September 5, 2013

Home Buying-Why 20:80 scheme is unsafe?

Recently RBI raised caution on banks allowing for home loans such as 20:80. But do you know what risks are there behind such schemes? Why you as an individual buyer should avoid such an offer? Let us discuss it in detail.

What do you mean by 20:80 schemes?

To understand it in a better way, let us say you shortlisted a property to buy worth Rs.1 Cr. So in such schemes you are only paying the 20% of this total value of property means Rs.20,00,000 as a upfront payment. Rest Rs.80% (in this case Rs.80,00,000) will be disbursed to builder by your bank to complete the project. The builder will pay the interest on this 80% of the amount till you get the possession of property. But the EMI will start once you are in possession of the property. So you are buying the property currently by paying just 20% of the value. Rest after the possession. Great !!! But let us go deep into it.

This scheme really works for those who have currently rented house and unable to bear the cost of EMI as well as rent at the same time. Once moving to own a house they can easily manage the EMI as there will be no rent payment from them. But few took the advantage of booking real estate and started to gain the profit. Let us say you booked the property for Rs.1,00,00,000 today by paying Rs.20,00,000. Rest Rs.80,00,000 disbursed by your banker to builder to complete the project within a period. So if we consider that your builder completed the project within the stipulated time say 3 years. Then the property value of today’s Rs.1,00,00,000 will not be same after 3 years. Few started to book this price difference by selling it. So if the property value after 3 years will be Rs.1,50,00,000 then the profit of Rs.50,00,000 within 3 years with the investment of Rs.20,00,000.

The above said story is one side when we consider the buyer perspective. Now let us understand it how this scheme is beneficial to the builder. When builder needs money to complete his project he need to borrow from outside which will fetch him an interest rate of around 15% to 16%. But if get it for around 12%  (home loan rates of banks)by such 20:80 schemes then he will save more when it comes to cost on the project. So builders also started to push for such schemes.

This is usually a tripartite agreement between buyer, builder and banks. Where buyer agrees to pay 20% upfront and rest 80% in EMI once property under his possession. The builder will get 80% upfront and agrees that he will pay the interest on that till the property completes. The banker will disburse immediate 80% to builder and start to get interest on that. So all three will be in a win-win-win situation. But…….

Say your builder defaulted in completing the project within a stipulated period, closed his business, unable to pay the interest on 80% within a stipulated period regularly or you have some legal issues after this loan disbursement then who will be responsible for the amount? Buyer, builder or bank? No it is only buyer as the loan will be in his name. So in all probability with 80% of the amount disbursed to builder the risk will be more on buyer than any one else.

Here is the live case of one builder (but not under 20:80 scheme) where the tussle between buyer and builder is going wider and wider day by day. 3 years back in Bangalore on builder announced the lowest price for his apartments which was Rs.14,00,000 (I don’t know the exact size but for double bed room flats). Now the problem is, recently builder sent notice to all buyers asking for another Rs.8,50,000 as the cost of construction escalated. For this builder gave two options either to pay the escalated cost within the stipulated period or cancel the agreement of buying. If buyer agreed to cancel then the builder will pay the amount already paid by the buyer with paying 9% interest on that. But that too once that booked apartment sold to someone or within 6 month period whichever is earlier. The builder is now ready to answer to queries in court if buyer knocked the door of the court. In such a typical condition what the individual will do? How much risky it is to enter into such 20:80 schemes?

This is why RBI cautioned banks to not to disburse such risky loans.

33 Comments

  1. Thank you Basu for this eye opener. Really never thought that pay later schemes can actually land me in trouble.

    Reply
  2. Hi I have a well known builder property in Bangalore , I went for the scheme for 20: 80, this property will find at the end of 2016 or early 2017 .now my question is if I will sell my property now what will b my profit based on only 20 percent ?

    Reply
  3. Hi Basu! What an informative article? An eye opener. Tell me something, one of a premium builders in Bangalore with an exceptional track record offers 10:20:10 scheme minus the interest payment commitment (only customers have to pay it). What could be the potential risk in it?

    Reply
    • Poorna-It might be 10:80:10. Loan will be in your name. So the risk of default from builder or delay may harm your credit rating or finance. Never believe to those who claim themselves as “PREMIUM BUILDERS” and claim to be “EXCEPTIONAL TRACK RECORD”.

      Reply
      • Ya, True. It is 10:80:10.. typo error 🙂

        Thank you for the expert answer 🙂

        Reply
  4. Hi Basu,

    I have seen in HDFC home loan site

    Adjustable Rate Loan
    RPLR: 16.55%
    Loan Slab Interest Rates (% p.a.) RPLR Minus Spread
    Up to and including Rs.75 lacs 9.90 to 10.40 RPLR – (6.65 to 6.15)
    Rs.75.01 lacs onwards 9.90 to 10.40 RPLR – (6.65 to 6.15)
    TruFixed Plus Loan – 2 & 3 Year Fixed Rate Variant
    RPLR: 16.55%
    Loan Slab Interest Rates During The 2 & 3 Year Fixed Rate Term (% p.a.)* Post The Fixed Rate Term The Applicable Interest Rates Shall Be The Prevailing Rate Of Interest Under Adjustable Rate
    Up to and including Rs.75 lacs 9.95 to 10.45 RPLR – (6.60 to 6.10)
    Rs.75.01 lacs to Rs.5 crores 10.05 to 10.55 RPLR – (6.50 to 6.00)
    Rs.5.01 crores onwards 10.15 to 10.65 RPLR – (6.40 to 5.90)
    TruFixed Plus Loan – 10 Year Fixed Rate Variant
    RPLR: 16.55%
    Loan Slab Interest Rates During The 10 Year Fixed Rate Term (% p.a.)* Post The Fixed Rate Term The Applicable Interest Rates Shall Be The Prevailing Rate Of Interest Under Adjustable Rate
    Up to and including Rs.75 lacs 10.05 to 10.55 RPLR – (6.50 to 6.10)
    Rs.75.01 lacs to Rs.5 crores 10.20 to 10.70 RPLR – (6.35 to 5.85)
    Rs.5.01 crores onwards 10.30 to 10.80 RPLR – (6.25 to 5.75)

    I have some queries for above data

    1.What is the RPLR?
    2.which one is the preferable Adjustbale home loan or Interest Rates During The 2 & 3 Year Fixed Rate Term (% p.a.)*

    Please be clarify

    Reply
    • Chennaiah-1) Retail Prime Lending Rate. 2) I think it is better to go with adjustable home loan. In current scenerio of decreasing interest rate you may get the benefit of it.

      Reply
  5. Hi basu
    I purchased a property under no emi till possession scheme. Until 4 months back every thing was going smoothly. But in today’s scenario if builder deposit money one month other month it become our turn to pay whole emi. Explanation on builder’s part being lack of funds. Can we do anything?

    Reply
    • Jyotsna-This is what I pointed, it is you who treated as loan holder. So, it is your responsibility to pay the EMIs due. Also, if they miss then it drastically affect your CIBIL score. Check them with the rules and regulations.

      Reply
  6. Hi basu,
    I have booked flat in 10:80:10 scheme. In which I have already played 10% and bank have disbursed 70% of the amount but now the problem is bank and builder is asking remaining 10% from us before possession saying bank will disburse the remaining amount only after our payment down to them. Is this correct as they told us while booking that we need to pay remaining 10% after possession only. What can I do for now. My flat possession is around in Dec 15

    Reply
      • its India bulls Housing Finance

        Reply
        • Pushpa-It is not a bank but NBFC. Check what the loan rules states by going through loan documents.

          Reply
  7. Mr. Basu still some builders are there like in Chandigarh area offering this 20:80 or 25:75 facility. They are financing from Tata Capital not from any banks. And telling that after possession the loan amount (total principal+ rest interest ) will be transferred to any bank as home loan as per us(buyer) . is it true or there is something hidden within it?

    Reply
    • Amiya-If they are still doing it then it is illegal. The problem with real estate is, it is hard to regulate for Government.

      Reply
  8. Hi Basu…I have 250k for investment. My target is getting some amount for down payment for house after 3 years. What is the best possible investment? My risk appetite is moderate.

    Reply
    • Akash-Whether your risk appetite is moderate or aggressive, you can’t take risk. Because your goal is very short. Better you can use FDs or Debt Funds.

      Reply
  9. Hi Basu,

    This article was really helpful to understand the insights of 80:20 scheme. However I had a basic question here. I didn’t understood your statement “The builder will pay the interest on this 80% of the amount till you get the possession of property”. Will this happen anywhere? Till this point I was thinking that the buyer has to pay the Interest and wait till the time builder gives us for possession. Please correct me if I am wrong. Appreciate if you can give me your answer in more detailed way.

    Thank you,
    Naveen.

    Reply
    • Naveen-Builder will pay, because he uses this 80% part for his business purpose. So why you?

      Reply
      • If that is the case, are all builders following this? Or it depends on your negotiation capability? Because, the current builder where I have booked an apartment, never promised me that he will pay the Interest for the 80%. Please let me know how should we deal with the build in this case.

        -Naveen.

        Reply
  10. Very Informative Article,Mr. Basu. I had a clarification – In any arrangement of payment – either 20 80 or the conventional method of various % amounts to be paid to the Builder till Possession, isn’t there a Legal Guarantee Doc issued by the Builder which states that there would no further hidden/unexpected costs to be incurred by the Buyer,if any, and would be taken care by the Builder, besides the ‘Actual cost’ which is paid by the Buyer at the time of Sale. The Objective being then there can be Multiple Hidden Costs which can arise like the construction Costs as mentioned above and the Vulnerable Buyers would not be in a position to meet the same. Thanks and Regards..

    Reply
    • Mohit-Including me it is hard to read each wordings of sale agreement. So they make sure to suites according to their need. Hence we buyer need to be aware. For your information there is no such legal guarantee document which no builder will provide you. Because they know the delay in project and cost increase.

      Reply
    • Thanks for the revert on the Clarification,Mr Basu.

      Reply
  11. Excellent!! Need people like you around to understand the nitty girtty of Financials!!

    Reply
  12. GOOD WORK BASU….nice

    Reply
  13. Timely & Useful article for the innocent buyers. Wishes! Mr. Basu

    Reply

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