The dream of any Indian middle-class family is to own a house. This is true irrespective of the city in which they reside.
When a child settles down to a steady job, there is enormous parental pressure to buy a house. In most cases, the child is fulfilling the unfulfilled dreams of a parent.
In such cases, the requirement is more an emotional need due to which logical risk analysis of one’s finances is neglected at great peril. Rational decision-making goes out of the window as emotion takes over decision-making and the borrower gets over-extended and falls into a debt trap. This must be avoided at all costs.
Long-term impact
The financial calculations ignore the fact that these decisions have a long-term impact as mortgages run for a period of 20 to 30 years.
Most of us assume that the price of real estate moves only in one direction, that is, in the upward direction. Nothing can be further from the truth, as property prices across any significant urban centre in India have demonstrated over the last decade. When buying a house with a large mortgage, one must realise that signing a mortgage agreement is a lifetime contract, the implications of which will be felt over a half of one’s working life.
It assumes that your salary or income will be perpetually going up. In most cases, the reality is contrary to expectations. This is what the current pandemic has taught us.
If you have decided to buy a house on a mortgage, buying a flat ready for delivery is preferable. Many middle-class families have discovered to their grief that several builders have collected payment from banks but have not completed construction of the flat within promised deadlines. In some cases, they have not been delivered even after a decade has passed. The law of the land is apparent; it is the responsibility of the borrower to repay the financial institution irrespective of whether a property has been entirely constructed and handed over or is hanging in between. This means you will have to pay the Equated Monthly Instalments (EMIs) while fighting the builder in court.
Choice of mortgage
The most important decision that a borrower has to make, after deciding to go ahead with the loan to purchase a property, is whether to take a fixed interest mortgage or a floating rate.
The interest rates on mortgages are dependent upon the monetary policy of the Reserve Bank of India. If the Reserve Bank is in the cycle of cutting interest rates, then one can safely expect mortgage rates to be low and can expect lower rates in the coming months. When the Reserve Bank turns hawkish and increases interest rates, one can be assured that the bank lending rates would go up.
During the lifetime of a mortgage, one can expect several such reversals in the monetary cycle.
Today, interest rates on mortgages have been at their lowest for a long time. Inflationary pressures are raging across the globe, and it can be safely assumed that interest rates will go up in India in the next six months and continue to be elevated at least for the next two years.
Monetary policy changes
Here are the reasons why the central bank would choose to change its monetary policy:
Interest rates in the developed markets worldwide are set to rise because inflation levels are elevated in the United States (inflation is at a 39-year high in that country).
When the U.S. Federal Reserve decides to increase interest rates, dollars that have been invested in other markets start to flow back to the U.S.
The Reserve Bank of India will be forced to raise interest rates to keep the rate differential between the two economies at the same level.
Two, prices of common goods in the wholesale market in India has remained elevated in the region of 10% over the last seven months. It is not yet reflected in the consumer price index.
Due to rising costs in raw materials, several companies selling fast-moving consumer goods and automobile manufacturers have been passing on the costs to the consumer in recent times.
Protecting the consumer
This will force the RBI to reverse its loose monetary policy and increase rates.
Therefore, it makes sense for a borrower to opt for fixed interest rates.
Ordinarily, financial institutions offer a fixed rate only for three years. It is advisable that one locks into interest rates currently low — for the next three years.
A word of caution is necessary on expectations around asset prices. Elevated borrowing rates act as a gravitational force on asset prices. So, one can’t expect a significant increase in real estate prices over the next three years as long as the interest rate remains elevated.
(The writer is a chartered accountant and a financial consultant)