Can I afford this property?

You see a nice house on the newspaper / net? You like it...it just seems perfect.

Can I afford it? This is a million dollar question...its seems so simple yet has many hues. Affordability requires three things, cash, credit and collateral.

In this blog, let’s take cash.

Firstly, look at what you have managed to save (exclude statutory savings such as PF) for the last six months. Now deduct the abnormal blips in income such as bonus or income from sale of any investments. Divide that by 6 (no. of months). This is what I can safely call your "gross disposable income" for a month. Next, deduct all statutory savings like PF, taxes etc. Let’s define the balance amount as your "Net Disposable Income".

You need money every month to pay for Food, Rent, Clothes, Entertainment, Medicines, EMI’s (Existing loans) etc. The spending (debits in your bank statements) appears to be “inevitable monthly expenditure”. Or is it? Take a close look again and mark out the purely voluntary spending that cannot be considered essential expenses. Make a list of that. You may be tempted to assume, that most of them you can give up since you are making a big purchase (property) and future benefits surely justify small sacrifices. That might be possible, but take my word for it, that over a period of time, this approach will fall by the side.

Pick up the same list again. Make a small note against each on the frequency of such expenditure. Aha....now we are talking...can we can cut down on that regular restaurant dining? What about that (inevitable?) dinner post the movie show? Talking about which, can we rent out more popular movies and watch them on the DVD player - with family and friends - go ahead and buy some instant popcorns to go with it – Great!! Now there’s some more money to add to your disposable income.

Next, depending on whether you are going in for a "ready for occupation" (residential) property for yourself, or for leasing it out; calculate the savings (of existing rent) or income expected from rentals. Add that to your “Net Disposable Income”. This is, roughly, the amount you can afford to pay on a monthly basis. You might want to take 75% of the amount to stay conservative.

• You need to assess your "Net Disposable Income" to calculate the maximum amount you can pay for the loan instalments. Be sure to keep a buffer of 15 – 20% at least for exigencies. This is your “Repayment Capacity”

• Identify and cut down on your impulsive spending. You will be able to increase your repayment capacity.

• Keep at least 6 months savings in liquid and near liquid savings as a buffer for life’s ups and downs. Beware; you may not be ready to compromise a lot on your current life-style. This is really important. Really!

By the way, most lenders will take approximately 35 – 40% of your monthly income as your repayment capacity per month. You will be able to club your spouse’s income (generally financial institutions would insist on both borrower and co-borrower to be assessed for income tax) .

Now to the next step - Margin money.

Every lender would like you to contribute a certain amount known as “margin money” or “down payment”. This is to ensure your equity and therefore your interest in repayment of the loan in the event that the value of property depreciates. This is where most first time buyers get stuck. Don't worry, just dive deeper into your finances.

You would have made investments in many instruments like Mutual Funds, Fixed Deposits, PF, Shares and bonds, Cash in bank, real estate and gold, all of which are liquid (ability to turn into cash) in various degrees.

Let’s assume the following amounts apply in your case:

Savings in Bank: Rs. 100,000
Fixed Deposits : Rs. 200,000
Mutual Funds : Rs. 350,000
PF : Rs. 400,000
Gold (worth) : Rs. 500,000
Shares : Rs. 75,000

• PF: You will be able to withdraw your PF savings to fund your house. Go ahead and take it. It’s one of the few windows provided by PF rules to withdraw. Make a mental note that this is really a withdrawal from your retirement fund. (Assumed w/d: 85%)

• Fixed Deposits: Right time to break the deposits – your FDs earn far less that the borrowing rate on the loan. (Assumed redemption: 90%)

• Gold: Tricky – Lender of the last resort. Family jewels helps maintain a healthy relationship with your spouse. Remember, it would be better to keep it for a rainy day. Unless, of course, you have a door open for more inflow of the same. Just kidding! However, if you really need to, dip into this instrument with caution. (Assumed sale: 25% )

• MFs and Shares: This is near liquid and requires some thought. To sell, identify the ones providing weak returns or low liquidity and keep working through the rest till your requirements are met. (Assumed sale: 90%)

• Family: This source is subject to availablity. However, you may want tread cautiously here. Check whether your family can contribute some capital for down payment. Always assume that this is a personal loan. Most family members including your parents will not be able to forego that money indefinitely – hence clearly state the time-line for repayment. If you can top up the loan by a generous amount when returning, do that. Your family would be too embarrased to point out that they have lost “bank interest" on the principal lent. Insist even if they refuse. (Assumed Loan from family: Rs. 500,000)

Raising the margin money:

Ignoring your savings account balance, which anyway should be applied to the 6 months income rule, you could raise the same from the investments listed earlier:
• FDs : Rs. 180,000 (90%)
• MFs & Shares : Rs. 380,000 (90%)
• PF : Rs. 340,000 (85%)
• Gold (worth) : Rs. 125,000 (25%)
• Family : Rs. 500,000 (Assumed as interest-free loan)

Total money available for down payment: Rs. 15,25,000.

Most financial institutions lend up to 85% of the value of the (to be acquired) property. The actual amount depends on specific guidelines of the lender for income recognition, value of the property and a host of other credit parameters including your past record of repayments.

A quick note: Ensure there is no outstanding EMI on existing loans (Home loans, personal loans, credit card loans etc.). Most lenders do check on your previous track record though a credit rating agency. Also, in case you have gone in for a compromise settlement of outstanding dues in the past – that would work against you.

Cheers, till the next blog on Credit.