Your Property Could Have Two Running Loans! Here is What You Need To Know

Dual financing is perhaps the best kept secret of Indian banking – often, banks end up granting multiple home loans against the same collateral and when this happens, home buyers may be in for a rough ride if the builder stops construction or absconds. How do the home buyers find out if the property is dual financed, or in simpler words, have existing loans other than the ones they apply for? What can the banks do to ensure that they do not end up offering loans against the same collateral? What can happen if one invests in a dual financed property?

Best-selling author and real estate expert Vivek Kaul speaks to PropGuide on the practice and why it can have huge implications for home buyers and their investment in property in this exclusive interview with PropGuide.

Edited excerpts:

PropGuide: What is dual financing?
Vivek Kaul: It is one of the best kept secrets of Indian banking. Let's say, you want to buy a home. You go to a bank and take a loan. The home you are about to buy becomes the collateral for the home loan. Now, let's say the builder from whom you are planning to buy a home already has a loan against that property from a bank. He has taken the loan before he started to market the project. Further, there might be many other individuals who will buy a home in the same project by taking a home loan by offering their prospective homes as collateral. So now, we have a situation where the same asset has been offered as collateral by buyers as well as the builder. This is dual finance.

PropGuide: What are the complications arising out of excessive dual financing?
Vivek Kaul: As you would know, over the past few years, many builders have left residential projects incomplete and some have even taken the money from buyers and disappeared. If such builders have defaulted on the loan they had taken from a bank as well, then there is a problem. The builder has taken the loan before the buyers did; hence, the first charge is created in favour of the bank that lent money to the builder. A first charge ensures that the loan given by the bank to the builder takes precedence over the home loans that have been borrowed by buyers against the same collateral. 

What happens next? The bank goes after the collateral offered by the builder following the provisions under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI Act).
The buyers, meanwhile, would have to continue to pay the Equated Monthly Instalments (EMIs). At the same time, they would have to fight a legal case in order to establish their ownership on the property. So, the buyer basically ends up without a home, has to pay an EMI and also has to bear legal costs. And, if he bought the home to live in, he continues to pay the rent as well. Not a happy situation to be in.

PropGuide: What are the steps RBI can take to curb the practice?
Vivek Kaul: The interesting bit is that the RBI does not allow urban cooperative banks to carry out dual financing. It has made that very clear in the Master Circular- Finance for Housing Schemes – UCBs: “The builders / contractors generally require huge funds, take advance payments from the prospective buyers or from those on whose behalf construction is undertaken and, therefore, they may not normally require bank finance for the purpose. Any financial assistance extended to them by primary (urban) co-operative banks may result in dual financing. The banks should, therefore, normally refrain from sanctioning loans and advances to this category of borrowers.” 

But a similar regulation is not in place for scheduled commercial banks. As the Master Circular—Housing Finance for scheduled commercial banks points out: “In view of the important role played by professional builders as providers of construction services in the housing field, especially where land is acquired and developed by State Housing Boards and other public agencies, commercial banks may extend credit to private builders on commercial terms by way of loans linked to each specific project. However, the banks are not permitted to extend fund based or non-fund based facilities to private builders for acquisition of land even as part of a housing project.”
This anomaly needs to set right.

PropGuide: What can the banks do to avoid this?
Vivek Kaul: In fact, the Master Circular on housing finance for scheduled commercial banks makes it mandatory for banks to insist that builders, who borrow from them, declare these things. As the circular points out: “In a case which came up before the Hon'ble High Court of Judicature at Bombay, the Hon'ble Court observed that the bank granting finance to housing / development projects should insist on disclosure of the charge / or any other liability on the plot, in the brochure, pamphlets etc., which may be published by developer / owner inviting public at large to purchase flats and properties.”
Hence, banks need to insist that the builder declare that the property is mortgaged. As the circular points out: “While granting finance to specific housing / development projects, banks are advised to stipulate as a part of the terms and conditions that: (i) the builder / developer / company would disclose in the Pamphlets / Brochures etc., the name(s) of the bank(s) to which the property is mortgaged. (ii) the builder / developer / company would append the information relating to mortgage while publishing advertisement of a particular scheme in newspapers / magazines etc.”
So, on paper, we have the regulation in place. The trouble is, how is this actually being implemented? A basic smell test for this is the fact that almost no one knows about the “dual-finance” issue. When I wrote about this recently, people were surprised to discover that such an issue even exists.

PropGuide: How can home buyers avoid this?
Vivek Kaul: The only way to avoid it is not to buy property that is dual-financed. The trouble is, how do you find out that the builder has offered the property as a collateral with a bank? One answer that I have been given is that the encumbrance certificate should reflect this. Another option is to ask the builder directly if the property is mortgaged with a bank. Also, if any pamphlet/ banner about the property mentions that the project is financed by a particular bank, then the property is definitely mortgaged.  The trouble is that there are no guidelines on what happens if such disclosures are not made, and they are usually not made. This has to be set right.

PropGuide: What is the extent of dual financing in India and why is it less talked about?
Vivek Kaul: There is no publicly available estimate for that. I would be surprised if the RBI also has gone around collating such a number.

Vivek Kaul is a writer and author of the bestselling 'Easy Money' trilogy. Currently, Vivek writes regular columns for www.firstpost.com and is also the India editor of 'The Daily Reckoning' newsletter published by www.equitymaster.com. His writing has appeared across various publications in India including The Times of India, The Economic Times, Business Standard, Business Today, The Hindu Business Line, Forbes India, and Quartz, among others. Vivek has also lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore) and taught a course in 'Indian Economy' at IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He tweets @kaul_vivek.