Hello fellow NRI’s,
As you all know, we belong to the group of people who have made a home away from home. Be it USA, Australia, UK, Japan and even Iceland (I’m not lying after I enjoyed a crazy expensive meal in Reykjavik in a restaurant named Gandhi), we Indians are all over the globe. I have lived in United States for nine long years now and while most of us constantly worry about the immigration policies and how long before we finally have our permanent residency, we often tend to overlook our investing choices.
On most occasions we tend to follow what our relatives, friends and colleagues have been doing for several years, who in turn have also followed the same group of people in their own lives. However, this often leads to oversight. Today, in the information age, where data is so easily accessible, we tend to ignore its value and make decisions based on word of mouth. Therefore, I wish to talk about how we are often coaxed into buying a home with simple forms of advice such as – “Renting is just throwing money down the drain”.
When deciding whether to buy a home one must ask the following questions:
- Are you buying because my friend/neighbor/family/colleague asked me to or thinks I should?
- Do you think it is an investment?
- Have you compared the value of the home to other investment options and projected the home value?
- How much liquidity are you willing to give up?
If you answered Yes to question 1, you need to STOP and reevaluate right now!
The simplest answer to question 2 is NO! Let me explain this a bit further as we all tend to have this idea misconstrued. We often think that the home we live in is an investment because we are no longer paying rent and whatever EMI we pay is essentially going into purchasing ownership of our own home. While in essence this is true, home ownership is not an investment, but a liability. When you purchase a home and live in it, you are not only paying the monthly mortgage, but also paying the maintenance, taxes, HOA fees etc. At the end of 15 or 30 years this home will surely belong to you, but we often tend to overlook the fact that this so called ‘investment’ did NOT give us any ROI(return on investment) through all these years. The only way you can get your return is when you actually sell the home when the price is right!
For question 3, we are often limited to fewer choices to compare with. For example, a savings account in USA only yields less than 1% interest annually which is certainly a terrible option to choose. Secondly, we tend to be weary of the stock market and feel real estate would just be a safer bet. Last, we tend to overlook the option of investing in our home country instead (I will elaborate on this in my example later).
Question 4 will lead to my simple example of why your friends have been wrongly advising you all along.
Let us consider you wish to purchase a home in the city of Chicago
The median home value is $250,148 today.
The total appreciation based on data from the year 2000-2018 is 47.18% with an average annual appreciation rate of 2.14% (https://www.neighborhoodscout.com/il/chicago/real-estate)
Therefore, we can calculate the median value for this home in the year 2000 using future value calculation
Future Value = Present Value X ( 1 + Rate )^number of years
(Present value = Median value in year 2000)
Present Value = $250,148 ÷ ( 1 + 0.0214)^18 = $170,866.12
For ease of calculation let us round off and assume the median home value was $170,000 in the year 2000.
Idealist Case : If you can buy the house without a banks mortgage
Now you invested your entire liquid cash of $170,000 to purchase this home and never got any ROI during these 18 years because you continued living in this house.
You finally decided to sell the house with a profit of 47.18% or $80,000 in the year 2018.
Now let’s explore the option of investing in your home country. The average long term interest rates in India between 2000-2018 is 7.8%
If you invested this entire amount in a fixed deposit scheme it’s current value would be approximately ….. $657,000 ! ! ! 🙂
Realist Case : You mortgage the house and pay interest every month
The average mortgage rates for 15 years at a fixed rate in the United States is 4.9% (https://fred.stlouisfed.org/series/MORTGAGE15US)
(The above is assuming you refinance your home each time rates drop and maintain good credit score)
Assume a down payment of 20% = $34,000
Total amount paid towards the house at the end of 15 years = $192313 with a total interest paid worth $56,313
Now your pay off in 2018 is approximately $58,000 because you also paid interest to the bank over 15 years (Note that I have not included any additional property taxes for simplicity here)
This reduces your ROI from 47% to only 34% 😦
This is the case most of the general population seems to adhere to and say we managed to save 20% of the home value for the down payment.
Instead of paying this down payment, say you invested this amount again in a fixed deposit in India, the current value of your $34000 would be $131,406! Investing in a home you wish to reside in is not an investment but a liability, which in turn reduces your liquidity and ability to venture into alternative investment options.
Many of you could argue that my example of Chicago would not hold true across all cities or nations, and that may be true, but my point here is to help understand what factors one should consider before making this life changing decision. A home buying experience is often grueling and comes with loads of hidden aspects that result in stress and lack of freedom of choice. While I only accounted for the basic financial aspects, there is no formula to quantify the stress when one wishes to quit their job or loses a job or simply wishes to change their location. At such times, this hard earned money is no longer working for you, but you are still trying to find ways to make that monthly mortgage payment.
One might also argue that transferring the money to India has the risk of exchange rates associated with it. This is certainly a factor worth considering, but seems a risk worth taking after seeing the difference in returns from each strategy.
Do your research before you find yourself as part of the homeowners herd!
Be Frugal, Be Smart, Be Rich!