Loan rates should mirror unfinished homes' higher risk, highlight gap

Requiring banks to hold more capital for under-construction loans and less after completion would make their higher risk evident through the resulting interest-rate differential

Rajesh and Seema lived in a rented apartment in Delhi, dreamt of owning a home, and saved diligently towards it. They fell for an irresistible offer for an under-construction flat in Noida: pay 20 per cent now, finance the rest through a bank loan, and pay no interest until possession. It looked like a dream deal until it turned into a nightmare. The project stalled midway; the bank had already released the entire 80 per cent to the builder. Under a tripartite agreement, the builder was to service the loan until handover, but when he defaulted, the fine print shifted the burden to them. Overnight, Rajesh and Seema were paying interest on a home that existed only in glossy brochures while still paying rent for the one they lived in. Stories like theirs expose a deep fault line in India’s housing-finance system.

 

I was reminded of Rajesh and Seema’s fate while reading the recent Supreme Court order directing the Central Bureau of Investigation (CBI) to register first information reports (FIRs) against builders and bankers suspected of colluding to defraud homebuyers. Across India, hundreds of under-construction properties (UCPs) have languished for years; one study puts the average completion time at eight and a half years  — nearly three times what buyers are promised. The UCP risk — that the project may not finish on time or at all — is the biggest blind spot in Indian housing finance.

 

Banks are not blind to risk. When they sanction a home loan, they consider three broad ones. The first is the borrower’s creditworthiness — whether income can support EMIs through the loan term. This is measured by the fixed obligations to income ratio (FOIR), which limits total EMIs to about 40 to 55 per cent of net income so that the balance covers other needs. What FOIR misses is the possibility of double payments — rent on the home one lives in and interest on the UCP. A system built for ready-to-move homes simply collapses when faced with this UCP risk.

 

The second risk is the seller’s title and approvals. In completed projects, these are straightforward to verify, but UCPs often have partial or conditional permissions that can leave buyers exposed if the project stalls. The third risk is the building’s ability to last the full 20- to 30-year loan tenure, which lenders manage through engineering checks and insurance.

 

What none of these covers is the most critical risk — that a UCP may never be completed. The gap exists because India’s housing-finance norms were borrowed from Western markets that rarely sell a property before it is built. Where they do, such “off-plan” sales are uncommon and tightly regulated. Buyers’ advances are kept in escrow or backed by bank guarantees, ensuring funds remain available for a possible refund. If the builder defaults, the buyer can recover the deposit with interest or have another developer complete the project.

 

India’s Real Estate (Regulation and Development) Act (RERA) was meant to offer similar protection — refunds with interest or even buyer-led takeovers in case of long delays — but these rights largely remain on paper. Because the escrow account is meant to fund construction, refunds are uncertain. Weak enforcement means that even buyers with favourable RERA orders often struggle for years to get them implemented. The situation worsens when developers seek protection under the Insolvency and Bankruptcy Code (IBC), which overrides RERA and forces homebuyers to queue up before banks, whose lending often fuelled the problem in the first place.

 

It never ceases to amaze me that both banks and buyers largely ignore UCP risk. Banks do so by treating loans on UCPs and completed homes alike — same interest rate, same capital-adequacy requirement — even though one exists only on a brochure and the other has families living in it. Buyers too blur the distinction, assuming they are buying a home on loan when they are really taking a loan to fund a developer, trusting that the project will be delivered simply because it’s on a registered document. RERA has improved transparency but remains far from the safety net buyers imagine it to be.

 

Truth be told, an institutional nudge is urgently needed. If banks were required to hold higher capital for UCP loans and could reduce it once construction was completed, the difference would appear as lower interest rates for completed homes. That would make the UCP risk starkly visible and end the unintended subsidy that homebuyers in completed projects now give to developers. I realised that women in India live longer only after I saw that insurance companies charge them lower term-insurance premiums. Lower home-loan rates for completed properties should drive home a similar truth about the UCP risk.    The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor; X (formerly Twitter): @harshroongta