- Total monthly cost: ₹4,500.
- Total over 20 years: ₹4,500 × 240 = ₹1,08,00,000.
Tax Savings Home Loan Interest:
- Yearly tax savings: ₹60,000 (₹2,00,000 × 30% tax rate).
- Total tax savings over 20 years: ₹60,000 × 20 = ₹12,00,000.
Net Cost of Buying:
Net Cost = Total EMI + Maintenance and Tax — Tax Savings
Net Cost = 1,12,28,400 + 1,08,00,000–12,00,000 = ₹2,08,28,400
Future Value of Property:
- Property appreciates at 6% annually.
- Future value of property: ₹65,00,000 × (1 + 0.06)^20 ≈ ₹2,08,46,150.
Net Gain from Buying:
Net Gain = Future Value of Property — Net Cost of Buying
Net Gain = 2,08,46,150 – 2,08,28,400 ≈ ₹17,750
Step 3: Opportunity Cost of Buying
If you invest the down payment and the money spent on EMI in mutual funds at 12% annually, let’s calculate the opportunity cost.
Down Payment:
- Amount: ₹13,00,000.
- Future Value if invested:
FV = 13,00,000 * (1 + 0.12)^20 = 13,00,000 * 9.6463 ≈ ₹1,25,40,190
EMI Payments:
- Total EMI over 20 years: ₹1,12,28,400.
- Future Value of EMI payments if invested:
FV = 46,785 * ((1 + 0.01)^240 — 1) / 0.01 = 46,785 * 989.26 ≈ ₹4,62,00,000
Total Opportunity Cost:
- Down Payment: ₹1.25 crores.
- EMI Payments: ₹4.62 crores.
- Total: ₹5.87 crores.
Step 4: Net Gain from Buying
1. Future Value of Property: ₹2.08 crores.
2. Net Cost of Buying: ₹2.08 crores.
3. Opportunity Cost of Down Payment and EMI: ₹5.87 crores.
Net Gain:
Net Gain = Future Value of Property — Net Cost of Buying — Opportunity Cost
Net Gain = 2.08–2.08–5.87 = -5.87 crores
— -
Step 5: Comparing Renting vs. Buying
Renting:
- Total Cost of Rent Over 20 Years: ₹3.33 crores.
- Future Value of Investment (₹65,00,000 at 12% for 20 years): ₹6.27 crores.
- Net Gain from Renting: ₹6.27 — ₹3.33 = ₹2.94 crores.
Buying:
- Net Gain from Buying: -₹5.87 crores.
Final Recommendation
After accounting for rising rent costs (8% annually) and property appreciation (6% annually), the analysis still shows that renting and investing the difference is financially more advantageous in this scenario. The key reasons are:
1. Higher Investment Returns: The 12% return from mutual funds outperforms the 6% property appreciation.
2. Rising Rent Costs: While rent increases at 8% annually, the cost of buying (including EMI, maintenance, and property tax) still outweighs the benefits of property appreciation and tax savings.
However, if you value stability, ownership, or the emotional benefits of owning a home, buying might still be a viable option. But purely from a financial perspective, renting and investing the difference appears to be the better choice.
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