How to price a loan for projects with a different risk profile?


The Real Estate Regulation and Development Act (RERA) was passed at a time when public trust in the real estate industry was at an all-time low. Hundreds of thousands of house purchasers have put their whole lives’ wages into projects that were never completed for various reasons. The transfer of funding from one project to another was more of a rule than an exception. In other situations, apartment sales occurred before the acquisition of land.

The real estate development industry, which appeared to be an easy way to earn money, witnessed an inflow of opportunistic fly-by-night entrepreneurs looking to cash in. These fly-by-night entrepreneurs were unconcerned about providing the consumer with anything more than the absolute minimum promised and were unconcerned about building quality.

These concerns were addressed by the RERA. Not permitting developers to sell or promote a project before registering with the authorities, which was only allowed after receiving approval to commence building from the relevant body. The RERA recognized that most projects were funded by inflows from house buyer sales and that it was thus important to guarantee that the funds were used to construct and develop the project.

The assumption was most likely that it is the developers’ responsibility to guarantee that a lack of finances is not the cause of project delays. The Act’s penalty was sufficient to guarantee that developers found the finances. It is past time for housing finance institutions (HFIs) that fund mortgages to give differential mortgage rates (even if just during the building stage) to projects that can demonstrate financial closure.

How can a financial institution price a loan with the same interest rate for projects with varying risk profiles?

Financial institutions can charge higher interest rates on loans for projects under construction where financial closure cannot be proven, and lower interest rates on loans for projects where financial closure can be demonstrated. With an acceptable spread, we would see house purchasers flocking toward these safer developments, and the safety was reflected in the interest rate they had to pay. As a result, more and more developers would seek financial closure to sell their properties on the market.

The government enacted RERA to address an issue in the sector. It is past time for industry participants – financial institutions – to take the next step and join forces with developers to safeguard clients. Just in case it got misplaced, this would minimize NPAs for banking institutions while also requiring more developers to sign up for construction finance, resulting in much-needed fee-based income.

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