Is RBI set to make affordable houses unaffordable? - The 5 Minute WrapUp by Equitymaster
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Is RBI set to make affordable houses unaffordable?

Oct 9, 2015

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I bought my first house in 2005 for Rs 3 million. The house was located within an hour's commute from my workplace (quite reasonable by Mumbai standards). I shelled out an equated monthly installment (EMI) to the bank that was less than 60% of my net salary. And I was confident to repay the entire loan well before the 15-year tenure. The house was affordable.

What is considered affordable housing has changed dramatically since then. House prices in Mumbai have multiplied three to five times in the last ten years. And if you are a house buyer in the metro suburbs today, you need to add several more hours of travel time to your workplace. Your equated monthly installment is unlikely to leave you much disposable income. And your home loan burden might stay with you for the better part of your working life.

With all this in mind, the RBI's recent order to banks comes as a surprise. The central bank has directed banks to lend Rs 90 for every house costing Rs 100. The condition being that the house should be in the 'affordable category' costing Rs 3 million or less. That's a loan-to-value (LTV) ratio of 90%. An LTV ratio below 70% is considered low risk for the bank.

The RBI's objective to make houses affordable to everyone is noble. Keeping the political agenda aside, a shelter for every Indian is a must for a growing economy. But I am not entirely convinced of two aspects of this new policy.

The first is if a house costing Rs 3 million or less can be defined as affordable.

The second is if allowing banks to lend up to 90% of the purchase price of the house will make it affordable.

Forget Mumbai, there are hardly any metro cities in India today where Rs 3 million will get you a house in a choice location. Except tiny houses in far flung suburbs, this budget cannot accommodate any reasonable needs.

If the Rs 3 million affordability threshold is for people in smaller towns and cities, then we have a problem of a different sort. The average income levels in such cities are substantially lower than the metros. Hence, it is quite likely that even the Rs 2.7 million loan (90% of 3 million) will be beyond the average loan servicing capacity.

So we will have a situation where more urban Indians will buy houses in places they cannot live. In other words, they will be speculate that the house prices will go up enough to afford them a better residential location some day.

Or people who cannot afford to purchase houses will go ahead and buy one because 90% of the loan is the bank's problem!

There is yet another angle to the affordable homes problem. Truly homeless Indians will still find home ownership beyond their means. But existing homeowners of one or more houses will find it easier to invest and speculate on the affordable homes. Since the banks will be funding 90% of their speculative bet, they have little to worry about. And God forbid, if their speculation holds well, the 'affordable' Rs 3 million houses will soon become unaffordable.

Involving banks in social causes is one of the worst economic ideas. Like a bad investment idea, it may work in the short term, but it almost always ends in disaster. If the government truly wants every Indian to own a house, they should focus more on education and employment. Encouraging speculative, debt-fuelled home buying in India will not make houses more affordable.

Do you think getting banks to lend up to 90% of the value will make houses costing Rs 3 million more affordable? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
The year 2015 so far has been a big year in terms of fund raising activity. And of course, the Initial Public Offerings (IPOs) have been at the forefront of this. Now, this is particularly true if the IPO is of a well known brand and of a big ticket size. Investors tend to go overboard in their enthusiasm to own a new business. Fear of losing out on the opportunity to own shares of a big business right from the start tends to cloud their rationale of investing.

Something of this sort is being observed in the upcoming issue of Coffee Day Enterprises (owners of popular coffee chain Cafe Coffee Day). Investors are intrigued about the fact that with plans to raise about Rs 11.5 billion, the issue will be amongst the biggest in past 3 years! Mind you; we are not giving out any view on this IPO here. You can read our detailed view on the IPO in today's 5 Minute Premium and IPO special report. But the point we are trying to bring to your notice is that too much optimism around over hyped IPOs tend to distract investors from their long term interest.

Let's look at the historical data of the performance of investments in the BSE-IPO index over the past 6 years.

Returns from IPOs in the long term

Going by the data, if one had invested Rs 100 in BSE IPO index in September 2010, it would now be worth Rs 134 (CAGR of 6%). This means even over the long term period of five years, the investors could not make money. On the other hand, an investment of Rs 100 in the index at the depth of the crisis in September 2013 would have fetched you Rs 240 by now (CAGR of 55%)! Therefore while there is no guarantee of every IPO making money even over the long term, the best businesses bought at reasonable valuations certainly do.

Long time readers will be aware of our caution in recommending IPOs. After all, there have been instances when the small investors have been mis-sold expensive IPOs using the carrot of big listing gains. Therefore, one needs to evaluate each IPO on its merits. That is considering its fundamentals and most importantly the valuations, particularly when the hype and mania surrounding an IPO is at its peak.

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The first part of the 'Income at Will' Master Series is already live. I strongly recommend that you watch it now.

At the time of writing, the Indian markets were trading in the green. The BSE Sensex was up by about 134 points or 0.5%. Gains were seen in metal and banking stocks while FMCG and pharma stocks were trading weak. The Midcap and smallcap indices were also trading firm.

 Today's investing mantra
"The person that turns over the most rocks wins the game. And that's always been my philosophy." - Peter Lynch

Publisher's Note: Vivek Kaul, the India Editor of the Daily Reckoning, just made a bold call - Real Estate prices are headed for a fall. Well, if you are someone who is looking to buy real estate, or is just interested in the space, I recommend you read Vivek's detailed views in his just published report "The (In)Complete Guide To Real Estate". To claim your copy of this Free Report, please click here...

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).

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10 Responses to "Is RBI set to make affordable houses unaffordable?"

Narayanan Srikanth

Oct 12, 2015

These are my general observations and things that I have in mind. Nri's pls excuse for being harsh on you guys coz you send the funds only when the rupee is weak.

Houses in India are not constructed to cater to the needs of the common masses. Its for NRI's only who doesn't even bother to look at the property where it is constructed whether it is near the burial ground or not no clue. Someone will send it on email and yes the Non-taxable income flows to India and inflates the prices in India. Why do we allow NRI's to buy property. Do you know approximately in how many years an NRI closes Home loan its roughly 1-2 years and they go for the next. Even if you don't provide loans an NRI can buy a property with his annual savings. Property in chennai suburbs used to be 5-10 lakhs today its 1cr-1.5cr. Earlier people used to register for 5lakhs and exchange 1cr in cash govt has lost in the previous govt even this is like a 2g scam. The present govt has brought the municipal prices to that of the market prices whereby now the realtors are taken by surprise and they are dumbstruck with their jaws wide open not knowing how to cheat. A builder makes 1 cr in a project of 8 flats i wonder anyone has a clue basic mathematics a builder files a tax for 3-5 lakhs income and happily its accepted and seal is affixed. For a turnover of lets say (50lakhs per flat 8 flats 4crs) will the profit be 1% then for the last 10 years the inflation should only have increased by 10% with an average of 1% in this sector.

Don't form reforms to support the builders and don't think that if this sector is not thriving its a doom situation. There are so many sectors which are not thriving are we bothered about that? Why only real estate. Is it really an estate or a liability posted on the citizens.

If at all India has to succeed keep aside all non-sense like software(we used to call data entry operators earlier) and focus on agriculture without using lot of pesticides.

Reforms to make home loan affordable to all:

Don't give home loan with combined income of Spouse beyond 50 lakhs.

Maximum home loan must be 50 lakhs only.

For an NRI provide only 1 home loan during the tenure accross all financial organisations.

Provide only 75% of the home loan if you implement this then only you are doing justice to the prices creeping up.

Is there any cap on the number of not constructed property (in sq ft) that can be owned by the citizens.

Government must sell properties to the public like Singapore so that the debit and credit has clarity.

All project apart from Bank approval must be pushed for IT approval to assess the margin kept on each flats the lets say if the cost of the flat is 40 lakhs the margin can be 10-15% not beyond that.

Government must arrive at the logic of the flat cost for any area UDS + cost of construction per sqft as per indian standars + 10% margin must be the cost per sq ft.

Cash payments/deposits in banks should not exceed 50000/= if we are so concerned about parallel economy why didn't we try to arrest it. Stop this property prices will come down.

The present condition is not conducive for property purchase since property prices are expected to come down further. All real estate people just want to offload the projects and get out of this mess. And even the home loans are getting attractive to trap us. Are we earning for our family or for the builders family. A small time builder with no qualification or knowledge sorry to comment on the qualification part coz this sector doesn't need any qualification drives a BMW and with all qualification and poor control of economy we go in motor cycle and buy a dream home not home dream flat 650 sq ft and drive 20 yrs to pay it.

Those days thieves used to steal our hard earned income nowadays it has become a profession where a pound of flesh is taken without our knowledge.


S Prasad

Oct 11, 2015

Very true fact has been explained. Very bad move by RBI.



Oct 10, 2015

affordable housing is bad concept , one way by speculation we allow Land price appreciation and no price control on Land , If govt seriously thinking of providing affordable to all then they must make single point speedy clearance to Housing projects and should eliminate corruption in real estate sector , this will bring down construction cost by Rs.1000/- per sq.ft. One of the best thing is like developing industrial park Govt on own should develop New city and provide all the facility.



Oct 10, 2015

The valuation of real estate is a subjective assessment. The valuation could be rigged. The probability of rigging is higher. Hence it will result in over financing.


vipul jasan

Oct 10, 2015


When RBI order came to Banks and how did you know about this??

Certainly agree strongly with your views and at the same time belief has become stronger that our Gov't., systems and RBI works for corporates, developers and so called investors and do all policy changes to save them and against interest of poor and common man irrespective of who rules the country.

Like (2)

jayabrata Deb

Oct 9, 2015

RBI/Government may introduce some sort of “Insurance” system where premium is charged if the financing is more than 70% of the cost of the house. Thus Bank does not take any risk for higher funding.
I am aware that in Canada, Bank normally finances up to 80% of the cost. However borrower can get additional 15% finance from the bank ( This is to promote housing in a society where saving propensity is very low), if the borrower pays some extra premium which is lump sum added to his Loan component and recovered as part of EMI. (The premium component is paid by the bank to the “Insurance” company and recovered from borrower as EMI)
If there is default, the "Insurance” pays only up to excess finance i.e. 15% of the cost and balance 80% is taken care of by the Bank according to their business risk.
If this policy is followed, the Banks will not be subject to additional risk for higher financing and more importantly, the bank may not be able to play with the “Spread”. There can also be an option for the Bank/borrower to either take insurance cover or pay higher spread. This way there will be competition among Insurer and the Bank !! Further by accounting method, higher spread charged may be transferred to a “Reserve fund” to take care of default instead of charging to P&L and show profit on short term. This way the health of the bank will also be secured.
In Canada, the Premium is quite high at about 20% of the excess funding since default rate is high. In India, it should be much less, say at 5%.

Cost of the Property 10,00,000
Standard funding % 70%
Standard Funding 7,00,000

Now Funding Required by Borrower 90%
Funding Required/Loan 9,00,000
Excess Funding by Bank
over standard 2,00,000
Insurance cover % 5% Assumption
Premium 10,000

Revised Loan amount 9,10,000
Percentage Increase of
Loan/EMI due to additional
funding over 70% value 1.111%

Like (2)

jayabrata Deb

Oct 9, 2015

My comments may not be directly linked to the topic but I feel that this is also very important for home loan borrowers.
You all may be aware of following effect after RBI reduce the repo rate by 0.5%
i) Reduction in the base rates by the Banks are less than the reduction in Repo rate by RBI
ii) Reduction in home loan rates to new customers are less than the reduction in the Base Rates by the banks. The Banks have achieved this by manipulating the spread/margin of the borrowing rate over the Bank Rate.
I am therefore suggesting following for RBI to bring transparency in the spread charged by the banks.

RBI has already put up a discussion paper on fixing the base rate. But now they should bring some transparency in the Margin/spread charged by the bank.
Theoretically, the spread should depend on the risk involved. While it may be difficult to standardized risk profile for industry and other borrowers, it is comparatively much easier for home loan borrowers. As I see, for a borrower, the risk profiles can be made as below.
A) Customer Income Type
i) Salaried- minimum spread under this head.
ii) Professional
iii) Business
iv) Others

B) Customer liability towards loan.
i) Percentage of Net income paid towards EMI and other liabilities. Higher the percentage, more is the risk of default.

C) Percentage of the cost of house being financed.
i) If 90% or more is financed, it is more risky for the bank.
ii) 80-90% financing, moderate risk
iii) 70-80% financing, low risk
iv) Less than 70% financing, minimum risk.
Based on above, Banks may be asked to adopt following to have more transparency.
1) Bank can make more classifications on above as per their business policy. But once it is fixed, the same (Classifications) is not expected to be changed in 10 years or so.
2) Once the classifications are fixed by the bank, they should now publish the spread over the base rate for different class of borrowers as per their own classifications. This spread should be constant for at least 3-5 years which the Bank may decide or RBI may put a minimum period ceiling. This revision period thus fixed should also not be changed by the bank for at least 10 years.
3) The borrowers should also have the right/option to reclassify his risk profile every fixed period. However this client risk profile revision period should not be less than the spread revision period fixed by the bank as per para 2 above.
4) Similarly, the bank will also have a right to revise risk profile of the borrower, after same risk profile revision period.
5) If a customer seeks risk profile revision, bank may charge a nominal fee, which should not be more than 50% of the processing fee or other charges charged by the bank for a new home loan borrower.

Like (1)


Oct 9, 2015

RBI should learn a lesson from West. Way back in nineties when Clintion passed a law that anyone can borrow for housing with as little as 10% down payment and can get a loan. When I build my house in 1985, there were strict rules-you should have atleast 37% of your income set aside for mortgage payment, insurance cost, and property taxes. Because of liberalization of borrowing, today America is in big trouble. I don't need to tell you what has happened since 2008 to the American Economy. Rbi should get smart about it by learniong from West.

Like (1)

sadashiv potadar

Oct 9, 2015

Affordable does not mean that the buyer of the property should be able to take on the burden of the loan and interest due thereon. Why we tend to purchase a home at such astronomical price and who forces such decisions on the buyer? Certainly Not RBI. This is a herd mentality. Ask your employer to provide accommodation during the tenure of your service at reasonable cost/ rent within the commutable distance of about 5 kilometers. Construction of Buildings is yet to be governed by Law. So far, a few rules and regulations framed have a number of loopholes to evade punishment to the builders. It is beneficial to be on rental premises in current situation in India.

Like (1)

Easwaran Trichur

Oct 9, 2015

You bought a house in 2005 for Rs.3 Million. 10 years down the line this has become a drop in the ocean for house buyers. It is not the real estate alone, everything else has become unaffordable. Say for example I used to pay Rs.40/- a reasonable hair-cur near my place (Juhu). It is now Rs.100/-. You will appreciate, land values have gone up and added to that look at cost of cement and everything else. Look at what you earned in 2005 and what you must be earning today. RBI or no RBI things are not going to change. City dwellers particularly working class will have to struggle it out.

Like (1)
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