As some people will term, real estate is the only real asset which is worth owning. After all, they don’t make land any more and hence with growing population, the demand for owning a real estate is always poised to grow. Often to lure the buyers into real estate transactions, developers come up with innovative deals and one such deal is Interest Subvention plan.
Under the interest subvention plan, the developer agrees to bear the interest cost of loan taken by the buyer to purchase a flat. This on the outset may sound very lucrative to the buyers as it reduces their cost of ownership with the builder bearing the interest cost, but it is very vital for investors to know how this product works and what to watch out for.
How does it Work ?
Interest subvention plan all starts like a conventional construction linked plan whereby the buyer pays an upfront contribution towards the flat to the builder from his pocket and remaining amount is financed using a home loan. As the property construction progresses, the builder requests for further installments which are paid by bank from the home loan.
As a part of subvention plan, the builder, bank and the buyer sign a tri-party agreement whereby the builder agrees to pay interest on the loan till an agreed duration to the bank. Based upon two agreements inspected by us with different banks, the banks tend to deduct the interest cost for the entire duration of the subvention period from the loan disbursement before providing the installment cheque to the builder. For example, if the subvention tenure is for 3 years and the current installment requested by the builder is Rs. 10 lacs, assuming interest for 1 year is 1 lac and for 3 years is 3 lacs, the bank will deduct Rs. 3 lacs from the loan installment of Rs. 10 lacs and will disburse net Rs. 7 lacs to the builder. By this way, the bank is able to secure its three year’s interest by taking the amount upfront from the loan installment paid to the bank. The buyer hence not required to pay any interest till the end of the subvention tenure.
Who Bears the Risk ?
Putting all elements together, this risk always vests with the buyer like any other conventional mortgage based purchase agreement.
The bank secures itself by entering into a usual mortgage contract whereby the property would vest with the bank in case of non payment of loan installment and interest.
The builder gets the installments towards the purchase of the property. It signs a builder buyer agreement with the buyer whereby if the builder doesn’t get the property installments in time, the builder will forfeit the installments received till date and will cancel the allotment.
Now comes the buyer – the loan is provided on his credit history and if there is a default, his credit history will be tainted, the builder will forfeit the property or the bank will take it over.
Who Benefits from Subvention ?
The answer to this is – ALL parties. Lets see how individual parties benefit :
Well the first thing which a buyer benefits is reduced cost of ownership as the builder will pay for the interest cost. This benefits a buyer more if he is already in a rented accomodation and will not be doubly hit with his rent + loan interest. In addition, it also gives some bit of additional comfort that since builder is going to bear the interest cost, this may act as an incentive to the builder to provide possession on time.
2. Developer / Builder
You will never see a builder coming up with subvention schemes when the markets are at boom, after all this eats into the builder’s margin / profitability. When the real estate markets are at a lull, builders will come up innovative marketing strategies to lure the buyers and subvention is one such schemes. Firstly it helps the builders to get additional demand for their flats in a dull market. And secondly, they get a cheaper source of finance (home loan rates) compared to expensive real estate loans (over 18-20%) which are also scarcely available from banks and financial institution.
Well – no suprises – banks get interest income.
Top 7 Points to Look Out for In a Subvention Contract
1. Fundamentals First
When it comes to any real estate deal, you must ALWAYS look into the fundamentals of the deal. For real estate it involves location of the property, credibility of the developer, valuation of the property and growth potentials. Generally the poorer the fundamentals are, the more mouth watering the deal on the offer will be. If you have taken a right decision here, then you will be able to get good returns out of your property investment else it may end up sulking your hard earned money.
2. What Price are you getting into a Contract
For a subvention contract, you need to ask the builder, – if I buy using subvention, what is the per sq ft price vs if I buy the same property using similar construction linked plan without a subvention clause. This will give you a like for like comparison of the premium which the builder is charging for subvention. You may notice that there may be a premium of upto 10% in subvention as the builder tends to recover some bit of the interest cost from the buyer by charging a higher price for the flat ! Not fair huh !! However, this is where you need to keep your eyes open. If your subvention contract is for 3 years and you are paying 10% premium, this will work out approx 3.3% per year cost of borrowing for you. Your target should be to haggle as much as you can to reduce the premium.
3. How long is the subvention for – longer the better
Given a choice, the builder would want a very small tenure under subvention contract. However to benefit a customer, you must go for a contract which offers subvention till possession. This will cover a buyer for an uncertainty that the builder will eventually delay on the project and the buyer continues to bleed his finances on account interest payouts / opportunity loss of a huge capital invested in a project which is getting delayed.
4. Don’t believe the words – get them in the contract
If the builder says that he will bear interest till possession of the project, get him to show you all the contracts and documentation which mention this very specifically. If such contracts are to be provided after you sign builder buyer agreement, go no further as this may be a trap whereby the builder may just enter into a contract for a fixed duration and may verbally promise you to extend it after the expiry of the contracted period. From our previous experiences we know that the builder will eventually end up delaying the project and we need to be absolutely sure that the contract is water tight. Also, inspect the tri-party draft agreement between the builder, bank and customer to confirm if it will include a statement that the builder agrees to pay interest to the bank directly.
5. Generally banks won’t allow an open ended Subvention
While the builder may promise an interest subvention till possession, there is no specific end date as the possession could be 3 years, 4 years or even 5 years down the line. The tri-party agreement with the bank needs to have an end date. We have inspected two such agreements and generally the terms of the tri-party agreement mentions the end date which is 3 years from the contract date. If the builder has promised for a subvention till possession, ask for what additional contracts a builder would be able to sign to enforce the builder’s liability to pay interest till possession.
6. Don’t commit till bank approve
Even if you are happy with the documentation, fundamentals of the property, builder’s credibility, DO NOT proceed till such time your loan has been cleared by the bank. For a subvention contract, the most important dependency is having a bank loan. If you are an investor, you must not sign the builder buyer agreement + stay away from paying the first installment to the builder till your loan is cleared. This will protect you from a scenario whereby if the bank rejects your loan for what so ever reason, you are not stuck with the builder who may not refund your money. Remember, it is not an easy task to get your money out from a developer who is always cash strapped and may quote all possible terms and conditions to force you to either pay the subsequent installments from your own pocket irrespective of rejection in bank loan OR face a forfeiture of your deposit so far OR finally get your money back after several months / quarters.
7. Subvention Doesn’t Force a Builder to Perform
It may be not be a very good assumption that if you end up taking a property under a subvention contract, the builder would be more likely to provide possession on time. It may be more likely than not that the builder may still not be meeting his deadlines. Rather, the builder has more incentives to delay as he will be getting funding from the bank at the rate of home loan (sub 10%) on the credibility and risk of the buyers. Don’t be suprised that the funds may get diverted to more pressing projects for the developer, after all if you reach a builder’s office to get him to deliver on time, you are more likely to get a response – ‘why are you worried, we are bearing the cost of interest’. We firmly believe that timely execution of projects comes more from the values and DNA of the developer. Ill reputed developer will do what they do best – cheat the gullible investors ! And hence what we said as the first point – look into the fundamentals of the property you are investing in.