Saving money to build a house
The Sunday Nation
Nairobi,
25 September 2011
Last week, we looked at the cost of constructing a house following two different plans. The first one was taking a loan for the full amount (Sh900,000) and paying it back in six years. The second method was to borrow six different instalments – one each year – and complete the project in phases.
In the first method, the total cost came to Sh1,266,840 while in the
second plan it was Sh1,172,700. Even though it is more expensive, the
first option has the advantage that Jack (the reader who had asked the
question) will complete the construction quickly and move into his new
house in a few months. After that he will have only one monthly
obligation – the loan repayment. He will not need to pay rent any more.
Jack had also proposed a third option: saving amount equivalent to a
monthly instalment of the loans above and gradually construct the house
for a period of 72 months. Now the monthly instalment of the first
method is Sh17,595, while that of the second plan varies from Sh13,300
in the beginning, to Sh19,550 in the final year.
It is not clear which of these amounts Jack had in mind, but we can
tackle the problem from a different angle. We can find out how much Jack
needs to save each month in order to complete the construction.
Last week, we found that when we account for inflation at an average
rate of 8 per cent per year, the six annual amounts required are:
Sh150,000, Sh162,000, Sh175,000, Sh189,000, Sh204,000, and Sh220,000
from the first to the sixth year, respectively. The total cost comes to
about Sh1.1 million. The additional Sh200,000 arises from inflationary
pressure alone.
By dividing the annual amounts by 12, we are able to find out the
required savings per month for the project. The results are: Sh12,500,
Sh13,500, Sh14,600, Sh15,750, Sh17,000 and 18,300 respectively for each
year.
This calculation ignores the fact that the money will be accumulated in
an interest-earning savings account. Currently banks are paying about 3
per cent per annum for fixed deposit accounts. Assuming that Jack can
negotiate this kind of rate, the monthly instalments for his project
will go down by a small percentage. The new amounts are: Sh12,330,
Sh13,315, Sh14,400, Sh15,535, Sh16,770, and Sh18,050, respectively.
The differences in the monthly instalments seem insignificantly small,
but not so when we calculate the total cost after six years. It comes to
Sh1,084,800. This is about Sh15,000 less than the previous amount where
the savings interest was not included.
Finally, even though it was not one of Jack’s plans, we may want to know
what would happen if he saved continuously for six years in order to
accumulate enough money to build the house at one go. Inflation will
push up the cost from Sh900,000 to about Sh1.45 million in that period.
To raise enough money for the project, Jack would have to save about
Sh18,150 each month for the six years. This is assuming that he will get
the same 3 per cent interest per annum for his savings. The total cost
to him comes to about Sh1.3 million. The balance of about Sh150,000 is
paid by the interest earned from the savings account.
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