In July 2019, the National Housing Bank (NHB) directed the Housing Finance Companies to refrain from lending under Interest Subvention Schemes to developers.
Under an interest subvention scheme (80:20 scheme or any other nomenclature), you pay 20% of the purchase value upfront and the bank disburses the remaining 80% cost to the builder upfront. The only difference is that the builder pays the interest on the loan for a few years or until such time you get possession, whichever is earlier. I have just given an example. Such interest subvention scheme can take any shape. The key is that the builder pays the interest on your behalf for a certain period. The buyer, the developer and the bank would enter into a tripartite agreement to effect this repayment structure. This wouldn’t be possible now. In fact, if your loan has been sanctioned under such an interest subvention scheme but not disbursed, HFCs have been asked to stop the disbursal.
As I understand, banks were already prohibited by the Reserve Bank from lending under such structures. However, the Housing Finance Companies were regulated by the National Housing Bank and could continue to lend under such structure. By the way, housing finance companies will now be regulated by the Reserve Bank (Union Budget 2019).
How Interest Subvention Scheme Helped the Buyers, the Developers and the Housing Finance Companies?
- It helped the buyers because they didn’t have to pay any EMI until such time they got the possession. They didn’t have to worry about paying rent and pre-EMI at the same time. Therefore, such schemes were easier on their pockets.
- It helped the builders because they got the entire amount upfront. Thus, it improves their cashflows. Remember, most real estate developers are in serious financial mess. They won’t be able to get a business loan at as low an interest rate. They would have gotten the funds at 18-24% per annum. You got them funds at 10% per annum. Such a scheme would have helped builders retain pricing power too.
- The banks don’t care. The builder must pay the pre-EMI (you can’t expect the builder to pay the full EMI) until the construction is complete. Once the construction is complete, you pay the full EMI. If the builder can’t pay for any reason, the bank will force you to pay. Such schemes help the bank grow their loan book fast.
Where Is the Risk?
When everything looks rosy, risk is often underappreciated. We all know the real estate is one shady sector. There is no dearth of accounts about diversion of funds towards other projects or to buy a land parcel or outright siphoning of funds (Amrapali). And there could be genuine dark clouds over the industry.
What if the builder defaults on your loan? And I am not cooking up a story. Read this article on MoneyLife for an example. What happens then?
The loan is in your name. The bank will come after you. Don’t expect the banks to show any leniency. You must pay the full EMI or pre-EMI. Clearly, since the builder has defaulted on the loan (your loan from the bank), you wouldn’t expect him to possess the money to complete construction of your house. So, your house is stuck (with not a great chance of completion anytime soon or ever) but you still have to pay the EMI. The complete down payment is also gone. I just shudder to think how hopeless this sounds.
You can argue that this would have happened in a construction linked loan too. However, there is a big difference. Under the subvention scheme (or 80:20 scheme), the entire loan amount has been disbursed upfront. Under a construction linked home loan, the disbursal is linked to the completion of construction milestone. Under 80:20 schemes, it is possible that the bank has disbursed the complete amount while there is negligible construction on ground. A construction linked disbursal would at least avoid these extreme cases. Disbursements would be made in line with the progress in construction.
Moreover, now that the builder has all the money upfront, there may be an incentive to go slow on construction, depending upon whether your state RERA has any teeth.
For more on this, you must read this brilliant piece from Deepak Shenoy of CapitalMind.
Is This Restriction Good or Bad?
There is no crisp answer.
From the perspective of the builders, it is unequivocally bad news. They lose upfront payments and a cheap source of funding at the same time.
From the perspective of the banks and housing finance companies, nothing changes except that their business may be affected. If they have lent to builders, there may be stress on such loans as builders will experience cash crunch (not necessarily because of this). However, at the same time, these are risky structures. Too much of mindless lending under such structures could have come back to haunt them later.
From the perspective of buyers, this means that their interest costs will go up (they didn’t pay anything during pre-construction period). Those buyers would have planned to purchase a property under interest subvention scheme earlier. At the same time, I have highlighted the various risks earlier in the post. A construction linked home loan is much less risky. Given the state of real estate sector, I would give thumbs up to this move.
Disclosure: I could not find the circular on National Housing Bank website. For some reason, many documents were password protected. I have relied on information available on the websites of leading business dailies about this move from the National Housing Bank.