Should you be investing in a plot by taking a Loan
Investing in a plot by taking a loan may not be a wise decision
“There have been few things in my life which have had a more genial effect on my mind than the possession of a piece of land.” Harriet Martineau
No doubt that owning a piece of land gives a great sense of satisfaction. Real estate is one of the most preferred investment options in India for people belonging to all economic classes. Mainly because investing in real estate is more emotional than a financial decision.
The land is always treated as a prized asset as it is limited in supply. Many people invest in real estate through different means such as plots, individual houses, commercial complexes, apartments, etc., to achieve their financial goals.
Properties like apartments, individual houses etc., are high-value investments and may not be suitable for small-time investors. Such investors usually opt to buy plots of smaller sizes, which they hope to sell on appreciation or whenever they need money to meet their goals.
Plots costs around 20-30% of the cost of house construction or an apartment. Also, many buyers invest in plots with the hope of constructing a house at a later date.
To facilitate plot purchase, most banks and NBFCs offer loans to buyers. Though the land loans or plot loans are similar to home loans in tenure, interest rate and processes, there are many differences in terms of tax benefits, the quantum of loan approved and tenure.
But how beneficial is for a person to buy a plot by availing a loan? Is it worth borrowing money on interest to buy a plot? Let us first understand the difference between a home loan and a plot loan.
Plot Loan Vs. Home Loan
Home loan is usually considered as ‘good’ debt by many people as they.
- Tax Benefits
The interest and principal paid on home loans are eligible for tax exemptions. So, many people prefer to reduce their tax outgo by investing in apartments/individual houses by securing home loans.
Plot loans alone, are not eligible for any tax benefits. However, if you construct a house on the plot by availing a construction loan, you will be eligible for tax deductions.
- Lower Loan To Value
Most financial institutions sanction home loans up to 80% of the total cost or the loan eligibility of the buyer, whichever is lower. Depending on the cost of the house, sometimes the financing can go up to 85% -90% of the total cost.
When you buy a plot through a loan, most financial institutions sanction loans up to 70% of the plot value. So, a buyer has to arrange for the remaining 30% of the cost.
- Restrictions on the Type of the Property Purchased
Home loans are given for buying/constructing houses irrespective of their location. You can even avail home loan for construction in your ancestral village or to construct a house in the agricultural land also. Home loans are also provided for house reconstruction or to build additional floors on the existing property.
Plot loans are provided only for the purchase of residential plots. Such loans are usually provided for plots within the municipality or corporation limits. You cannot buy agricultural land or plantation or land in a village by availing a plot loan.
- Foreclosure Charges
Charges are applicable for prepayment and foreclosure of plot loans at the rate of 1-5% of the total outstanding. Also, plot loans are not reducing interest loans.
As you can see, a plot loan has many disadvantages over a home loan, although both are given for property purchase.
However, banks also offer composite loans to buy a plot and construct the house on the same. However, the clause is that the construction of the house should finish within 3 years from the date of purchase of the plot. The construction component of this loan is eligible for tax deduction just as a home loan.
Many land developers insist that even though plot loan has no benefits, the land value will always appreciate and ample gains can be made by buying now and holding for a longer time. Also, as land is a tangible asset, there is no possibility of losing the amount invested.
But how prudent is it to take exposure to real estate asset class by investing in plots through loans? Do the returns really match the interest outgo on the loan? Let us understand with a case study.
Sanjana has finalized a plot of value Rs.30 lakhs. Her bank is ready to fund 70% of the plot value i.e. Rs.21 lakhs. The interest rate is fixed at 8.75% for a tenure of 10 years. The EMI works out to be Rs.26,318 per month. She already has Rs.12 lakhs to make the down payment and for other charges like registration, legal fees, processing fees etc.
However, she is in a dilemma if she should buy the plot or invest it in any financial assets.
Let us assume that she invests in the plot and it would yield a return of 10% pa over a period of 10 years. Also, let us assume that instead of buying the plot, she will start a SIP in a balanced mutual fund for a sum equal to the EMI of the loan i.e. Rs.26,318 and the fund also yields a return of 10% over a period of 10 years.
The below table illustrates the how much actual gains will be made at the end of 10 years if a monthly SIP of Rs.26,318 in a balanced mutual fund is started for 10 years:
If you compare both the tables above, you can observe that investing the amount in a SIP of a balanced mutual fund yields better returns.
Also read: Should you invest in a Second home or not?
Even though both the asset classes are assumed to yield the same return of 10% pa over a period of 10 years, the returns on the plot is reduced because of the interest outgoAlso, she has to bear the cost of down payment as well as the cost of registration, brokerage, loan processing charges etc. The actual return is reduced to 2.27%.
However, if an amount equal to the EMI of the loan is invested as a SIP in a balanced mutual fund along with the amount of Rs.12 lakhs which was marked for down payment and other charges, she will be left with a decent corpus of Rs.85,50,411 after 10 years.
Also, the capital gains arising from real estate is taxed at 20% with indexation or 10% without indexation. Hence, the post-tax gains from the plot will reduce further. The capital gains from the selling of balanced fund units attract a tax of 10% on the gains above Ra. 1 lakh.
Apart from the disadvantages of availing a plot loan and the negligible gains obtained, there are many other factors to be considered before investing in a plot.
- Real estate is a highly illiquid asset class, and it may not always be possible to find a buyer at the need of the hour.
- You have to double ensure that the land you plan to buy is free from any litigations and all the documents are in order. Due diligence from a legal expert is a must before any property purchase.
Excepting a case where you want to build your own home, investing in a plot by availing a loan is not a prudent investment decision. It is better to invest your savings in a financial asset regularly.