R.I.P. interest subvention scheme

Imagine this scenario:  You want to buy a dream flat in an under-construction project. It promises everything you need, but you are worried that the developer will not hand over the project within the guaranteed tenure of two years. No problem. The salesperson from the developer’s office gives you a win-win proposal. You pay 20 per cent now, and XYZ Home Finance will provide a loan for the balance amount. The developer will pay the interest on the loan till the construction is completed, and after two years, you start paying the regular equated monthly instalment on the loan. All that you need to do is sign the tripartite agreement between yourself, the developer and XYZ Home Finance.

So why has this so-called fantastic offer that supports home buying been banned by the National Housing Bank (NHB)?

The reasons are contained in the ‘asterisk’ mark of the advertisements publicising such offers. The famous “T&C apply” (read terms and conditions). The tripartite agreement between the housing finance company (HFC), the developer and the buyer is loaded against the buyer. While the buyer is under the impression that the developer is solely responsible for paying the interest during the construction period, the agreement provides that the buyer will have to pay the interest if the developer does not. Secondly, most contracts will also ensure that the buyer will need to pay the interest after two years, even if the developer delays the project handover. If the developer does not pay during the two years or delays payment, the credit record of the buyer is adversely impacted. These hidden gems only become visible when the project is delayed.

No wonder, NHB has banned this product. But why now? It was already seized of the situation. In 2013 and 2016, it issued warnings against this practice. And in 2019, it has finally banned it.  

Developers and HFCs like this product because construction is a significant risk in India, given the minefield of regulatory approvals and on-site inspection a project has to go through. So, if a developer were to take a loan for constructing a project, the loan rate stands at 12 per cent to 18 per cent. On the other hand, the buyer who is putting his risk profile to acquire a loan gets a loan at 8.75 per cent to 9 per cent. The system worked perfectly fine till real estate prices kept rising. But in the last decade, prices are stagnating, projects have been delayed, and buyers are feeling the pinch.

The builder lobby is crying hoarse that this will be one more impediment in the recovery of the real estate sector, but no industry can demand a licence to cheat.

It’s a shame to waste a good crisis. The Reserve Bank of India, the new regulator of HFCs, should use nudge economics, and at least signal the less-risky nature of buying ready-to-move houses by reducing the risk weight on such properties. Like elsewhere in the developed world, retail buyers should only purchase ready properties and not under-construction properties.

The writer is a Sebi-registered investment advisor