If you are a middle class Pakistani under the age of 40, unless you are one of the lucky few born into a wealthy enough family – or made it big early enough in your career – the odds are high that you do not currently own your own home and expect to have to buy one at some point in your life. And the decision of when and which home to buy will likely be one of the most consequential ones in your life.
This is the inaugural article of Profit’s new series on personal financial advice, where we will be answering your questions on matters of personal finance. E-mail us your questions, and we will answer them every week in this space, keeping your identity and information confidential. What are my qualifications to answer your questions? I am the founder of Elphinstone, a personal financial advisory company currently in the process of becoming a registered investment advisor both in Pakistan and the United States.
In this article, we will be addressing one of the most important personal finance questions facing most Pakistanis: the home buying decision. More than anything else, this involves being honest with oneself and one’s family about expectations and resources available to buy a home. While the advice presented in this column will not be equally applicable to everyone, we will try and lay out some questions that everyone should ask themselves before making a plan – and the eventual decision – of buying a home.
Fundamentally, there are three questions you need to answer: whether or not you want to get a mortgage to buy a house using debt, how long you can wait (and therefore how long you can save) before buying a home, and how much are you willing to spend on buying a home?
We want to emphasise that this is an iterative process: as you answer each of these questions, you may not like the final answer (usually how much you can actually afford) and so therefore you will likely go back and change the answers to one or more of the previous questions. Let us address each of these three questions in turn.
Question 1: To borrow or not to borrow?
It may seem strange to ask this as the very first question about home-buying, but our advice would be to make a decision about whether or not getting a mortgage – a loan to buy a home – is an option you are willing to consider. Why is this the first question? Because the answer to this will determine whether you are saving for the down payment on a mortgage (usually about 25% of the purchase price of a home) or whether you are saving for the full purchase price. The difference is quite substantial – literally 75% of the home price.
In answering this question – particularly in an economy like Pakistan where getting a mortgage is not common and not easy, and some people have religious considerations as well – there are several factors to consider. The first, of course, is how easy it might be for you to get a mortgage at all.
Different banks have different policies when it comes to approving a mortgage and how much they are willing to lend, but in general, Islamic banks are more willing to lend for a mortgage than conventional banks, and smaller banks are more willing to lend than larger banks. It is not coincidence that one of the largest mortgage lenders in Pakistan is BankIslami – which is both an Islamic bank and a smaller one.
In time like this, it is generally helpful to have a conversation with a bank staff about what kinds of factors they would consider in determining whether or not you would be eligible for a mortgage. Some banks, for instance, are uncomfortable lending to people who derive their income from certain sectors (agriculture is a common one across many banks) and so knowing which bank would be willing to lend to you is important.
For some people, there are religious considerations as to whether or not a mortgage conforms with their religious values, generally conservative Islamic values. Neither Profit nor Elphinstone is in the business of offering religious advice, so we can only say that you should consult whichever sources you trust on religious matters if this is an important factor in your decision.
We can, however, say that that, in general, while there are disputes among religious scholars about various forms of Islamic banking, one of the forms of Islamic lending over which there is generally favourable consensus is Islamic home loans, since they are asset-backed and one can enter into a clear agreement consisting of two components: an installment purchase plan, and a rental payment on the bank-owned portion of the home.
Question 2: When to buy a home?
The answer to this question is partially influenced by the question before: are you able and willing to borrow or not? Assuming you are able and willing to borrow, you would only need to save up to 25% of the total value of the home loan. The State Bank of Pakistan (SBP) and the Securities and Exchanges Commission of Pakistan (SECP) only mandate that banks and other home lenders require a minimum of a 15% down payment for a home loan, but most banks are extra cautious and ask for between 20% and 25% as a down payment.
The next component that will help you answer this question is where you currently live. If you currently live in a family home, the answer will depend largely on family dynamics: how big is the home, how big is your nuclear family unit, and how well does everyone get along? Generally speaking, if the home is bigger and/or your nuclear family unit is small (for example, you only have one or two small children), it is easier for everyone to get along. A smaller house, or a larger nuclear family unit, however, can make it more difficult, and makes it more urgent for one to move out.
Again, while family dynamics can often play a role, in general, even the most traditional households are comfortable with their adult children moving out of the family home if they are moving into a home that they have bought.
This the part where an honest conversation between you and your spouse can be very important: how comfortable are you staying in a joint family home, and for how long?
Our advice? Stay in a family home as long as possible. The savings on rent can be quite substantial, and if you invest those savings systematically, that can dramatically increase your home buying power.
Okay, you might say. This is all a lot of fluff. Give me a number! When should I buy a home? If we had to give a range, we would say buy anywhere between the ages of 45 and 55, with earlier within that range being slightly better than later.
How did we come up with that number? Because Pakistani banks do not give out home loans with a tenor of longer than 20 years, and require you to be a maximum of 65 years old by the time you have paid off the loan. That means that you can get the loan with the lowest monthly payment when you are 45 years old. If you wait longer, the loan tenor will be shorter, which means a higher monthly mortgage payment.
What if you are not willing or able to buy a home? Then the answer is 100% dependent on how long you are comfortable living in a family home if that is where you live. Because the longer you can avoid paying rent, the more you will be able to save and invest, and the better the home you will be able to buy.
Paradoxically, if you already rent the place where you currently live, it makes the most sense to keep on renting for as long as possible. Why? Because rents in Pakistan are way lower than mortgage payments. The typical annual rent payment equals anywhere between 2% and 4% of the value of the home being rented. However, the annual payments on a mortgage – with average annual interest rates of 12% historically – costs approximately 10% of the value of a home.
In other words, even though a mortgage allows you to buy a home, it can cost more than twice as much to buy the same home as renting it. Of course, rental payments go up every year while mortgage payments are little more steady, so that is a factor. But let us explain our math using concrete numbers.
Let us say you currently rent a place for Rs30,000 a month. If you had to buy the same place, it would likely be worth closer to Rs1 crore (10 million). If you were able to save up the Rs25 lacs (2.5 million) to put a down payment on buying a similar place, your mortgage payment would come out to Rs82,581 per month, assuming a 12% interest rate on a 20-year, Rs75 lac (7.5 million) loan.
The mortgage payment would stay roughly the same over the next 20 years. However, the rent payment would go up by approximately 8% per year, based on historical data collected from the Pakistan Bureau of Statistics. It would take approximately 13 years for your Rs30,000 a month rent, going up by 8% every single year, to catch up to the Rs82,581 per month mortgage payment.
What if, instead, you continued renting, and invested the difference between your rent and the mortgage payment? You would be able to save upwards of Rs50,000 a month, which is quite a substantial amount that would result in significant savings over an extended period of time. And if you are younger than 35, it might even make sense to invest in stocks, which would yield significantly higher returns and allow you to buy a much bigger home.
So let us take this person who can save this much and assume they are 35 years old: they can save up to Rs50,000 per month, even as their rent continues to rise by inflation every year. How much would they have at age 45, 55, and 65 respectively, if they invested that amount every month in stocks, assuming the historical average return rates of Pakistani stocks?
For the purposes of this analysis, we will express all amounts in real estate inflation-adjusted terms. That means that we will give you the current price of the home this person would be able to afford 10, 20, and 30 years in the future, assuming they do not want to borrow any money at all.
Ten years from now, at age 45, this person would be able to afford a home with a present-day value of Rs95 lacs (9.5 million). [To clarify this point, our estimate is that the price 10 years from now will be Rs2.7 crore (27 million). We have just adjusted it backwards to the present day, to show how much it would be worth today, so that you can go on Zameen.com and search for what that amount of money could buy.]
Twenty years from now, at age 55, this person would be able to afford a home with a present-day value of Rs3.2 crore (32 million). And in 30 years, at age 65, this person would be able to afford a home with a present day value of Rs8.5 crore (85 million).
Waiting – and systematically investing in stocks – generally results in a big payoff.
Question 3: How much can I afford?
Ultimately, this is the question that everyone is really trying to answer. How much can I afford and what can I buy in that amount? The answer to this question depends on all of the questions above, plus your current income, your age, and your willingness to save. Here are some principles that will help you understand how to think about what you can afford.
Generally speaking, the younger you are, the more time you have to save, which means you can invest aggressively and therefore have more money to save. The more time you have, the less you have to save each month. The reverse is also true: the later you start saving, the more you have to save per month to catch up to what you need to save.
If you decide to get a mortgage, you might be able to buy a bigger home, but not always. If you are young enough – and in no rush to buy a home – it might actually make some sense to wait until you can pay cash for the home you want.
One final principle: if you do decide to borrow, the total amount you borrow should not exceed three times your annual income at the time you get the loan. That will keep your monthly mortgage payments manageable and ensure that you do not overborrow and find yourself defaulting on the loan to your own home later in life.
Generalised advice on personal finance is always difficult since each individual’s situation can vary a lot and therefore change what is the most feasible option for each person. But applying some of these general principles might help in formulating an individual plan.
If you would like to ask us for personalised financial advice, please send an e-mail to [email protected] and we will try to answer your questions through this column every week. Your identifying information will always be kept completely confidential.