This article is written by Meera Annie Koshy, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.
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Owning a house is a dream for an average middle-class family in India. With more and more people moving to urban areas with the prospect of better standard of living, better education and more opportunities for career growth, the demand for property has gone up in the past few decades. Builders and developers have taken advantage of this opportunity and are coming up with projects that are made affordable to various income groups through different financing schemes.
Many of these prospective buyers would have to depend on loans for acquiring these assets. In most of the cases the booking starts when the property is under construction and the buyer can choose between the various options that are available for payment. Subvention scheme is one such option which is favourable for both the buyer and the builder in certain cases. We will be discussing in detail the pros and cons of the subvention scheme and the type of buyers to whom it is suitable the precautions that needs to be taken by the buyer before opting for such a scheme.
What are subvention schemes for homebuyers
Subvention schemes are targeted at buyers who avail home loans. The buyer will have to make payment of an amount that may range from 5-15 % of the total price of the property to the Developer or Builder upon booking and thereafter opt for the subvention scheme available with the developer. There are various schemes of Subvention like 10:80:10, 15:75:5 etc. The developer may already have tie-up with certain banks from which the buyer can avail a loan under the subvention scheme. There is a tripartite Agreement between the home buyer, the developer and the financing company or bank as the case may be, where the loan is granted to the buyer in his name but is disbursed to the developer at various stages of construction and the developer pays the interest till the buyer receives the possession. The disbursement of the loan amount in various stages is in line with the RBI guidelines prohibiting lump sum payment to real estate developers to prevent siphoning of funds. The buyers EMI payment will commence after taking possession. The pre-EMI interest on the disbursed amount is paid by the developer.
This can be explained with the help of an example. A buyer approaches the developer for buying a flat which costs 50 lakhs and will be ready for possession after 36 months. The buyer does not have ready cash and needs a loan so that he can make monthly payments, the developer also does not have the financial resources to complete the project. The buyer opts for a subvention scheme of 10:80:10. The buyer will have to pay 5 lakhs upfront. A loan of 40 lakhs loan will be disbursed by the bank to the developer at various stages of construction spread over the 36-month period. The bank usually credits the disbursements after deducting the pre-EMI interests. The buyer has to pay the balance of 5 lakhs due to the developer when he gets possession and his EMI payments for the 40 lakhs loan will also commence on possession.
This is a win-win situation for the buyer as well as the developer where the buyer will not have to bear the burden of interest till, he gets possession and the developer will get the a loan at the rate available for home loans for individuals that may range from 6-10 % whereas the cost of capital for the developer may range from 15-20 % if he has to rely on his own funds.
Pros of subvention schemes
- As the builder is paying the pre-EMI interest the buyer is relieved from payment of interest till possession. This reduces the financial burden for those who stay in rented properties.
- Developers get a steady flow of funds at cheaper interest rates.
- Developers shall adhere to the previously agreed construction schedule because the loan amount will be disbursed as per the construction schedule only for the completed work.
- The developer is motivated to deliver possession in time as he would have to pay the interest till possession.
- Loan disbursement is linked to stages of construction. If the developer is not adhering to the construction schedule. The loan amount will be limited to loan amount disbursed as per the construction stage and not the complete loan amount.
- Project delays will not affect the buyers as the EMI will commence only after possession.
- Subvention scheme is also beneficial for the financial institution as they will be able to procure a greater customer base while the due diligence and the verification process associated with the subvention scheme is performed only once. Which makes processing of loans fast.
- Buyer will get the benefit of price appreciation of the property with minimum interest.
Cons of the subvention scheme
- If the developer defaults and the project is delayed the credibility score of the buyer is affected as the loan is in the buyers’ name. Once damaged, credit scores may limit the borrowing capacity of the buyer in the long run.
- Due to the presence of the liability shifting clause in cases where the bank does disburse the loan amount without deducting the pre-EMI interest or in cases where the project gets delayed the burden of payment will shift to the buyer.
- If the subvention period is mentioned as a fixed duration and not till the date of possession then in that case if there is delay for completion and even if the buyer has not obtained possession the burden EMI will commence. This will be a heavy financial burden for those who stay in rented properties.
- There are no free lunches. If the developer is paying, he will obviously increase the price of the property in most of the cases the buyer may have to pay a premium of 10- 15 %. In some cases, this may be more than what the developers pay as actual interest.
- Although the buyer is indirectly contributing to the pre-EMI interest in the form of the premium price for the property, he can claim the tax benefit only on possession or the date from which his EMI payment commences.
Tripartite agreement between buyer, developer and financing company /bank
As part of the subvention scheme a tri-party agreement is executed between the homebuyer, the developer and the lending institution or bank as the case may be. This is attached to the sale deed of the buyer.
The essential elements of the tripartite agreement can be discussed in light of the pros and cons of the Subvention schemes. The buyer should read the agreement carefully to ensure that it safeguards his interest. Before executing the buyer needs to ensure the following details in the agreement:
- EMI to commence only on possession – The builder may claim that there will be no EMI till possession and in the agreement, they may mention a cut-off date for possession meaning EMI will start after the cut-off date. This discrepancy should be removed and the buyer should ensure that the EMI should start only after possession.
- If the developer does not adhere to the construction schedule or if the possession is delayed in any other manner the burden of paying the interest should be borne by the developer.
- Subvention period for a fixed duration should not be agreed to since the buyer will not have a remedy if possession is not granted.
- The penalty to be paid by the developer if the project is delayed and the remedy for the buyer should be clearly mentioned.
Word of caution to home buyers
Before availing a loan under the subvention scheme the buyer should perform the necessary due diligence as his hard-earned money and credibility will be at stake if the project does not go as per the initial claim. The following should be verified.
- The credibility of the developer should be verified by looking into his past record financial strength, delivery and completion of projects, ongoing projects, pending litigation etc.
- Ensure that the project is RERA registered. The Real Estate Regulatory Authority was formed to bring about transparency in the real estate sector. At present, it is compulsory for all builders or developers to carry out RERA registration before they start a project.
- Ownership details and clearances, approvals etc which are required for the construction project should be verified.
- Legal disputes if any and nature of the dispute? Will the dispute affect the timely completion and possession?
- The bank/ financial institution’s profile also should be verified.
- The various payment schemes available in the market should be evaluated to select the one that is most suited for the buyer.
- The National Housing Bank (NHB) in a circular dated July 2019 has advised housing finance companies (HFCs) to stop providing loans to finance subvention schemes offered by builders to sell homes. But banks that are not bound by the circular continue to finance subvention schemes.
Subvention scheme is no doubt a blessing for home buyers who do not have the necessary funding for a one time payment and are staying in rented properties provided the possession is delivered on time. One cannot altogether label a subvention scheme as good or bad but prospective buyers should evaluate each project on its merits and then take a call. Although the National Housing Bank (NHB) in a circular dated July 2019 has advised housing finance companies (HFCs) to stop providing loans to finance subvention schemes offered by builders to sell homes.
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