This article was first published on Moneycontrol
For the last few years, the sales in the Indian residential market has been plummeting. There is a supply glut in most large markets in the country. Despite an improvement in the sales and supply numbers from 2017 low, the high of 2014 is elusive.
After a decade long boom in launches and rising rates, consumers have seen hardly any price appreciation in the real estate investments. This has adversely affected demand. NRIs have stopped buying into real estate as an investment class because of hassles around management and poor rental yields. The own-use segment remains strong in intent but has been hesitant to bite given the elevated prices. To excite the customer to buy, multiple new financing options are being made available to home buyers.
Financing options for buyers
Getting the right financing option shall help buyers increase their buying power and boost cash flow.
There are two options available for a homebuyer. Either buy a property that is yet to be constructed or under-construction or buy a ready-to-move-in property. Various financing options available are given below:
1. Full upfront payment
In this type of payment, the buyer has to pay 10 percent of the property value as an initial payment and pay around 80-85 percent of the property value within two months of the initial payment. The remaining 5 percent can be during possession.
Benefits – Upfront payment usually offers healthy discounts to the buyers. No other plan can offer a discount of 8-10 percent on the total property price.
Risk – Recovering money from the seller will become difficult if there are legal issues with construction. Also, if there is a delay in construction or in getting the possession of the property, it might cost the buyer heavily.
2. Bank/NBFC loan with a down payment
In this case, the builder gets the full amount upfront, partially from the customer and the remaining from the bank or NBFC. The buyer can choose his share of payment. While 20 years is the most favorite tenure for home loans in India, a tenure of 30 years is also available with most banks.
At the current interest rates, however, 15 years term is financially more beneficial even at a slightly higher monthly EMI. For a Rs 50 lakh, 20 years loan at 9 percent, the monthly EMI is Rs 45,000 per month. For a 15 years period, it increases 11 percent to Rs 50,000 pm. The total interest outgo, however, decreases from Rs 58 lakh to Rs 41 lakh, a 29 percent decrease.
Benefits – The buyer can choose a comfortable option to finance his investment. Based on his money inflow he can choose the tenure of the loan and his payouts.
Risk – In case of project delays, non-completion or builder frauds, the customer still has to repay the loan in full to the bank. Many customers who are plagued by long delays or non-completions are suffering.
In this plan, the buyer pays a booking amount of 10-15 percent of the property value. And, the remaining amount is linked to construction milestones, for example, with each floor that is being constructed the buyer would be paying a pre-determined percentage.
For example, the following plan is very common in most large residential markets:
Of all the financing options available, this is the least risky option. As the payments are linked to the construction progress the chance of delay will be less. Since the builder wants regular cash flows for the project, he will ensure timely completion of the work.
For a ready to move in property, availing a bank loan or arranging for a full payment can be done without much risk of delay, default or fraud by the builder taking a loan might be beneficial because of the tax breaks. Interest on bank loans is exempt from tax for up to Rs 2 lakh per annum. And the principal being repaid is available for Section 80C tax saving for up to Rs 1.5 lakh per annum.
Is EMI holiday actually a holiday?
EMI holiday is where one need not pay EMI for the first few months of their loan tenure. An EMI holiday is usually given to people who take a loan so that they can adjust to their change in financing before they start their EMI. A huge amount of money is usually paid during registration for stamp fees, down payment and registration. To adjust to these expenses, one usually gets an EMI holiday. So, if the loan tenure is 120 months and the EMI holiday is for three months, then one will have to pay EMI only for 117 months.
But is EMI holiday actually a holiday? Let’s take an example and see if this is beneficial for a buyer.
Aakash Shah, a software employee, wants to buy a 2BHK apartment in Hyderabad that costs Rs 60 lakh. The down payment for the same is 15 percent. He pays the down payment of Rs 9 lakhs and takes a home loan for 15 years (180 months) for the rest of the amount at 9 percent interest.
He gets an EMI holiday for the first three months so he will pay EMI for only 177 months. The EMI he will have to pay is Rs 53,326 a month for 177 months to clear his home loan.
But what if he doesn’t opt for EMI holiday and pays EMI for the entire term of 180 months. Then he will have to pay an EMI of Rs 51,728 for 180 months. The total amount paid by him is Rs 93,10,968. Whereas the total amount paid by him if he opts for EMI holiday is Rs 94,38,702. By opting for EMI holiday Aakash is paying Rs 1,27,734 extra. So EMI holiday is not as lucrative as it is made out to be.
Government of India has introduced Pradhan Mantri Awas Yojana for the Middle Income Group (MIG). They are further classified as MIG I and MIG II. MIG I category includes households with income in the range of Rs 6 lakh to Rs 12 lakh and are eligible for 4 percent interest subsidy on loans up to Rs 9 lakh. MIG II category includes households with income in the range of Rs 12 lakh to Rs 18 lakh and are eligible for 3 percent interest subsidy on loans up to Rs 12 lakh.
Let’s say a person wants to buy a 2BHK flat (770sft). The value of the house is Rs 25.23 lakh. He is getting a home loan at 9.5 percent interest rate for 20 years. If the loan to be taken is Rs 20.18 lakh (after 20 percent down payment), the EMI will be around Rs 18,814. For a person under MIG I category the EMI will be Rs 16,623 and his effective interest rate would be 7.79 percent. A person under MIG II category the EMI will be Rs 16,669 and his effective interest rate would be 7.83 percent.
With multiple financing options and supportive government policies, the convenience in procuring loans and housing finance is at a high. Yet, this should not be the primary decision-making criteria. If it’s the first house for the customer and he is planning to stay in it, then the convenience in financing should help.
If the same house is being bought as a pure investment, then the current market conditions do not support it. The gross rental yields in the Indian real estate market are 3-4 percent per annum along with a low expectation of capital appreciation in ready-to-move-in properties.
Buying a house as an investment also comes with the hassles of maintenance, tenancy, taxes, and illiquidity. Thus, investors looking for pure returns should look at other investment options.