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Should you stretch to buy your dream home?

Posted on 07 Dec 2021
Author: Sayan Sircar

Tags: Loans ; Real Estate ; House Purchase

7 mins read
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What do you do if your dream house is above your budget? How to know if you can stretch?

Should you stretch to buy your dream home?

This article is the next part of our guide to purchasing your dream home. Read the other parts here:

📚 Topics covered:

Introduction
Step 1: You must get your financial house in order
Step 2: Re-prioritise your goals
Step 3: How to stretch your investments

Introduction

It happens to all of us: what we want to buy ends up at a higher price than we initially budgeted. There could be many reasons - last-minute price increase, locality change, a good deal that comes your way amongst others.

Given that for most people, a home purchase is the most important financial activity given its size, the long commitment to a bank for paying back the home loan and the opportunity cost of the down-payment. This post deals with the specific case where your desired house comes 10-30% or even more than your original budget.

If you are starting your house search and deciding on a budget, it is better to read this post instead: Goal-based investing: check if you can purchase your dream home

We assume that you have already decided on a goal amount for the down-payment and have invested for that goal for some time. However, you have now come across a deal above budget and are wondering what to do. In that case, this article is for you.

Step 1: You must get your financial house in order

If you are buying a house over budget, you must at the very least have completed your financial pre-requisites and have sat down with your family to perform a goal-identification exercise. Otherwise, it is risky to continue. For example, one of the reasons for the 2008 financial crisis was people buying homes that were way above their budget or what they could reasonably afford.

Please follow these steps:

Once you have completed the steps above, do an affordability test of the house price and down-payment using the calculator described in this post: Goal-based investing: check if you can purchase your dream home. I am not a fan of thumb rules that say “EMI should be x% of income”, etc. I prefer calculations since everyone’s situation is different.

If the calculations say you can afford the home, congratulations are in order. Move to this step, and you are done: Where to save for the down-payment of a house?

If the calculations show a higher SIP amount that you can afford today, you move on to the next step.

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Also read
How to buy SGB from the stock market?

Step 2: Re-prioritise your goals

At this point, you need to revisit your goals and check the priority of each:

do you wish to change the goals related to travel (vacations) and entertainment
do you wish to buy a cheaper car
do you want to revisit FIRE plans, given the higher amount of investments you need to make for it? - I am 25 and want to FIRE by 40. How much should I save per month?
do you want to take a loan for children’s college education goal?

Here are some articles that will help:

If you still need to stretch after this re-prioritisation, move on to the next step.

Step 3: How to stretch your investments

At this point, you need to acknowledge that you are putting your other financial goals at risk by purchasing an expensive house. These risks are

loss of income due to job loss
reduction of family income due to health reasons (for example, pregnancy-related career break) - if the EMI requires both spouses to work, then this could become a big problem
an increase in interest rates will jack up the EMI, and you might be unable to pay. This was another issue that caused the 2008 financial crisis
your salary hikes do not keep up with your projections
you need to shift after a few years and cannot get a reasonable price on the house. You decide to keep it on rent, and that blocks your capital. In the new location, you will have to pay rent while earning low amounts from your home, where rental yields are generally poor in metro cities
if you have purchased an under-construction house, that gets delayed. If you are stretching to buy a home, buy ready-to-move and not under construction

The standard recommendation is to ensure that your emergency fund can handle the impact of income reduction. Read more: Emergency fund: what, why, how much to save and where?

It will also be a good idea to have a long enough loan duration to go all the way until retirement. This plan will keep EMI low, and over time, you should hope that an income increase in your job and business will take care of the gap in your goals. If you take this plan, you will be adversely affected if either interest rates rise or salary hikes are not in line with your assumptions.

It would be best to have enough term insurance to ensure that one or more earning members dying does not lead to EMIs being stopped. All loan applicants should have adequate term insurance or take loan insurance as a part of the house loan. Read more: Term life insurance: what, why, how much to get and from where?

You can also keep costs of interiors and appliances to a minimum and slowly decorate over time. It will be good to avoid purchasing non-essential items on EMI since that will further strain your budget.

Borrowers should also keep in mind that most home loan rates are floating i.e. the rate of interest will fluctuate over time. An increase in interest rates will increase the EMI and may cause a strain on the household budget or other investments for other goals. You should perform an immediate portfolio review, including emergency fund review, as soon as the interest rate changes. To be on the safe side, use a slightly higher interest rate, say by extra 1%, when calculating the impact on goals and emergency fund amount when you are stretching to buy a house.

Ultimately it may happen that things will all turn out right over time. For example, salaries increase over time, health is fine, and home prices rise. However, if they do not, then you need to be prepared.

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Next steps:

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2. Use our goal-based investing template to prepare a financial plan for yourself.

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