Should I buy a plot on loan to meet my goals  or should I reinvest the monies in the market – Which will fare better?

Real Estate is one asset class which never fails to lure the masses. In India, people prefer to invest in Real Estate to meet their goals. With land being in limited supply, it is very enticing to invest in this asset class.
With increasing costs, building or buying a house has turned out to be an expensive affair. To overcome this limitation, many people opt for buying plots.
Investing in these plots is much lighter on the pocket as it comes to around 20-30% of the cost of building a house/apartment. Also, there are many banks/NBFCs offering loans on these plots at the same rate orat reduced rates.
The objective of the discussion hereis how good an investment is a Plot or land for meeting your goals. Is it really worth borrowing money to purchase a plot?
Most banks/NBFCs give loans for plot purchase at the same rate as that of home loan. However if the loan tenure is beyond 3 years, the bank may choose to  increase the interest rate by 2-3% if the plot is not constructed. .Also, most lenders lend only 60-75% of the property value for plots.

Let us consider an example:

Apoorva has finalized a plot of Rs.20,00,000 and has finalized a bank to take a loan to purchase the plot. The lender is ready to lend 70% of the plot value which is Rs.14,00,000,for a tenure of 5 years and interest rate of 10.5%The EMI works out to be Rs.30,091. Assuming the growth of real estate to be 10%, let us see which option is better for Apoorva – Purchasing the plot on loan and paying an EMI or investing the downpayment amount and the same amount of EMI in financial assets for the same loan tenure

Below is an illustration showing the working of interest payments on EMI for 5 years and interest / appreciation earned in financial instruments (mutual funds) over the same period

.

Particulars Buying a Plot on Loan
A Value of the Plot Rs.20,00,000
B Bank Loan approved Rs.14,00,000
C Interest Rate 10.50%
D Tenure 5 years
E Amount funded through savings Rs.6,00,000
F EMI Rs.30,091
G Total Interest paid in 5 years Rs.4,05,488
H Miscellaneous charges(Brokerage, Stamp Duty, Bank Charges etc.) Rs.2,00,000
I Annual rate of appreciation of plot 0.1
J Value of plot after 5 years @10% growth per year Rs.32,21,020
K Total cost of the Plot(A+G+H) Rs.26,05,588
L Actual Gain(J-K) Rs.6,15,532
Actual return 4.33%

Now let us see below if the same amount of EMI were to be invested in a balanced fund, what will be the actual gain and return.

  Particulars Investing monthly amount equal to EMI/month in a Balanced Fund
A Monthly SIP equal to the EMI had she bought a plot Rs.30,091
B Existing savings invested(used for self -funding of the plot) Rs.800000This is the self-funded amount invested as a lump sum(E+H) from the table above. (pl change 600000 (above amount is 600000  to same figure here) Rs.800000 is the self funded amount for the plot and miscellaneous expenses of Rs.200000 mentioned in H of the above table
C Rate of Return 10%
D Tenure 5 years
E Return on lump sum invested for 5 years Rs.12,88,408
F Return on the monthly SIP invested for 5 years Rs.23,22,175
G Total value of investments after 5 years Rs.36,10,583
H Actual Return 10%

For both the tables above, the growth rate for both the assets – Plot and Balanced Fund is 10%.

However due to the interest out go on the loan, the appreciation of the asset almost gets nullified and actual return reduces to 4.33%.

Also, the gains from the sale of the plot is subject to Capital Gains Tax which reduces the rate of return further.

Since a plot, as a physical asset still lures you, there are few points you have to keep in mind before purchasing one.

  1. Real Estate is a highly illiquid asset class and finding a buyer at the right time may be difficult. If the plots are ear marked for any goal, then the goals might have to take a back seat in case a buyer is not found.
  2. Due diligence for a plot is complex since the legal ground work is not done. You have to ensure that the land and the layout is free of any litigations.
  3. Try and create a corpus for down payment through self funding as much as possible and lessen the loan amount taken. This will reduce the interest cost borne by you.
  4. If you want to map your plot to any of your goals, then assign the plot to a long term goal – beyond 10-15 years and work on sale of the plot at least 1 year before goal date to avoid delays in finding the right buyer.
  5. Plot loans are not eligible for tax deduction unless and until a house is constructedwithin 3 years of plot purchase.
  6. Prepayment or foreclosure charges are applicable for plot loans as they are not treated as home loans.

So, think twice before taking the plunge on purchasing a plot!

Akhila Muralidhar
Senior Para Planner- Advisory
Dilzer Consultants Pvt Ltd