Friday, August 28, 2009

How to become bankrupt once a loan is approved

As everyone knows the availablity of home loans in India has propelled the market to new highs in 2007, sometimes upto 300% in 3 years. Most homes are unaffordable to the average Indian who is somehow supposed to magically generate money out of think air. Indian loan rates are double that of the US so the average interest payment on a loan is more twice of an average US loan. Someone suggested in one of the comments on how one can double money in 3 years by buying a property. Lets analyse this myth and see if the investor doubles this money or just goes bankrupt.

Property value total including registration : 1,00,00,000 (1cr)
downpayment : 15L
loan amount: : 85L
interest rate: : 10%
loan period : 20 years
EMI : 82026.84
payment towards interest 1st year : 8.4L
toal payment towards interest after 2nd year : 16.7L
total payment towards interest after 3rd yar : 24.8L

total principal paid in 3 years : 3.5 L
Total equity in house : 15 + 3.5L = 18.5L
Loan early termination fee 1% of oustanding principal : 1% of 80L = 80k

After 3 years the property has to sell for atleast (1.25 +80k ) = ~1.26 crore to break

Lets tabulate the gains based on the projected returns.

increase = -20% gain = -46%
increase = -10% gain = -36%
increase = 0% gain = -24%
increase = 26% gain = 0%
increase = 50% gain = +129%
increase = 100% gain = +400%

All we can say is that leverage is a high risk, high reward game. If you have the guts to lose 50% of capital or 46L in 3 years, you can make anything from 129% to 400% in that same period.
All the best to the risk takers. You deserve the reward as it is commensurate to the risk.

 The above example is more relevant for an leveraged investor.  Let us now think from the point of view of the renter. If the annual rent is 3.6L,  over 3 years the renter pays approx 11L for 3 years. It makes sense for the renter to buy an apt for a price where EMI is closer to rent, rather then further way. Its more common sense then any complex math

Lets do the same calculations for a 60L apt with a rent of 20k

price 60L
downpayment 15L
loan                   45L
tenure               20 years
interest rate    10%
EMI                   43400

total interest over 3 years : 13.1L
total principal paid             : 2.4L
total equity                          : 17.4L

total rent paid  over 3 years  : 7L

here a 3 year rent payment leaves only 5L as a difference over 3 years over the interest paid. 


skeptic optimist said...

Bottomline is that buying property for doubling investment is fool's gold. Property has value only if you buy to live in. Even renting is a waste at current market levels.

No one will rent that house even for 20k for which EMI is 80k.

I am doing this
- down 10L
- Loan 26L

House price may decline further max by 10-15% which may wipe out my down payment, which I am ok with in the short term. In 3 years it will most definitely be the same value as today.

So calculating your risks is very important. I can afford 1 crore house based on my US salary - but I am buying only 1/3rd of my technical affordability :)

Anonymous said...

Fewer Catching Up on Lapsed Mortgages

Homeowners who fall behind on their mortgage payments have become much less likely to catch up again, a new study shows.

The report from Fitch Ratings Ltd., a credit-rating firm, focuses on a plunge in the "cure rate" for mortgages that were packaged into securities. The study excludes loans guaranteed by government-backed agencies as well as those that weren't bundled into securities. The cure rate is the portion of delinquent loans that return to current payment status each month.

Fitch found that the cure rate for prime loans dropped to 6.6% as of July from an average of 45% for the years 2000 through 2006. For so-called Alt-A loans -- a category between prime and subprime that typically involves borrowers who don't fully document their income or assets -- the cure rate has fallen to 4.3% from 30.2%. In the subprime category, the rate has declined to 5.3% from 19.4%.

"The cure rates have really collapsed," said Roelof Slump, a managing director at Fitch.

Anonymous said...

I suppose this is why BB calls himself Bindass or devil may care..these are same people who get wiped out. Because the vicissitudes of fate swing both ways.

From Bindass to Sandass(Shit) in short order,such can be your fate.

If someone tells you that taking inordinate risk is the only way to make money, remember all the great investors have been risk averse. Don't trust me go read their biographies...Be risk averse and safe go for the low return with no risk to principal and over the longer term become a rich person without losing your self.

The other path leads to Sandass Bhai...

Anonymous said...

Very Nice Analysis Vik!

Thanks its an eye opener. I suppose the next step would be to attach likely probabilities to the likely outcomes..

Outcome of 50% gain in the short term from these prices? maybe..but very low probability

100% gain from here..impossible.

20% loss very likely...

One problem I see with this is that you have not computed the possibility of say 50% loss and maybe even 80% loss.

If you can do that and add it to the post that would be awesome. Because I see a 50% loss from these prices having a mid-high probability and maybe a 80% loss as well.

On the other hand, noted analysts are claiming that rates are going to swing higher and that too maybe from October 2009 onwards..The chances of the market tanking and rates rising to much higher levels is very high. The builders are playing their shenanigans and the buyers seem to be sitting tight..the buyers need to just do this for another year to bring all these builders, along with their black money and politicians and bindass bye's to their knees :)

Remember the power is always with the buyer. The buyers who blink first now are going to curse themselves roundly and are going to be big time losers in the long term..

-Samajhdar Behan

Anonymous said...

God analysis but you have not taken care of the rent out going. Finally we need a house to stay. All these calculation were applicable since last two years when most of us predicted fall in prices.

Media and economist say that the worst is behind us. Now taking a call we all have to think like Bindas Bhai and not like Sandaas Bhai which most of us are.

I am really fucked staying on rent house and now this Diwlai the landlord wants me out. God knows when the so called crash will come. My elder brother feels that now since market had corrected there is no chance that prices will come down. Prices pre-election results will become the base and RE will move up further for Bombay. Hope you guys are right. I seriously wish i had brought in March 09, i would have saved atleast 25L on a 2BHK house.

Please pray for me.

Anonymous said...

Ha Ha Ha Ha Ha Ha......

The joker Bindass again. He sounds like a broken record. The same message over and over again...there is only one chance and that is to buy houses at inflated prices. If you miss it the prices will inflate again. All bubbles/balloons have to burst, the bubble which expands indefinitely has not been found. So if you have been living on rent, you have been wise and will survive and one day thank yourself for staying on rent.

The balloon has to burst and it will if you take a loan and buy a house you will suffer not a loss of 46 lacs but over the term of the loan you will squander away all your security...go ahead and blunder BB. I know its you....your moronic comments are very clearly the comic relief in this site.

Ha Ha Ha Ha Ha Ha....

Anonymous said...


You have missed the Intrerest Amount that would have been earned on Downpayment of 15 Lakhs. (Nearly 1.35 Lakhs per year and 4.0 lakhs for 3 years. ). Return of 9% based on Low Risk Debt Funds.

If you add this the losses of 1 cr house increase further.

Redo your calculations.

As for Sandaas Bhai, beware just like we have malware and anti-virus google is coming up with blogger-ware where shitty blogers like you will be flushed.

shailesh said...

Vik - You have to substract Rent for the same duration. Assuming you are Renting to stay somewhere.

In reality, most people in India live with their Parents (unless you moved to other town for work). In that case, the rent for most will be 0, and your analysis would be correct.

shailesh said...

Forget home prices, even Rents fall.

Dubai rents 'plummeting'

The property advisor said office rents across Dubai fell by 25per cent in the second quarter, but the decline is falling compared to the 45per cent fall in the first quarter. Rents for Grade A space, excluding DIFC, now average at AED225 per square foot, in line with levels seen in mid 2007. This now made prime Dubai offices cheaper than those in London, Paris, Hong Kong, Mumbai and Moscow, the firm said.

shailesh said...

'Affordable housing needs a holistic look'

Say for example, a 300 sq ft flat is a decent livable area for a driver working in a government or private firm. Then, he should get it at 5 times his annual income which is defined as Rs 60,000 a year. So he should get a 300 sq ft flat worth Rs 3 lakh somewhere near his area of work. If he cannot get houses at that rate, then we have a problem that the market is not producing products that people could pay.

The other day at the seminar of Maharashtra golden jubilee celebrations, there was this talk to whether post-6th pay commission, the chief secretary who earns Rs 1 lakh a month could afford a house in Mumbai. At this rate, he will probably get it at Dahisar. There is something wrong in the real estate market when such a large section of people cannot buy a flat.

shailesh said...

The above link has some good quotes,

Naik: If we are talking about 20% as reasonable profit, then two years ago, we were selling a flat at Rs 4,000 a sq ft at Andheri and now, it is Rs 15,000. Land cost was same. Add construction cost of 1,500 a sq ft. At 20%, then the cost should be Rs 6,000-7,000.

Banerjee: Lots of affordable housing has come in the market. One benefit of economic recession is that many good projects have come in. The problem would be for developers who have bought land at high prices. Even land owners have become saner in their price demands. If this drought continues and the economic doesn't improve, then next Diwali you may be able to buy a house at an affordable rate.

Irani: Prices have rationalised about 20-30% lower. Developers have become wiser and are not in a hurry to increase prices. The housing stock has improved. Four to five developers have launched housing projects which are affordable rates above Rs 1,500 a sq ft. I would think this is the right time to buy.

shailesh said...

Affordable Housing: An Idea Whose Time Has Come

shailesh said...

Soon, a train every three minutes on Central Railway

shailesh said...

MMR got due attention only in the recent past

Anonymous said...

Regulators shut down banks in Calif, Md, Minn - 84 US bank failure continues

By Marcy Gordon, AP Business Writer
On Saturday August 29, 2009, 2:22 am EDT

WASHINGTON (AP) -- Regulators on Friday shut down banks in California, Maryland and Minnesota, pushing to 84 the number of bank failures this year amid the soured economy and rising loan defaults.

Hundreds more banks are expected to fail in the next few years largely because of souring loans for commercial real estate. The number of banks on the FDIC's confidential "problem list" jumped to 416 at the end of June from 305 in the first quarter. That's the highest number since June 1994, during the savings-and-loan crisis.

Anonymous said...

I'm posting after a long gap, have been busy getting the registrations done, loan application etc ..

I sold my old flat in bhandup and bought a new one ... My old flat was a bit too small ... new one suits family's needs better ...
was a real estate bear, so felt that the risk was lesser, if both transactions were executed at the same time :) ..

I'm not new to this blog have posted before .. am the Ex-TCSer (now work for an foreign MNC) .. thats enuf for the intro i guess ..

I have been watching the bhandup, mulund, kanjurmarg, thane market very closely, since the last couple of years ... and I can tell u one thing ... the trend is north ... and people are buying ..

Just happened to visit a site office on Kolshet road (out of curosity I must add) in the EMI compound, next to the Maruti Service station (I own a maruti) .. the quote was 4050/sq ft, possession 2011(this was on 9th of August) ...
For comparison an earlier experience ... I had visted the Everest site on Kolshet road in June, rate was 3000 /sq ft ...

And I found a long queue at both the places ... in the EMI compound we jumped the queue and asked the agent just give us the rate ... didn't intend to buy anyways ...

This is the ground reality and my analysis fails here ... I anticipated a crash but there seems to be insatiable demand in this area ... perhaps people moving to thane from Ambernath/Kalyan ... don't know !!! but the dynamics of Mumbai real estate market needs to be studied more...

There is always a price point where something would find a buyer ... and in case of areas mentioned above this price point is way higher than what I think .... but if it's 4000+ in Thane then what would be the rate in say Mulund,Bhandup, Chembur, Sion, Powai, Santacruz etc ... Kolshet road or Ghodbhander is hopeless as far as connectivity is concerned ...

Anyways ..
Am I a convert ? Would I invest at these prices ... A DEFINITE NO ...

But then whats the right strategy ... what If someone has spare cash and wants to invest in real estate ?

Anonymous said...

What a question!!

"What if someone has spare money and wants to invest in real estate?"

I do not understand the compulsion for investing in real estate only. If someone has spare cash why not invest in a low risk and highly liquid instrument?

Is the spare cash biting you for you to need to go out and invest in RE only...

RE is the worst thing to invest in. It totally revolves around the greater fool theory and is very high risk.

However, people who insist in playing with fire must discover sooner or later why wise men advice against such activity...

Anonymous said...

RE is a beautiful leveraged investment if it is done as a buy and hold over a 15 year mortgage, and is your ONLY home.

A 1Cr flat will cost 1.8L or so at 10% interest. In 15 years it is definitely going to be much more than 1.8Cr.

Helps if you are going to live in it yourself. Even otherwise it is worth it as a plain investment, forgetting even rental returns. It will be your retirement home.

If you can afford a 100,000 per month EMI that is.

It is not worth buying second and third flats on leverage.

Why spend all your salary on EMIs when you are young and end up as a rich old guy when you are too old to enjoy the money?

By the way RE is the best place to park your black/corruption money - that is unquestionably obvious.

Venkat ND

shailesh said...

Ex-TCSer: You asked for why dynamics of Mumbai market are different,

I think the answer is in this article.

Unlearned Lessons from the Housing Bubble

There is a lot of misunderstanding about home prices. Many people all over the world seem to have thought that since we are running out of land in a rapidly growing world economy, the prices of houses and apartments should increase at huge rates.

That misunderstanding encouraged people to buy homes for their investment value - and thus was a major cause of the real estate bubbles around the world whose collapse fueled the current economic crisis.

But we do not really have a land shortage. Every major country of the world has abundant land in the form of farms and forests, much of which can be converted someday into urban land. Less than 1% of the earth's land area is densely urbanized, and even in the most populated major countries, the share is less than 10%.

There are often regulatory barriers to converting farmland into urban land, but these barriers tend to be thwarted in the long run if economic incentives to work around them become sufficiently powerful. It becomes increasingly difficult for governments to keep telling their citizens that they can't have an affordable home because of land restrictions.

In Mumbai, the main issue is Builder/Politician/Mafia nexus controlling Land and Urban infrastructure. The citizens are living under too much fear to revolt. But surely the supply side response is coming back. Only thing is it will take some time.

rajni said...

Hey this is really very nice post...
Nd one of your best post...Thanks
Flats in kolkata