Wednesday, February 04, 2009

EMI Quiz

I was running some numbers thru an EMI calculator and was surprised at some of the results, so I thought why not play a little game with the bloggers and have some fun.

Assuming a principal of 10L, interest rate of 12% and repayment of 20 years, how much of the EMI payment would go towards interest at the end of 5 years ?

Interest paid
A) 2.52 L
B) 3.85 L
C) 5.78 L
D) EMI = equal interest and principal payments so does not matter.

Now if a US homeowner borrowed the same at 6% what would be the result

A) 1.20 L
B) 2.78 L
C) 3.21 L
D) Half of the answer of Q-1

The answer as some people have pointed out is C for Q1 and B for Q2. The black magic of the EMI is responsible for a payment of more then 500% of the EMI towards interest as opposed to principal. After 5 years the borrower wouldve paid 80k as principal and 5.8L as interest. At the end of 10 years the principal payment is 2.3L as opposed to the interest of 10.8 L. After 15 years, you have finally paid of 1/2 the principal and 15L as interest. At 20 years you have paid off the 10L principal and 16.4L as interest.

Now for an average apt of 1crore in Mumbai with 10% down lets do the numbers for 90L loan. Here I wouldve paid an interest of 1.4 crores for a 90L loan and god forbid if I couldn't make the EMI after 5 years and had to sell the apt I wouldve paid 52L as interest with 7L as principal and the house would have to be worth atleast 1.4 crores to break even.

The EMI method of loan repayment is one of the worst methods of calculation and benefits the banks the most, leaving the borrower shackled in loans forever. As finance professionals will tell you, there are many ways of calculating interest where interest and principal are paid off in equal chunks per payment. Here the interest payment is drastically reduced due to the reducing principal. Unfortunately the bank has no interest (pun not intended) in principal payments and all they care about is the interest.


Anonymous said...

You can get this in XLS in 3 mins

Q1 - Option C

EMI value 11010.86

Q2 Option B

EMI Value 7164.31

What price for me?

Anonymous said...

EMI value meaning monthly payment...

Dont tell me that this is for fun and no price... you need to reward me

Vik said...

You need a reward for 3 mins of work :)

Anonymous said...

Dear Shailesh & Bharat,

Was a bit busy and hence could not reply to your specific questions.

Most of the asset class will not grow YOY on a fixed percentage. In property generally after the crash, it will be stagnant for couple of years, later show some moderate growth and when the sentiments are right it will shoot up.

The same has happened to this time, we saw a crash in 96-97and again a boom started in early 2005 and went on to mid 2007. It was during this period the prices of property went in multiples of 3 times and in some cases 5 times.

Area which have gone three times have grown @ around 9% CAGR but areas which have grown 5 times have seen more then 13% CAGR,(year 1997 to 2009) which I feel is abnormal for a city like Mumbai.

When we look at our 97 salaries vis a viz the current salary I feel 9% CAGR is not a great jump. If we look at India during 97 and the current India, we all know that things have changed drastically.

Shailesh the basic change is mind set of people, their expectation. Sizeable number of people with one kid and in some cases with no kid is looking for 3 & 4 BHK.

Look at the cars around, owning a 800 was a big thing in 97 but now even a Octavia is like OK types.

There are lot of thing I can keep on writing but does not make sense as I am sure we all will be knowing about it.

Bharat: I work for an MNC in Mumbai and I have personally checked with people who have brought houses in late 60's, early 70's and even early 80's. I have done the working personally with today’s price and have arrived at this figure of 12% CAGR for 3X properties(refer my earlier post).

I would request you to carry this simple exercise for Mumbai and let this group know.

I don’t want to influence anyone in this forum to buy now or later because I am no authority but the reason I participated in this blog was only because of my strong conviction.

Some days back one of my friends told me Mumbai is in for a 100% crash because we are only 20% lower then Tokyo. I just asked him what areas are you comparing of Tokyo with what areas in Mumbai. Even assuming if you are comparing the likes of Tokyo to likes of Mumbai even then we cannot say that we are only 20% lower.

Tokyo has an FSI of 10 and whereas Mumbai with TDR has only 2. Which means Tokyo is 6 times more expensive.

I know this is a calculation has not taken into account a lot of other parameters and hence wont make any sense but lot of report which we read and make judgment on also does not necessarily reflect the truth.

All the Best to all you guys!!

Bindas Bhai

Anonymous said...

Shailsh said:

The last one is just a big scam created in people's psychology. Mumbai has lot of land in surrounding areas. Also now that Supreme court has allowed 4 times FSI for redevelopment, the amount of supply is significantly more than what population of mumbai will need for next 10 years. Just drive by Thane Ghodbunder road and you see 80% flats are empty. No lights burning at night.


If you could see my earlier mail, around six months back I have always mentioned that Thane and New Mumbai will correct in a big way and the same has happened especially in Thane

I have no doubts that where ever there is excess supply rates will definitely come down

about: FSI

Govt of Maharashtra had proposed FSI of 3 in City i.e Dadar down south of Mumbai and 4 for Suburbs. This is only for very old tenanted building and not across the board and with effect the supply will be limited.

I feel no builders will go for any fresh development till things settle down.

Let us wait and watch and understand the trends. I feel by June this year we will get some more clarity where Mumbai market is heading for.

Bindas Bhai

Anonymous said...

Typical scare tactics. On any housing or vehicle loan, interest payments are quite shocking for a person who is not familiar with the way these loans work. The obvious foolish conclusion will be to never borrow money to buy a house. It is fine if you have money for 100% down payment. If not, you will be stuck in a rented house forever. The only place you can brag about your sorry state will be blogs like this.

Anonymous said...

For the last five years the interest component for 10L @ 12% will be Rs.170668/ and @ 6% will be 61,160/=

Anonymous said...

Inflation for wk-ended Jan 24 at 5.07% vs 5.64% WoW

Vik said...

Anon at 12:40 am

That is exactly the point I'm driving at.
@ 12% the indian buyer is paying more the twice the interest to the bank as compared to the US.

The US consumer has more equity in his house, pays less interest and gets a higher tax break on the interest, as there is no 1.5L cap like India.

At the end of the loan, the Indian consumer pays 160% of cumulative interest as opposed to 72% in the US scenario.

the magic of compounding.

Observer said...

Bindas Bhai is correct in stating that housing prices have appreciated at 12% CAGR. Inflation over the last 20 years has averaged around 12% as the Govt prints money to make up for the difference between revenue and spending. We all know how populist our governments are, and thus cannot control spending.

It is natural that housing will grow with the rate of inflation. This is because, people tend to spend a certain fixed percentage of their income (maybe around 30-50%) on housing. Hence, as incomes go up with inflation, housing will also go up with inflation. Actually it is not housing, but the value of land. More income in people's hands will mean people paying more for land. In fact, consumer price inflation contains rents as one of its biggest components, about 30%. Thus, by definition, expanding the money supply will lead to inflation as more printed notes go into people's hands.

However goods like cars, electronics, and other items, will in general not appreciate at the same rate of inflation because of efficiency and productivity improvements in the manufacturing process. These also form a smaller component of the basket of goods used in the inflation calculations. This is one reason a Maruti 800 costs only about 30% more today than in 1998. For a more detailed breakdown of the basket of goods and services used, one can go the RBI website.

Rents, food and grocery costs, medical costs including pharmaceuticals, and educational costs form the majority of the basket of goods and services in the inflation calculation.

Now, real estate prices go through booms and busts, and the average comes out to be 12% or so. However, it should also be noted that interest rates have also gone up and down during these periods, with a lag. This is because when the money supply increases, leading to more printed notes in people's hands, which leads to them bidding up prices for housing, but also causing banks to lose money as their debt is inflated away in cheaper rupees. After all if money supply becomes 10 times in one year, people's wages are going to go up by 10 times, which would lead them to pay off the entire bank loan in one year itself with cheaper rupees. That is why banks immediately raise interest rates so that people cannot inflate away their debts.

So, the point is that investing in a fixed deposit would lead to a lag in the inflation adjusted returns, thus with a slightly lower appreciation rate compared to housing. However, it will not be volatile like housing prices. Unless one does not care about one's principal for about 20 years or so, then it would be ok to invest in housing.

For people looking to buy a property for themselves and not for investment, and want to stay in the property for 20 years or more, the only metric that really makes sense is affordability. After a serious correction making properties affordable, and achieving job security, it may make sense to buy.

For investors, they should probably wait till the correction completes its cycle before buying near the bottom. Even if they miss the bottom it is ok, but at least their investment will not suffer large losses, at the cost of some missed opportunity to the upside.

Observer said...

Of course my strategy is different, since I have some issues with metros in India, particularly their noise, pollution, extreme overcrowding, poor sanitary conditions and higher crime. I would rather rent and save money and buy a plot in a small town to build a house and retire. This allows me to take advantage of the arbitrage in wages between metros and small towns, which drives housing prices (land prices really).

For others, who only want to retire and live in metros, then my previous summary would apply in terms of buying when properties become affordable based on income levels and job security.

Anonymous said...

Thanks Observer for your support.Your point is vaild and informative

Thanks once again,

Bindas Bhai

Aditya said...

There is one more angle you have missed. There will be a cash flow of owning either the rental income or equivalent amount you save by owning. Of course in early years, you will be paying much higher interest than equivalent rent. So your point is still valid.