Advise House Buying and Subvention scheme - Should you or shouldn't you?

Discussion in 'RAIDers League' started by JD666, Oct 20, 2015.

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  1. JD666

    JD666 RAID Leader Staff Member

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    So I thought of putting my thoughts down on the subventions schemes going around in the Indian property market. As most of you would have already read, the Indian real estate market is at an all time low, and builders have thousands of units unsold.

    Most of these units are either under construction, nearing completion or simply on paper. Some have not left the design phase and most details are yet to be finalized.

    How does a subvention scheme help matters?

    A subvention scheme or a 20-80 scheme or even a 10-80-10 scheme is where in, the buyer (you) pays the builder 10 or 20 percent of the unit price (unit being your apartment or flat that you have booked) in advance to the builder. The bank (your bank - that you take a loan from), pays the remaining 80 percent to the builder, as demanded by the builder, or as construction progresses. It can also be a one time payment (in full) to the builder.

    Until the flat is delivered, the builder pays the bank the pre-EMI interest, on the loan, and you don't have to pay anything. Once the unit is delivered, you can either choose to pay the bank in full, or start paying your EMIs on the apartment, and commence living in it.

    Simple enough, you don't have to pay anything till the flat is ready, and the builder is obliged to complete the flat in a given time. Sadly no.

    How does a subvention scheme help the buyer (you) ?

    A subvention scheme offers very little in terms of benefit to the buyer. However to try and find some suitable plus points in its favor, I can think of factors like, if you buy from a reputed builder, you might get your unit delivered on time. Or you save the hassle of paying the builder time and again in a construction linked plan.

    If you are living on rent, it saves the hassle of taking out two payments (rent + unit monthly installment) from your monthly income.

    But it pretty much ends there.

    Now, How does a subvention scheme help the builder?

    If a builder were to take a loan from a bank, he would end up paying anything between 14-18 percent interest on the amount taken. A subvention scheme, entitles the builder to a much lower rate of interest on the loan ( between 9.5 - 12%). This saving of upto 8% benefits the books of the builder immensely.

    After all, the builder is in it to make money, and if the company ends up paying higher interest on setup cost, then it is profit lost for them.

    Secondly, the builder can agree to a fixed term for which to pay the pre-EMI interest. Once that period is completed, and for whatever reason, you do not have possession of the property, the bank will charge the EMI+ interest, or the full EMI to YOU, not the builder.

    A full order sheet entitles the builder to 'build' further on its reputation, thereby multiplying launches and projects. Something that would've been fully funded, now becomes publicly funded (by the buyers), and the company is free to launch or put their fingers into other businesses. This is at the risk of delaying the money flow for an existing project, and is one of the core factors that have spoiled names and reputations here.

    Fourthly, A subvention plan allows the builder to charge full price for their units, with all kinds of additional charged thrown in. I can give a quick example of a project that I was buying into. The difference between CLP (Construction Linked Plan) and Subvention, just in the total price of the property was about 15%! (15.4% to be exact). The subvention plan was higher by that much amount.

    And this was a property that was quite below 1 Crore INR.

    Now the fun parts -

    Unless you have a prior agreement or contract with the builder (the fine print), with regards to the payment of the pre-EMI interest, the bank can/will start charging you the EMI (full) once the due date is past. Whether you get your property or not.

    The loan is based on your credit score, and consequently affects your credit rating. So if the builder defaults on any payment, the bank will again look at settling it with you, and changing your score accordingly.

    If the builder does not have clean or complete papers on the property, or if there is some dispute, you are again in limbo, since the bank has already paid the builder the remaining 80% of the sum. You can either settle with the bank (by paying the 80%) or pay EMIs on a unit that your builder has not completed.

    So basically if it all goes well, everyone is happy, you start living in a house for which you are paying much more than anyone else who didn't opt for a subvention plan. The builder got way more money than it would have in a full down payment or CLP. The bank starts getting the EMI, and you are tied in for whatever period of installments you signed up for. How sweet. Just that you'll end up paying as much as 30% more, than someone who would've gone for a CLP or a direct bank payment to a ready to move in place.

    But if something does go wrong, you're jacked essentially. The builder has limited liability. It is liable, but not as much as an 8 to 5 worker that you are. Or a person who has saved hard to be able to afford the down payment. The bank will hound you, you will have to pay EMIs or risk losing your un-delivered property, or probably signing it off to the bank to settle. And all this while your credit score will be taking a massive massive hit. Not much fun is it?

    A lot of people give me this argument that what the hell, take a home loan, pay it off in 15-20 years and then live easy. Your property appreciation will handle all the pains and efforts that you put in to pay those EMIs. So even if it meant skimping on a holiday here or there, or not buying something you really desired, you at least have a wonderful place to call home. Awwwww.

    I did the maths over a few properties that I saw during my time. Sure, there were booms and property price tripled for some units that I saw. Some jumped to 10 times their value in a period of about 10 years. However, now, and for the last several years that I can see, that has not been the case. At best, a unit purchased in 2008, has probably gone slightly over double (Gurgaon - Sohna road), but that is still before tax is deducted.

    If I were to buy the said unit on a home loan (20% downpayment - 80 % financed), things get really interesting. Say you find a property that is worth 60 Lakhs, all inclusive. So it would start at about 49-51 Lakhs, and then the builder would add all the ancillary charges, EDC/IDC etc.

    The bank would finance a said amount, and for ease, let's assume that you have 20% in your pocket to pay upfront. So you pay about 12L when the builder asks for it. It will generally go in the first 90 days of your booking (10% booking + 5% in 45 days of booking + 5% in 90 days of booking).

    Then the bank steps in, gives you a loan, and as and when the builder sends you a demand note, you send a letter to the bank, get the amount disbursed, and start paying an EMI on the loan. Now you can also choose whether to start paying your EMI in full (on the 48L), or pay the pre-EMI interest.

    The pre-EMI interest will be charged until the unit is delivered, and it will go on increasing as the payments are made to the builder. For e.g. it might be 4-5k per month after the first payment to the builder, but might be 7-8k after the second payment and so forth. This will go on, until the unit is delivered to you, and the bank is notified that you have taken possession. From then onwards, your full EMI (Interest + principle) will start.

    Here's a quick glance at an online calculator -


    You actually end up paying the bank, the same amount (nearly) that you took a loan for! Over a period of 15 years, which is a reasonable time frame for a home EMI. If I skewer it towards the 20yr mark, though the EMI would go down only by about 2,100 Rs, you will end up paying an additional 14,50,000 Rs as interest.

    Even if your property were to appreciate to that mark, very few places are left where in a 60L unit would double in price or maybe give more. And whatever you stood to gain in property appreciation, has been lost (mostly) to the bank as interest. The rest would be taken care of property gain tax, though I'm not entirely clear how it would work if you sell after several years.

    Sure you'll get tax rebate on the home loan, but the essential picture is, you'll be at no profit no loss, or slightly better than neutral, after all this hassle and years. You will have a house to your name that you can call your own after maybe 15-20 yrs.

    Sorry for the long rant, but a number of people have been touting subvention plans as the next best thing to happen to infrastructure since CLPs. This isn't however the case. Start with a small project, buy a small unit, that you can afford to save for, and pay off directly to the builder in the period that the unit is constructed.

    You will earn in appreciation, and can eventually use it to build upon and move into a bigger unit, until you find your dream house, or something that fits your budget. But stay away from subvention plans, and stay away from home loans that are for too long a tenure. In the long run (short run for subvention) they benefit the other party more than they do you, the end user.

    Here's a property hunting potato family for your time in reading this post -

    potato family.jpg
  2. MOZ

    MOZ RAID Leader Staff Member

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    I'm not going to write a long post, cause I don't think someone would want to read it after your wall of text, but:
    1. Yes, subvention doesn't make sense, it looks very nice that you don't have to pay the EMIs until you get your unit, but guess what, with the liability on you and even the reputed builders notoriously missing deadlines, you'll be paying much more earlier than you get your place. I know many people who have booked apartments in Noida and not one person has got it on the mentioned deadline, couple of years is the norm and expected delay. I've been told the "internal scheme" of builders is to take bookings, and use the money to buy more properties and start new projects, while the older projects move on at snail's pace.
    2. Property investment definitely was a wise choice a decade ago because of the general property appreciation. Now, it isn't that simple, you have to do a lot of market research to identify areas where there will be considerable appreciation in the next 5-10 years, specially if taking a loan from the bank.
    3. All of this makes even more sense when the property you are looking to spend on is an investment, and not a place you intend to stay yourself. If you do look for a place that you want to invest in for investment purposes, look for a place that can be inhabited soon, so you can rent it out and can generally get half your EMI from that.
    JD666 likes this.
  3. JD666

    JD666 RAID Leader Staff Member

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    Regarding point number 3, this is a generic calculation that I did for a few places -

    Property in Rajasthan - worth around 45L - Rent - 15,000 INR per month. thats like 4% of your asset value in rental income (before taxes)

    2 properties assessed in Gurgaon - 2 Bedroom flat - 75-80 lakhs - Rent - 25-30,000 per month, That is again 4% of your asset value.

    - Won't cover your EMI

    - The appreciation is probably the only component that will return benefits.

    What needs to be done is invest in a reliable project, with reasonable project size (nothing that breaks the bank). The push is towards smaller units, and for instance, 1BHK units are gaining popularity in India, since they can be owned for as little as 15-25L.

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