Friday, April 4, 2014

Why National Housing Bank’s move to allow lenders (banks and housing finance companies) to give 90% of property value as home loan can actually be detrimental?

Author: Sachin Gupta | Find me on Twitter

Recently, country’s National Housing Bank floated a proposal that seeks to allow banks to lend 90% of property value to home buyers. According to the proposal, people seeking home loan above Rupees 20 Lacs can avail 90% of property value as home loan from banks and housing finance companies. However, these loans need to carry mortgage guarantee cover from companies registered with RBI. Lending institutions (Housing Finance Companies) need to enter into a contract with mortgage guarantee companies when the loan application is originated.

With mortgage guarantee companies coming into the picture, there is widespread belief that it will help in reducing the default risk. And at the same time, it can help in securitization of home loan portfolios. Now, isn't this what is practiced in USA? Where, one can avail 100% of property value as home loan and that loan is guaranteed by Federal Reserve supported fannie mae and freddie mac. When a loan is guaranteed by State’s agencies, investment bankers jump in and create a portfolio of home loans and securitize it and sell it to investors. These investors get returns on installments generated from home loan buyers.

The only difference it seems in Indian context is that 90% of property value is given as loan as against 100% of property value in USA. The other difference is that in US, person availing the loan is not personally liable to pay in case of a default, but in India, person will be liable to pay the amount in case default happens.

What happened in USA?
We all know what happened in sub-prime crisis in USA in 2008. When property prices began to fall people simply walked away by putting the house key on the bank’s table and that triggered a financial crisis. Read more about the US sub-prime crisis here. We in India do not want to repeat that mistake. What can happen? Let us think, you buy a property worth Rupees 1 crore and avail 90 Lacs in Home loan with about 90K installment every month for 20 years. Now, due to slowing down of economy as is the case today, you are not able to pay those EMIs. What will bank do? Take possession of your house and sell it to claim their investment in that house. We all know, Banks will be left with no choice but to sell the house in distress in tough economy thereby making a loss. However, banks have already sold this portfolio to investors and the home portfolio is already guaranteed by mortgage Guarantee Company, who is registered with RBI. So, who bears the brunt of slowing economy, yes, mortgage Guarantee Company, just like fannie mae and freddie mac did in USA. So, ultimately, the system will be saved with tax payer’s money.

One can argue that we are stretching the matter too far, yes, we are stretching the argument, but there is ever so slight possibility of such a scenario happening in near future. Hope, policy makers will consider that scenario before bringing in this new policy. As we see today, real estate sector is in doldrums and property prices in India have in fact fallen or remained stagnant. Will people who have bought the property stay invested when returns from property investment are actually less than what they will be paying to the banks against home loan? If the returns from property investment stay low for several years, then we might see the US sub-prime situation repeating in India with the implementation of new policy.

As a matter of fact, Indians banks were praised in 2008 for being conservative. Looking around the globe, Chinese banks have a limit to what they’ll lend for housing. Currently, buyers need to put between 20% and 30% down on the value of a house before securing a loan. While in Singapore it is 80% for first home and 60% for second home. Why are Indian policy makers raising it to 90% when we do not have huge scale infrastructure plans? Isn't the whole move going to put pressure on existing cities, further increasing the property prices?

OK, let’s think of the consequences of this new move

  • More people will be able to buy a house

Of course, the move is aimed at encouraging people who are sitting on the fence to buy the house. Till now, it took people some time to arrange for the 20% of the property value. But with this new move, all they need to do is arrange for Rupees 10 Lacs to buy a Rupees 1 Crore house.

  • Revival of real estate sector demand

With increased sales velocity of homes, the demand for overall real estate sector can pick up. The industries such as cement, steel will also see revival in demand. Overall, the move can boost the economy.

  • More speculators will come into the picture

With only 10% of property value to be paid by the investor, it will encourage property flippers to take advantage of the new policy. One would simply invest in an under construction project and exit as soon as the prices have risen substantially. Can government bring in measures wherein property speculation is controlled? Can government differentiate between first time home buyers and second time home buyers as is the case in Singapore? It seems unlikely. Who will suffer? The real property buyer will suffer due to higher property prices.

  • Without new cities or infrastructure, it might increase the property prices further

Do we have plans in place for city infrastructure development? Or build new cities? Unless, those plans are in place, the new move will actually put pressure on the existing cities and property prices will further increase with the new move. Simple because, more people including the speculators will purchase a house in the existing cities.

What we instead need?

  • Securitization
Surely, securitization is the need of the hour. But it can be brought in at existing 80% Loan to Property Value (LTV) ratio. More on, how securitization can help in housing finance in India?

  • REITs
Real Estate Investment Trusts are important and we need them in India. REITs will encourage retail investors to participate in property markets who till now cannot afford to invest in real estate. REITs can provide the necessary financing for realty sector which it needs today. Find more about REITs in India here.

  • Rent Laws
The government needs to reform the Rent act which is outdated. There are large numbers of people in India who own multiple properties and do not bring that stock into the market because of the fear of illegal possession of their properties by the tenants. Reforming the rent laws will revive the rental market and that will bring some sanity to the property prices.

  • Policies to differentiate between first time home buyers and second time home buyers

Government is right in encouraging home ownership. But differentiate between first time buyers and speculators. It should be quite simple to track at registrar’s office and by making it obligatory for real estate developers to disclose the details of their buyers to a central authority. If the 90% Loan to Value (LTV) policy has to be brought in, it should be for first time home buyers and not for property speculators.

what do you think??

Have any Questions?


  1. Raising the limit to 90% is good thing. the advantage of it is it would increase and boost the sales but disadvantage is more number of people would be under debt and this is not good for the nations success.

  2. 90% of property value to home buyers is certainly good news for home buyers as well as real estate professionals.
    This can boost the tumbling real estate sector of India.

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