The math behind the correct loan amount

It’s 18:00 now. The sun had just set and the sky had turned a maroon, as it often does on occasional evenings. Pooja watched the sunset from her rented apartment in the central suburbs, talking on the phone with her mother-in-law or mom Gee.

“Do you remember Chinta?” Mom Ji asked.

“Yes,” she replied, “your younger sister’s eldest son.”

“Yes,” Ji’s mom said, “he bought a 3-room apartment in Bangalore in January.”

But wasn’t he fired after that?

“Yeah, but he still has the apartment,” she replied to a rather irritated mom ji, “and my sister reminds me of that every time she calls.”

Scene 2

Later that same evening. Around 21:00. Pooja’s husband Rahul is back from work.

– Well, how was your day? – he asked.

“They were used to further develop my doctoral thesis,” she replied. “Besides, your mother called last night.”

– AND? he asked, as always, slightly apprehensive when she spoke of his mother.

“She wants us to buy an apartment.”

– Nothing new.

“Yes,” she said, “but she was quite emotional today.”

“Hmm. So what are you suggesting?” he asked. “Should we buy it?”

“I mean, there’s nothing wrong with thinking a little,” she said. “Anyway, it’s not a decision that can be made overnight.”

scenes 3

Early next morning. Around 7 am. Pooja has a serious expression and looks at her laptop. Her husband has just made coffee.

– Did you sleep well? she asked as he handed her a cup of coffee.

“Aha.”

“I couldn’t sleep at all. The conversation with Mama Ji made me very tired.”

“This is not good,” he replied.

Anyway, I got up and did some basic research.

“AND?”

So I figured out the math behind taking out a mortgage.

“Although this is not the kind of conversation I want to start first thing in the morning,” he replied, “but now that you have begun …”

First things first. I took a break from work to complete my doctoral dissertation. So I don’t have a steady income and that limits the total amount of credit we can take out.”

“Hmm. Of course, two incomes matter more than one.

— I looked at your payroll. Your salary is approx. ₹2 lakh per month.”

“Oh, don’t you?” he asked. “You know I have no idea about these things.”

“So, given our costs, I think we should be comfortable paying EMI at about ₹70,000 per month.”

“It makes sense.”

If we are willing to pay EMI in the amount ₹70,000, we’ll get a mortgage ₹80.7 lakh at an interest rate of 8.5% maturing in 20 years.”

“My God, that’s impressive,” he said. “You already figured out the math.”

“It’s pretty easy if you know what features to use in the spreadsheet,” she replied.

“Hmm. What if we can’t get a home loan at 8.5% per annum, but we get a loan at 9%, what happens then?

At 9% EMI ₹70,000 over 20 years can repay the loan ₹77.8 lakh which is about ₹3 lakh less than the loan we can get at 8.5%.”

Interesting. Thus, the amount of credit that can be obtained decreases as interest rates rise.”

Yes. And vice versa is also true.”

– Vice versa? – he asked.

“It’s like if we managed to get a loan at the beginning of last year, when the interest rate on a home loan was 6.5%.”

– What would happen then?

“With a rate of 6.5%, a tenure of 20 years and EMI ₹70,000, we could take out a mortgage for about ₹93.9 lakh what would be about ₹13 lakhs more than we can currently take on.”

“Damn it!”

In addition, housing prices have risen over the past year.

“It’s a double whammy!”

“Not really,” she replied.

“How?”

“Because interest rates have risen over the past year, the benefit of low interest rates will not last as long. Of course, prices have gone up too, and nothing can be done about it.”

scenes 4

Early evening of the same day. Pooja looks down at her laptop and wonders if she really should be doing her PhD, given that everything else has taken a backseat to this one decision. As she was lost in her thoughts, her cell phone rang. Mama Ji called.

“Well, are we preparing a beta version?” Mama Ji asked.

“Mama ji,” she said, “you know what Rahul cooks in the evenings.”

“Oh yes, my son is an excellent cook,” Mom Ji replied, not missing the opportunity to praise her son, “but you should also learn how to cook according to his favorite recipes.”

“What is he already doing, mama ji,” she replied, ignoring the barb.

— Did you speak?

“About what is Mama G?” she asked, doing her best to hide her annoyance.

“On Buying a House”.

“Oh, that,” she said, “I started the conversation.”

“It’s good to know that,” replied the rather happy Mommy Ji, “Rahul is just terrible at financial decisions.”

Scene 5

Same day, late night. Husband and wife are almost ready for bed.

“You know, Pooja,” Rahul said, “I was talking to my colleague Ashish today.”

“AND?”

He said that we are very conservative.

“Not liberal?” she asked, trying to be funny.

“Puja yar…”

“Okay okay. Conservative in what?

“At my salary level, banks and home finance companies will give us a larger mortgage loan than just ₹You have worked 80.7 lakhs. And that we can easily stretch it out a little more. And that when buying this house, the income of which usually tends to increase, you have to take a certain risk.

What is true. I googled and checked home title calculators on the websites of various banks and home finance companies.”

– AND? – he asked.

“There is a rule of thumb that it is convenient for banks and home finance companies to issue a home loan up to 60 times a month’s salary.”

“Hm.”

“It means that in your house ₹2 lakh, we can get a mortgage ₹1.2 crores, which is almost 50% more than the amount of the mortgage ₹80.7 lakh that I feel comfortable with.”

“So what’s the catch?”

For a mortgage loan ₹1.2 crores at 8.5% per annum maturing over 20 years, according to EMI, ₹1.04 lakh. At 9% it turns out ₹1.08 lakh”.

“I see where it’s going.”

“Currently I am not making any money. IN ₹1.04 lakh, over 50% of our monthly income will go to EMI. This will really stretch us out and we will have to cut many of our other expenses. In addition, we will save almost nothing, and I don’t like it.”

Scene 6

Around 15:00 the next day. Ji’s mom calls, but her sister-in-law is asleep in the afternoon and ignores the call. Mama Ji immediately calls her son, who is scolded by his boss for failing to meet his sales target last month. Mama Gee throws her phone on the bed and leaves to make tea. Nothing irritates her more than the fact that the children do not answer her calls.

“I don’t know why they do this to me,” she cries in despair.

scenes 7

Late evening of the same day. Rahul returned early from the office. Pooja went for a run. Just as Rahul is about to make himself a cup of coffee, the doorbell rings. Puja is back. They look at each other and immediately realize that they had a hard day.

Can we take out a mortgage loan ₹84 lakh?” he asked Rahul.

“Theoretically yes,” Pooja replied, “at 8.5% and a 20-year maturity period, this would mean a little less EMI ₹73,000″.

“Hmm. I found out about this good BHK in a nearby building. The owner wants ₹1.1 crores for that. But the agent I’m talking to is Ashish’s friend, and he can get the owner to bring the price down to ₹1.05 crores.”

“Hm.”

Certainly. We will have to pay the stamp duty and also pay the agent’s commission. So, net net, the total cost should be equal to ₹1.15 crore With credit ₹84 thousand rubles, down payment ₹21 lakh, we can buy this apartment. And we would need at least another ₹10 lakhs for miscellaneous expenses.”

“The whole point is that we need at least about ₹31 lakh from our savings ( ₹21 lakh down payment plus ₹10 lakh for other expenses),” she explained.

“Yes, it is true,” he replied.

Our total savings is ₹40 lakhs. This means depleting a significant part of our savings, and I don’t like it very much.

But did Ashish say we’d have to stretch?

Fine. Ashish doesn’t know our finances, nah,” she replied with slight annoyance. We pay the rent, not him.

Scene 8

Late night, same day. Rahul and Pooja are ready to end the day when Rahul’s cell phone rings. Ashish calls.

“Is it a good time to talk to the boss?” Ashish asked.

“Yes,” said Rahul.

“Okay. So my brother-in-law wants to sell the one BHK apartment he invested in. He wants to ₹90 lakhs and doesn’t want to budge.”

Rahul put the phone on speakerphone so Pooja was listening as well. He looked at her and slightly raised his eyebrows and head to ask her what she thought about it. Pooja gestured that he should keep talking.

Scene 9

A few weeks later. Rahul and Pooja bought an apartment. They took out a loan ₹75 lakhs and made a down payment of ₹15 lakhs. They had to spend a few more lakhs to pay the stamp duty and other expenses of moving into a new apartment. Their savings have dwindled to about ₹18 lakhs. The savings situation was better than if they had gone ahead and bought an apartment next door, which would have cost them ₹1.15 crore In addition, EMI on loan ₹75 lakh was about ₹65000 and almost ₹8000 lower than EMI on loan ₹84 lakhs. Nevertheless, they had to cross the stream and live farther from the city.

“So Mama Ji should be happy now,” Pooja said.

“Yes,” Rahul replied, “we finally did what should make her happy.”

And now she will finally have something to talk about when her sister talks about her son Pinto.

“His name is Chintu,” said Rahul.

“Same difference,” Pooja said.

Scene 10

Rahul and Pooja have moved into their new apartment. Moominji is visiting. Rahul went to pick her up. Doorbell. Pooja goes and opens the door. Mummy Ji bursts in and quickly checks out the new apartment. Thirty seconds later, she runs out into the living room with a disappointed look on her face.

“It’s even smaller than the servants’ quarters that used to be in my father’s government bungalow,” she said. “And that’s just one BHK…Now, what am I going to tell my sister? Her Chintu has three BHKs.”

Pooja looks at Rahul with that look.

(Hypothetical example).

Vivek Kaul is the author of Bad Money.