Buying a home? Here’s the 3/20/30/40 rule to plan your budget

Scouting for the right property to fit in your lifestyle and even your pocket? The 3/20/30/40 rule can help you plan your budget smartly.

This rule can help you ascertain precisely as to what maximum property price you can afford without much financial burden. So, if you too are wondering what maximum property budget will suit your financial profile, here is a quick breakdown of the financial rule that can help in budgeting your home buying

‘3’: This part of the rule states that the total cost of your home should not exceed three times your annual gross income. Prioritise this rule such that you keep the loan well within limits. Else, if the choice looks really unaffordable you may defer your purchase or look for the right match in the suburban region where the prices are relatively less.

‘20’: ‘20’- here means keeping the loan tenure equal to or less than 20 years for minimizing interest payment. In India, even though banks offer a maximum tenure of up to 30 years for home loan, you as a young individual can opt it initially for affordability reasons, nevertheless if possible ensure that you make prepayments and foreclose the account in under 20 years.

‘30’: This specifies that your equated monthly installment towards the loan should not be more than 30% of your gross monthly income. Lenders in India, go beyond and offer EMI that are well above this mark and so to be on the safe side and account for other exigencies, inflation etc., try to keep EMI at or below 30%.

‘40’: 40% of the home cost should be paid as ‘down payment’ as per the rule. And in case you are able to pay this much amount out of your savings, investments etc, it can help you lower your final loan amount as well as reduce total interest outgo considerably.

Understanding the rule with an example

Say X person with an annual gross pay of ₹10 lakh is considering purchasing a house. Now his total monthly gross income comes to ₹83,333.

So, if he goes by the rule, then accordingly:

3x rule allows maximum price of the house = ₹30,00,000

‘20’- 20 means loan term of not more than 20 years

‘30’- it suggests maximum EMI to be not over 30% of ₹83333= ₹25,000 per month

‘40’- 40% payment as downpayment= ₹12 lakh

Now to further understand it:

Property cost: ₹30,00,000 Down payment: ₹12,00,000 Home loan amount : ₹18,00,000 Tenure- 20 years Home loan interest rate: 8.5% on an average Monthly EMI- ₹15,500; well within the 30% limit.

So, the rule allows an individual to prevent overleveraging, while reducing substantial outgo towards interest payments.