Banks must link disbursal of housing loans to construction stages: RBI

Taking serious note of borrower un-friendly home loan schemes introduced by banks in association with developers/builders, RBI has advised banks to refrain from making upfront disbursal of home loans to the builders without linking the disbursal to various construction stages of housing project. These subvention schemes, popularly known as 80:20 or 75:25 schemes, had gathered pace in the past one year in the metros like Mumbai and National Capital Region (NCR). In the past too, the RBI had warned against similar schemes such as 10:90 schemes.

Now you must be wondering: What is 80:20 scheme? Who benefits from it? How can it hurt the borrowers and the banks? What is the impact of this decision on the 3 parties involved: banks, builders/developers and borrowers?

What is 80:20 scheme?

In the 80:20 scheme, the buyer of the housing unit makes 20% down payment and the bank does upfront disbursal of the loan amount to incomplete / under-construction housing projects. This scheme may include signing of tripartite agreements between the bank, the builder and the buyer. In many such cases, the builder promises to pay pre-EMI or EMI until the construction is complete or for a predetermined period (say 6 months). The buyer is responsible for paying the EMI after this brief period.

Who benefits from it?

Developer / Builder: Unlike the loans at much higher interest rates from banks & NBFCs, this is a cheaper option for the developers to finance their construction. According to Deepak Parekh, Chairman of HDFC, construction finance is being made available to developers at the rate of interest being offered on individual home loans through innovative structuring. The added advantage is that the buyer is ultimately responsible for paying off the loan although the same money has been used to finance the construction of the project.

Buyer / Borrower: In some instances, buyers benefit from “discounts” offered by builders under those schemes. In addition, developer may offer to pay the pre-EMI (i.e., interest on the loan) until the construction is complete.

Banks: Through proxy lending to builders, banks funded the real estate sector at a lower interest rate and in a “less risky” way. The entire risk fell on the borrower. As the result, the home loan portfolio of banks grew 18.4 per cent in the 12 months ended July, to Rs 4,91,000 crores.

How can it hurt the borrowers and the banks?

The developers have less incentive to complete the projects on time under this scheme. “Any delayed payments by developers/builders on behalf of individual borrowers to banks may lead to lower credit rating/scoring of the borrowers,” said RBI. In essence, the builders have less skin in the game. Without a construction linked plan, the developer can get away with delaying the project OR diverting the funds for other projects or land purchase. Borrower has little recourse if the developer refuses to pay delay penalty. The buyer may have to start servicing their debt (i.e., pay EMI) even before getting possession of the property.

In this arrangement, the risks are underestimated and banks end up making less provisions when compared to a direct loan to the builder. Bad loans have been increasing in the last 2 years (2.36% in March 2011 to 3.92% in June 2013) and the situation can easily get out of control if these measures aren’t introduced.

What is the impact of this decision?

Due to cheap funding, wherein the developer had to pay only a low interest on cheap home loans, home prices were artificially held up and the sales volume increased. With the absence of such schemes, builders will be under pressure to reduce prices attract buyers. New developers will find it hard to fund their land purchase and construction projects.

With construction linked plan, developer will have to meet predetermined construction milestones in a timely manner to get the next instalment from the bank. This will ensure that the buyers (and the banks) are in control of the home loan disbursal to ensure its appropriate use by the builders.