Why 80:20 home loans had to go

Last Updated 19 September 2013, 13:49 IST

With the RBI banning the popular construction-linked payment plan, there is hope that the property market will now be more transparent and bloated prices will go down, says Vatsala Gurunath.

The next quarter is the festive season in the eyes of the Indian market. Builders prep up for the festive season launches on Vijayadashami, buyers look forward to discount deals and there’s excitement all over the realty sector.

But such bonhomie may not be visible this year as former RBI governor D Subba Rao, on his last day in office, dealt a hard blow to the builders by banning the popular construction-linked payment plan (CLP), also known as the 80:20 home loan. In what economists describe as an analytical move to avert the country’s sub-prime crisis, the Reserve Bank asked banks to desist from upfront disbursal of sanctioned housing loans to builders and instead link the loans to stages of construction of a project to protect the home buyer and the lender from additional risks.

The directive is a bitter pill to realtors as the 80:20 schemes were largely instrumental in boosting sales during low demand and also enabled funding when needed. The payment plan required the customer to pay the loan instalment to the builder as per a predetermined rate of building progress which was determined as per the builders’ construction-related milestones.

What is 80: 20 scheme

Under this scheme, the buyer has to pay 20 per cent of the total purchase price upfront and the balance 80 per cent upon possessing the house, irrespective of when the actual possession happens. Such loans involve a tripartite agreement among the builder, the lending bank and the buyer. The buyers make the payment upfront while the rest is provided by the banks on which the builder pays interest till the property is handed over to the buyer. At the time of possession, the loan is transferred to the buyer.

If the buyer books an under-construction flat under this scheme, he need not pay any pre-EMIs. The builder agrees to pay interest on the borrower’s behalf for a specific period of time while the bank disburses the entire loan amount to the builder. The loan, however, remains in the name of the buyer.

This was always seen as a win-win by the buyer and the builder because the builders sold their projects, got funds at cheaper rates and the buyer invested in a discount deal without immediate worry about installments. The scheme was usually offered in the pre-launch stage of projects. It became popular as liquidity-strapped developers used it for propelling sales.
But the buyer is exposed to all the risks of delayed possession, escalated costs and builder’s default on loan. The buyer unwittingly signs up for all of this, unaware of the impending risks, financial and otherwise. A defaulting builder could leave the buyer and the bank in the lurch and the risk is entirely borne by the buyer.  With the loan entirely in the buyer’s name, there is no insurance against a builder’s default.

The RBI became concerned that the scheme was offered only during the initial construction stage. It has now advised banks to link housing loans to stages of construction of a project. The directive highlights the higher risks associated with such lump-sum disbursal of sanctioned housing loans and customer suitability issues. The advisory is in line with its monitoring of banks’ exposure to the real estate sector. Banks run disproportionately higher exposures with concomitant risks of diversion of funds when loans are disbursed without any linkage to stages of construction.

Another concern was that in many cases the primary motive of the funds raised by such a scheme was not to complete the declared project but fund a newer project elsewhere. The scheme was also seen as largely benefiting commercial investors who only paid 20 per cent upfront and exited the project after completion for a profit.

In such a scenario, the genuine buyer was stuck with default liability and project delay complexities. With the loan in the name of the buyer, any delayed payment of interest by the builder harmed the credit score of the buyer instead of the builder. For a builder, the scheme was a winning formula as funds were available at the rate of interest being offered on individual home loans.

Falling demand and sales in a tanking world economy is the primary factor for the emergence of such schemes. The never subduing property prices despite a poor economy and low demand kept away genuine buyers from the market and the real estate sector witnessed poor sales in the past few years.

The result was a pile-up of unsold properties which needed to be liquidated to raise funds for future projects by the builders. Builders in duress had to resort to liquidating through such seem-easy schemes. The scheme, however, is not all evil as it justified its existence by bringing in parity and buyers saw it as a discount.

A tanking rupee, economic gloom-led poor sales, liquidity crises and impending general elections are not a great scene for the realty sector in the country. The tanking rupee and economy gloom led poor sales, liquidity crises and the impending general elections are not a great scene for the realty sector in the country. This 80:20 payment model was a sure way for some builders to finance construction costs at a cheaper rate via home loans without any accountability to either the buyer or borrower or the lender. 

The directive could make quite a difference to the industry. Though established builders may weather the rough ride, new entrants and smaller builders will be the first to be hit. The cash-rich builders may as well keep up the delivery dates by completing projects in time, but the others may not and this will delay possessions and new launches. Experts are of the opinion that this move by the RBI was entirely directed towards protecting the interest of genuine buyers.

It is also a means to protect the financial institutions that provide funding. The layman in these times of corruption only hopes that this directive will render the property market more transparent and bring down bloated prices. Will this enable a common man’s dream of owning home without bringing on a nightmare?

(Published 19 September 2013, 13:49 IST)

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