One of the most common loans that many of us take is a home loan. Owning a home is a special and important goal for most people, as it is where we spend a significant amount of our time. However, with the rising cost of land outpacing our salaries, it can be challenging to keep up and fulfill our dream of owning a house. In such cases, a home loan becomes a lifeline that helps us achieve our dreams, and banks are generally willing to provide loans for real estate investments due to the safety associated with this asset class.

Let’s delve into the topic of whether and when a home loan is a good option, primarily from an investment perspective. If you intend to buy a house primarily for personal reasons, you may not need to perform extensive calculations to determine whether a home loan is beneficial. However, this post is mainly aimed at those who view buying a house to diversify their investment. In such cases, any loan can be considered good if the return on the underlying asset exceeds the loan interest. Currently, home loan interest rates hover around 8.5%. Therefore, if you are planning to buy a house as an investment, it should generate a higher return.

On average, rental yields on houses range from 2 to 3% in Chennai, although this can vary depending on the location. Additionally, the value of a house tends to appreciate over time, influenced by factors such as the property’s location and whether it is an apartment or a villa. Generally, apartments do not experience significant appreciation, whereas individual houses see land costs appreciating by around 5% annually. This figure can change based on nearby infrastructure developments. However, it is important to note that only the cost of land appreciates, while the cost of the building depreciates over time. Typically, the cost of land accounts for about 60 to 70% of the total house cost, resulting in an average asset appreciation of around 3.5% over time. When we consider the rental yield and asset appreciation together, the total return amounts to approximately 6.5%. Therefore, buying an asset that provides a 6.5% return while carrying a loan with an interest rate of 8.5% may not make much sense.

To make a home loan more beneficial, we can either increase the rental income or decrease the interest paid. Increasing the rent can be achieved by selecting a property that is closer to workplaces, fully furnished, and suitable for renting to bachelors. These factors can raise the rental yield to around 4%, increasing our overall returns to 7.5%. However, is there a way to decrease the interest paid on the home loan?

Indirectly, yes. There is a tax exemption on home loan interest of up to 2 lakh for an individual. If both spouses are working, this exemption can be doubled to 4 lakh. Assuming both individuals are in the 30% tax bracket, the amount that can be saved per year would be around 1.2 lakh, effectively reducing the interest rate on the home loan. The exact effective interest percentage depends on factors such as the loan amount, tenure, and the number of years the tax exemption can be utilized. The picture below provides some calculations, showing the effective interest rates for a home loan with a 7% interest rate.

For a home loan with an 8.5% interest rate, we can lower the effective interest rate to approximately 6.5%, which would be favorable if our house generates a return of 7.5%. The situation becomes even more advantageous if the home loan interest rate is further reduced. If we can find land suitable for commercial purposes, the returns can be significantly higher, as rental yields on commercial spaces generally range from 5 to 6%. Every financial product has its pros and cons, and it is our responsibility to analyze and choose the right product based on our individual circumstances.

Hope this post might have given a different perspective on home loan. Feel free to write down your thoughts on this below.

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