I see a few otherwise prudent people getting into housing loan and trapping themselves. The story goes something like this. Often people see their friends and friends of friends purchasing houses in various cities and the talks in social connects involve how someone purchased a flat for Rs X near a new suburb and suddenly the price shot up to Rs 1.6X, often ending with some statement like, "If we think of buying a house at this point in time, I definitely cannot afford it. It was so fortunate and with god's grace that I happened to purchase this house 5 years before" And they want everyone to give them post-purchase approval and satisfaction. They make statements like, "See how this area has developed. Who would have thought this 5 star hotel and that huge mall would come here even a few years before".
Ok, now people who thought of saving and purchasing a house, they start to get tempted. And this story repeats itself in multiple occasions for the "saving" people to ignore it completely. And that's when the "home-buying" bug hits them. "We need to get a house. Dot!" But the outskirts areas in the cities are not affordable, so they settle something on outer-outskirts, the nearest to nearest district of the city they would want to work, consoling themselves, "These areas are the new bright spots, see how the place will look like a few years from now". A few years from now moves on and the area remains the same. The people who bought with that only hope are now in denial - how could they have made a wrong decision. The problem is not every area will develop in the same pace and the development takes into account multiple factors - no one will be able to judge or predict. For every owner who said their area got developed so fast in so less time, there will be 5 others who said the place is just as it existed 10 years before.
The problem is with the people who are buying houses not to live in but considering it as in investment. House, especially an apartment is never an investment. The rental yields are so low - around 2 to 2.5% and the building value actually depreciates over the years. It may sound like an investment because of the development that happens around, in certain instances. They get into huge loans for the entitlement of "I own a house now!" and "It is a great investment", "I do not want to miss the opportunity now".
By the way, until the loan is paid off, the house belongs to the bankers! Now coming back to the topic: loan amortization.
Consider this scenario: An apartment costs 30 Lakh Rupees (3 Million Rupees) for which a loan of Rs 20 Lakh taken at 10% to be repaid over 20 years as an equated monthly instalments (EMIs) of Rs 19135. The borrowers really have no clue about how this amortization works. They keep paying this amount every month and even after 3 or 4 years, their outstanding amount hardly reduces. And the weight of the loan sits real heavy on the shoulders! In the initial years, most of what is paid as instalment go in paying of the interest and only a little goes and pays off the outstanding principal.
Given below are the loan amortization inputs.
Now, if you look at how the balance repayment happens, it gives a very interesting perspective. Out of the 20 Lakh loan, it take about 9.5 years to pay the first 5 lakhs, 5 years to pay the second five lakhs. Out of the total loan tenure of 20 years, almost initial 14 years goes in paying off only half of the dues! The third and fourth 5 lakhs take around 3.25 and 2.25 years respectively.
Ok, now people who thought of saving and purchasing a house, they start to get tempted. And this story repeats itself in multiple occasions for the "saving" people to ignore it completely. And that's when the "home-buying" bug hits them. "We need to get a house. Dot!" But the outskirts areas in the cities are not affordable, so they settle something on outer-outskirts, the nearest to nearest district of the city they would want to work, consoling themselves, "These areas are the new bright spots, see how the place will look like a few years from now". A few years from now moves on and the area remains the same. The people who bought with that only hope are now in denial - how could they have made a wrong decision. The problem is not every area will develop in the same pace and the development takes into account multiple factors - no one will be able to judge or predict. For every owner who said their area got developed so fast in so less time, there will be 5 others who said the place is just as it existed 10 years before.
The problem is with the people who are buying houses not to live in but considering it as in investment. House, especially an apartment is never an investment. The rental yields are so low - around 2 to 2.5% and the building value actually depreciates over the years. It may sound like an investment because of the development that happens around, in certain instances. They get into huge loans for the entitlement of "I own a house now!" and "It is a great investment", "I do not want to miss the opportunity now".
By the way, until the loan is paid off, the house belongs to the bankers! Now coming back to the topic: loan amortization.
Consider this scenario: An apartment costs 30 Lakh Rupees (3 Million Rupees) for which a loan of Rs 20 Lakh taken at 10% to be repaid over 20 years as an equated monthly instalments (EMIs) of Rs 19135. The borrowers really have no clue about how this amortization works. They keep paying this amount every month and even after 3 or 4 years, their outstanding amount hardly reduces. And the weight of the loan sits real heavy on the shoulders! In the initial years, most of what is paid as instalment go in paying of the interest and only a little goes and pays off the outstanding principal.
Given below are the loan amortization inputs.
See how the initial payment contributes only Rs 3k towards principal, gradually increases to contribute to the whole of the outstanding principal towards the finishing years of loan tenure. And an inverse relation is observed with the interest which actualy keeps reducing from 15k to 0.
To put the same in terms of time period: if the 20 year period is divided into 4 year buckets, the balance repayment happening in the buckets are respectively 1.74, 2.3, 3.43, 5.11 and 7.42 Lakhs. It needs a very strong heart to see that the the outstanding amount even after 12 years is around 12.5 Lakhs!
Overall payment of Rs 19135 * 240 = Rs 45.92 lakhs for a Rs 20 Lakh loan!
I have published this online loan EMI calculator.
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