Promise of Pre-EMI Payment by Builders

You have been planning to purchase a house. A completed property is quite expensive. For an under-construction property, you understand it will be difficult to manage both EMI and rent at the same time. You have heard about the concept of pre-EMI and full EMI, that are typically available for under-construction properties. You understand a Pre-EMI loan will put lesser burden on your pocket initially. Under full EMI, you pay the full EMI (interest along with principal repayment) on the sanctioned from the first month. However, under pre-EMI, you pay only the interest on the disbursed amount till such time you get the possession. Clearly, the monthly burden on your pocket will be lower in case of pre-EMI and you may be able to manage both rent and pre-EMI. Once you get the possession of the house, you can move into your new house, stop paying rent and perhaps be in a position to afford full EMI. However, please don’t assume pre-EMI is a better approach. I have done a detailed discussion on pros and cons of both the approaches in a separate postNow, to the main topic of the post.

What If Your Builder Proposes to Pay Pre-EMI on Your Behalf till You Get the Possession?

This means your builder will make interest payment on your behalf till such time you get the possession. In other words, No EMI till possession. Can it get any better? You don’t even have to pay pre-EMI before possession.

Why Will a Builder Do It?

There could be two broad reasons behind it. The first is that this makes for a good marketing strategy and attract new buyers. The builder only needs to increase the cost of house to recover the cost of such interest payment.

The second case is more nuanced. For builders, your money is their source of funding. Even when they agree to pay pre-EMI on your behalf, this is probably the cheapest source of funding they can get.  Given the dire financial position most builders are in, they can’t even dream of borrowing funds at 8-10% from a bank or a financial institution. I have discussed a slightly different aspect (although related to cost of funding) in another post. Clearly, you must avoid dealing with such dealers.

What You Must Know?

For you, everything sounds hunky dory. In any case, you were prepared to pay pre-EMI. Always better if the builder is ready to fund the part. However, there are a few aspects of such schemes that you must be aware of. There are a few risks involved too.

  1. It is a tripartite agreement between you, the builder and the bank. Please understand a contract can be worded in any manner. Make sure you read the agreement before opting for arrangement to understand the extent of builder liability.
  2. The builder only pays the pre-EMI for a specific period or till such time possession is given to you, whichever is earlier. If there are delays in possession, you may have to pay pre-EMI or full-EMI (depending upon the contract) from own pocket after a few years.
  3. If the builder fails to pay pre-EMI on your behalf, you have to pay it. The bank has direct recourse to you. Therefore, the bank has little incentive to ensure compliance from the builder or make deeper assessment of builders’ financial strength. You have to do it.
  4. Any defaults on payments by the builder will reflect in your credit score. And how do you figure out that the builder is going to default on your payments? For a developer who has loans from banks, financial institutions and in the form of bond issuance, you (buyer) are the first one to be sacrificed. Even the very smart credit rating agencies can’t (or don’t) figure out the issue before the default has actually happened. For a retail borrower, it is virtually impossible to find this before builder defaults on your pre-EMI payment. As a buyer (and borrower), you will find out only when you get a letter from your bank for pending payments.
  5. There is no free lunch. The builder will in one way or the other, recover the cost of pre-EMI payments from you only. This will most likely be in form of higher property price. You must enquire about the regular price (with builder paying interest on your behalf) and scheme price to compare the two.

Recently, a prominent developer defaulted on its payment to the bank (for pre-EMIs). The buyers (borrowers) got notice from the bank to make payment within 7 days. Not only has the builder reneged on the commitment, chances are quite bleak that the project will be delivered anytime soon. Triple whammy (higher purchase price, payment of pre-EMI from own pocket and long delay in delivery). For all you know, the project may never be delivered. Read about the case of Jaypee Infratech on LiveMintThere are many projects that have been stuck for almost a decade and there is no relief for buyer. Always remember, for the bank, you are the borrower.

What Should You Do?

While there may be merit in opting for such schemes, do not fall for such schemes too quickly. Given the nature of real estate industry in India, the greater focus should be on finding a project where you can expect delivery on time. Funding/financing (pre-EMI, full-EMI, builder schemes) is important but it should be secondary. What good is a fancy scheme if you don’t get your house on time? Find out if the developer is delivering other projects on time. This is something you should do in any case. If the other projects are facing long delays or the work is stalled at many sites, there is no reason why your project should be any different. Stay away from such projects. If the developer is listed on stock exchanges, you can go through the financial statements to understand the financial position of the company. Do not focus too much on Profit & Loss statement. It is easier to manipulate P&L statement. Focus more on cash flow statement. Compare the regular price of property and the price under the scheme. If the differential is too high, you need to take a call.

Point to Note

Please note I am not referring to subvention schemes that were prevalent during the earlier part of this decade. Though the nomenclature will vary, under such schemes, banks used to make upfront disbursal of the entire amount to the builder (without any linkage to the stage of construction) and the builders used to make interest payment to the bank till possession. Such schemes were banned by RBI in 2013. Do note only upfront disbursal for an under-construction property is banned. The arrangement where the pre-EMI payments is made by builders in a construction-linked disbursal is not banned.

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