Home loan defaults can put personal wealth in jeopardy. Here is how

Last week, a very different question on real estate was posed to me – "How costly can a home loan default be?"

Two events in Mumbai real estate have made the question pertinent.

1). Popularity of home purchases via subvention scheme: Earlier, most people bought apartments through a construction-linked plan (CLP). Under this plan, as construction happened, the buyer made his payments or serviced the loan taken for an apartment.

Between 2015 and 2019, things changed and subvention loans became the flavour. Schemes such as 5:80:15 were common. Under the arrangement, a buyer pays 5 percent, a lender then provides 80 percent funding but the pre-EMI until possession is paid by a developer. To provide this facility, the developer increases the total cost of the apartment for the buyer. On possession however, the buyer pays the remaining 15 percent.

Until the possession date however, the buyer has paid only 5 percent for the apartment plus stamp duty of 5 percent. In stock market parlance, subvention loans are the F&O of the real estate market. Reliable data doesn’t exist but my estimate is that 35k-55k deals in Mumbai Metropolitan Region have been done under subvention.

2). Falling home prices: It is no secret that home prices are falling. As I mentioned in my earlier column, the price fall is sharper and more public in the resale space in comparison to transactions done by the developer. The only debate is on the degree of the price fall. At the premium and luxury end – it is not uncommon to see prices in the resale market lower by 25 percent. At the mid-level housing level, the fall is not as steep.

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These two factors are a lethal cocktail. Here is why: suppose an apartment under a construction-linked plan is available at Rs 1.75 crore, the cost under subvention would be close to Rs 2 crore – assuming that the possession date is around three years away. The difference in price is to make up for the expense that the developer will be bearing for paying your pre-EMI.

Now comes the price cut. The only thing is the price cut will be based on the construction-linked plan price: Rs 1.75 crore. The logic is simple: the resale buyer does not care whether the primary buyer booked the apartment through subvention or not. Psychologically, the primary buyer under CLP will just be taking a loss of only 6 percent even if he sells it at Rs 1.65 crore.

But the balance changes for buyers who have booked via a subvention loan. They will be acquiring an apartment which they know at the resale market is lower by Rs 35 lakh (purchase price of Rs 2 crore and resale price of Rs 1.65 crore).

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Lenders have improved their subvention game. The bizarre practice of disbursing the entire amount at one go to the developer has been replaced to the sane practice of doing it on a construction-linked basis. As the developer demonstrates, he has completed a particular slab, only then a disbursement takes place.

The latest RBI norms pegged the loan-to-value ratio at 75 percent for loans above 75 lakh. Yet, it is hardly a secret that many leakages take place in this regard as well. Hence often the loan amount can reach even 85–90 percent of the agreement value.

I understand the lender perspective with regard to home loans in markets like Mumbai. The prices have either risen or remained stable.

Hence, LTV norms were rarely tested. Now the twin blows of falling home prices and reckless subvention loans have turned that premise upside down.

What happens now? Some homebuyers who availed loans under the subvention scheme will grudgingly continue paying their loans. But what of the people who have faced substantial salary cuts or lost their jobs? A home loan default is highly plausible.

That sets a series of actions that ends with an auction of the seized property. And it can get messy for the home buyer.

Loan agreements have a clause wherein if the realised value for the asset is not enough to recover the loan amount – the shortfall has to be compensated by the homebuyer itself.

An example of the clause is:

“If the net sum realized through the enforcement/sale/transfer of security is insufficient to cover the Borrower’s Dues, then without prejudice to the other rights and remedies of XXX under the loan documents and/or in law, the borrower agrees and undertakes to pay to XXX forthwith at XXX’s demand such amount as will make up the shortfall. The decision made by XXX with respect to matter under the Loan Documents shall be final and binding on the Borrower.”

Loosely put this reads: a home loan is almost a personal loan with the home as collateral. If the sale of the home is not enough to recover, his other assets can be in jeopardy. Far from a home providing a degree of security, an attempt at buying a home through tools like subvention in a falling market can put to risk all the other assets built over time.

Whether the personal asset recovery is legally enforceable by the lender in a smooth fashion is debatable. But the persistent harassment against the home buyer is not.

To the original question – “How costly can a home loan default be?”

The answer: The costliest decision of your life.

(When not busy with his newstoon platform Snapnews, Vishal Bhargava is a real estate enthusiast who views and reviews new projects. Views are personal)