Comments
Most borrow money to buy a house for self-occupation. The question is: should you make 25% down payment and borrow the rest to buy the house or should you make a larger down payment? In this article, we discuss the factors to mull before deciding on the down-payment amount.
Lumpy investment
You have two assets during working life — human capital and your wealth. Human capital refers to the present value of your future active income (the income earned using your skills). You save and create wealth, the other asset, from your active income. At the beginning of your career, your human capital will be large and your wealth small. As you progress in career and save from active income, you accumulate more wealth.
Now, when you borrow money from a bank, you convert some of the human capital into wealth. How? The bank is willing to lend money because of your ability to repay the loan. That ability comes from future active income ( human capital). The borrowing helps you buy a house today, creating wealth in the form of a house, a physical (real) asset. So, the more you borrow, the more of human capital is converted into wealth. The issue is this wealth is concentrated in one single lumpy illiquid asset (your house). So, converting this wealth into cash later, if required, may be difficult.
Would it help if you borrow less and make a larger down payment? Not really. Your home equity (own money) will now be more and interest payments on mortgage lower. That would no doubt significantly lower costs but also lock-in more of savings into a single lumpy illiquid asset. So, a lower or a higher down payment is not necessarily better than the other.
Conclusion
The percentage of down payment on your house must be based on your income volatility, the uncertainty in the level of your cash inflows. If your income is not volatile, you should consider making a 25% down payment and borrowing the rest.
This will allow you to channel your additional savings into financial assets such as equity and bonds. If your income is volatile, reducing the proportion of bank borrowing would be preferable.
Emotional well-being
Finally, your emotional well-being is just as important.
If you are uncomfortable with a large borrowing, making a significant down payment would be meaningful.
(The author offers training programmes for individuals to manage their personal investments)
Comments
COMMENT NOW
Comments
Comments have to be in English, and in full sentences. They cannot be abusive or personal. Please abide by our community guidelines for posting your comments.
We have migrated to a new commenting platform. If you are already a registered user of TheHindu Businessline and logged in, you may continue to engage with our articles. If you do not have an account please register and login to post comments. Users can access their older comments by logging into their accounts on Vuukle.