Rent to pay EMI strategy: Pros and cons

For people looking at investing in real estate,there are two options available.

For people looking at investing in real estate,there are two options available. A house is an investment when you look at making money from it,either in the form of rentals or by re-selling it at a higher price. That is why in personal finance,the self-occupied property is never counted as an investment asset.

Two options

Let us look at the options available:

1. You can book a flat when the project is launched and sell it when the project is completed.

2. You can buy a ready-to-move in property and start getting rentals right away. These rentals can partially fund EMIs.

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Let us examine, which of the two options is financially better:

Book at launch and sell when complete: When you book a flat,you have to put in only a smaller sum of money. The return on investment may be better. However,if you were to borrow to purchase the flat,you might have to keep paying pre-EMI or interest on the amount borrowed until you can sell the property.

This is an expense without any tax benefits. Also,remember the capital gains tax aspect. If the property is resold for a profit within three years of the agreement date,then the gains are fully taxed with no scope of savings.

Booking a ready-to-move in property:

The above problems with purchasing and selling a flat can be partially negated when you purchase a ready to occupy property. You can purchase the property with a loan and start paying EMIs immediately.

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This means both the interest paid without any limit and also the principal repaid up to a maximum of Rs 1 lakh (under Section 80C) can be claimed as deduction from taxable income. There are many options to also save tax on capital gains when a property is sold after three years. Until then rentals can also be enjoyed.

However,it has its own setbacks:

Income earned as rental is taxable as income from house property

On an average,the rental income from house property will be in the range of 3-5 per cent of the value of the house. Which means,say you buy a house for Rs 50 lakh and avail loan for 80 per cent of the value,your EMI for a 20-year loan at 10 per cent interest will be about Rs 39,000. In addition,the same property will yield about Rs 15,000-18,000 as rent. The rest of the EMI is a cash outflow from your pocket

If you have the capability of shelling out the additional Rs.20,000 from your other income,Or if you have a bulk amount of Rs 30 lakh,which you can invest in the property and restrict your loan to about Rs 20 lakh so that your EMI matches the rent then this whole proposition will work wonderfully.

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More importantly,finding a good tenant is a big task in itself. On an average,expect your house to earn only nine months rental in a year. Assume that for about 2-3 months in the year the property will lie unoccupied but your EMI remains. You should have the ability to manage such an instance.

Therefore,the tax advantages and the fact that you may be able to resell the property for a substantially higher price after a longer period are the positives. On the other hand,the adverse cash flow situation in such a scenario is an obvious negative. Also,please remember a house property is an illiquid asset. If you are stuck with it,this can turn out to be a long drawn out affair. Go for it,if you understand the pros and cons well enough.

The author is CEO,BankBazaar.com