When a builder shares the interest burden on the home loan, the purchaser can breathe easy and manage cash flows better, says R.P. Deshpande
For the average salary earner, managing cash flows during the construction of his house/flat is a difficult exercise. He has to arrange large payments to the contractor/builder as the construction progresses, needs to pay the PEMI interest (simple interest charged by the home loan provider on the disbursed amount, payable every month) and also keep on paying rent on the present accommodation, till the house is ready.
For example, Mr. Murthy, who earns Rs. 30,000 per month, is staying in a house on a monthly rent of Rs. 8,000. He plans to purchase an under-construction flat for Rs. 20 lakh on the assurance of a home loan of Rs. 15 lakh by his bank, at nine per cent interest. The equated monthly instalments (EMIs) would be Rs. 13,496 for 15 years. He has savings of Rs. 5 lakh to meet the margin money.
The major attraction for Mr. Murthy to consider the flat is that the builder has offered to bear the interest on the home loan during construction period (with certain conditions), but will not offer any concession on the price of the flat.
Let us analyse whether this offer is good for Mr. Murthy.
As per the sale agreement to be executed with the builder, Mr. Murthy has to pay Rs. 5 lakh immediately and the balance amount in six instalments over the construction period of 18 months. Thus, during construction period, he has to make payments of Rs. 2.5 lakh every quarter.
In the absence of the above offer, Mr. Murthy would be a bit worried about his cash flows during the construction period, as not only he has to keep on paying rent every month, he needs to pay PEMI interest which goes on increasing every quarter.
The PEMI interest payable every month for the next six quarters would be approximately Rs. 1,875 (for first quarter), Rs. 3,750, Rs. 5,625, Rs. 7,500, Rs. 9,375 and Rs. 11,250 for subsequent quarters.
If the builder had not offered to bear the interest on the home loan of Mr. Murthy, he might have agreed for a concession of Rs. 1 lakh.
For losing the Rs. 1 lakh concession, Mr. Murthy would save approximately Rs. 118,125 (total interest payable) over 18 months of construction period, as this amount would be paid by the builder. In other words, surplus of Rs. 18,125 for a period of 18 months works out to 12 per cent interest per annum, which is attractive enough for Mr. Murthy.
Had Mr. Murthy opted for the concession and kept the amount of Rs. 100,000 in any saving instrument, probably he would have not earned 12 per cent interest, and he would have faced difficulties in arranging PEMI interest in time.
The builder bearing interest during the construction period on the home loan taken by the individual buyer, as in the example above, would be a win-win situation for both the purchaser and the builder.
For the builder, his offer is his USP. When there is heavy competition and when it is a purchasers' market, this option would help him in increasing sales.
Since he would not offer any concession (Rs. 1 lakh in the above illustration), such lumpsum amount comes to him in advance, helping him manage his cash flows during the construction period. If the builder were to arrange for Rs. 1 lakh, it could cost him 24-36 per cent interest pa (for unsecured loan, normally availed amongst builders community), whereas he can get the amount at 12% interest pa in the referred example.
There is one more option prevailing in the market, which is more in vogue. The builder offers to share the interest portion in the EMI during the construction period.
Under this scheme, the builder will make an arrangement with leading home loan providers for getting released the full loan amount of buyers of his flats at the beginning of the construction.
Although the builder offers 5-8 per cent concession on the cost of the flat, purchasers need to exercise caution as in most cases, this option may not be beneficial to them.
Since the entire loan amount would be released before the construction starts, the EMIs will have to paid from the next month of disbursement of loan. Since EMI contains both interest and principal amounts, the builder will share only the interest portion and the principal amount will have to be borne by the purchaser.
In such an arrangement, the builder will reimburse the interest portion only after the borrower has remitted the EMIs.
The purchaser will have to do proper home work in calculating the financial benefits he would derive. Unless substantial savings are there, one need not opt for this scheme as it involves many risks.
First, after getting full consideration, if the builder delays construction, the purchaser will be put to a lot of hardship. The purchaser's plans of moving to his own house within a certain time frame will get disturbed.
He has to continue to pay the rent for his present accommodation, and share the principal amount in the EMIs, which goes on increasing month by month. Since the borrower is liable to pay EMIs, the lender will pressure him to pay EMIs and if the builder delays the reimbursement of interest portion, the borrower will be in great difficulty.
One more option that the builder may put across to purchasers is that once the loan amount is released in full, the purchaser can claim Income Tax concessions for both interest paid on the home loan and principal loan amount repaid. This is incorrect.
The income tax concessions on the home loan repayment can be availed only from the year in which the construction is complete and the builder has arranged for completion certificate from the authority concerned.
(The author is the Director of Institute of Home Finance and can be contacted at firstname.lastname@example.org).