Property in India: Why the RBI Barred the 20:80 Scheme

The Reserve Bank of India’s decision to forbid financial institutions from funding real estate projects which are launched with schemes like 20:80 has caused a stir in the Indian real estate market. This decision is sure to have an impact across all stakeholders of property In India, be it buyers or sellers.

A 20:80 payment scheme is one in which the buyer pays an upfront 20% of the property and finances the remaining 80%, allowing the developer to pay the interest on behalf of the buyer.

While such offers can sound alluring to buyers of property in India, it involves a huge amount of risk and in some cases losses.

Here, we have explained the effects of a 20:80 scheme with the help of a scenario:

For example, there is an apartment for sale which measures 1,000 sq. ft. and sells at a price of Rs. 4,000 per sq. ft. with a said construction period of three years. In this situation, the total cost of the apartment would come out to Rs. 40 lakhs. A buyer who opts for upfront payment of full apartment cost would have made a payment of Rs. 8 lakhs (20%) from his pocket, and the remaining Rs. 32 lakhs would have been financed at prevalent interest rates of 10.5% for tenure of 20 years. Total cost of flat to buyer would have been Rs. 84.67 lakhs out of which interest component for the first three years would have been Rs. 9,83,912.

In case the buyer chooses a 20:80 scheme with an upfront disbursal of Rs. 8 lakhs and Rs. 32 lakhs financed as a home loan with no pre EMI, this 9, 83,912 is paid by builder. Hence, the total cost to buyer would be Rs. 74.87 lakhs.

There are two losses that the buyer is bearing by choosing a 20:80 scheme:

1. Loss of down payment discount
   The upfront disbursal amount is equivalent to the down payment plan offered by the builder; i.e. customer pays the full amount in one go and the builder offers him a 10% discount. In such a situation, the buyer would have only paid Rs. 36 lakhs. Assuming that Rs. 8 lakhs are paid by the buyer and remaining 28 lakhs are paid by the bank, the overall cost of ownership for the apartment would come to Rs. 75.09 lakhs, which is just Rs. 20,000 more than a 20:80 scheme. This, without the risk of placing the responsibility of interest payment on the builder.
2. Premium charged by builder for EMI scheme
   Certain builders charge an additional Rs. 200-300/- above the Basic Sale Price for giving No-EMI schemes. In such a case, the buyer was bearing a loss of Rs. 2-3 lakhs, along with additional interest on the corresponding amount.

Builders have plenty of money to make in such situations, as they would be able to recover the cost of EMI by increasing the Basic Sale Price, while at the same time denying discount to buyers. In addition to this, they also get financed at 10.5% (home loan) interest rates, which turns out to be much smaller than the rate at which banks fund them (18-20%).

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Additional risks involved in opting for a 20:80 scheme:

Default by builder on paying EMI: In case the builder defaults in the repayment of interest, the buyer would land in trouble as the loan would be registered in the name of buyer and his credit rating will be affected.

Non construction by builders: If the builder fails to construct within the stipulated period of three years, the home buyer would be paying EMI on the full amount after the third year. However, in case the buyer would have opted for a construction linked plan, his interest payments would turn out to be much lesser.

Flats bought with a 20:80 scheme would also be difficult to resell in case the construction is not completed in time, as a new buyer would not want to pay the full cost of an unconstructed apartment.

That said, barring banks from financing 20:80 schemes only seems like a wise decision by the RBI.

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