Everything you need to know about construction-linked payment plans

[ecis2016.org] Here’s everything home buyers need to know about construction-linked payment plans

As property purchases are highly capital intensive, most people opt for home loans, to finance the purchase. Home loans enable the buyer to start building an asset in the early years of one’s professional life and also provide tax benefits. When compared to ready-to-move-in homes, the cost of buying under-construction properties is much lesser.

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Now, those who are going to use home loans to purchase under-construction properties, must make themselves aware of the various payment plans offered to the buyer. In this article, we explain how a construction-linked payment (CLP) plan works and if it is beneficial, from a buyer’s perspective.

What is a construction-linked payment plan or CLP?

In a construction-linked payment (CLP) plan, buyers, builders and financial institutions come together, to enable each entity to turn it into a profitable venture. The buyer gets to book a property, even though he has limited liquidity. The builder gets advance payment to launch and build a housing project, rather than using his own capital or borrowing from expensive sources. The bank gets to earn interest.

How does a CLP plan work?

In this arrangement, the bank keeps supplying money for project construction to the developer, based on its actual progress. Do note here that the bank is not directly lending the money to the builder – it is basically lending the money to the buyer. However, as the project is still on paper only, it supplies the builder with the loan money in tranches, depending on the progress of construction.

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Simply put, each time a certain part of the project is complete, the bank will issue a portion of the total borrowed capital of the buyer to the builder.

How is the money paid to builders?

The common practice in most housing markets in India is that buyers are made to pay a certain portion of the overall property value periodically, depending on the project progress. Typically, the builder raises the demand for payment of tranches, as the project construction crosses certain landmarks.

At the time of booking, buyers are generally asked to pay 5%-10% of the transaction value. A similar percentage of the property value is then to be paid within three months. Builder-buyer agreements also specify that another 20% of the purchase cost has to be paid in the next six months. This means that within less than one year of the booking, the builder is paid up to 40% of the cost of the house, from the bank on behalf of the borrower. Barring 5% of the money, the remaining amount is paid only when the basic structure of the building is complete (known as bare shell structure). The balance amount is paid to the builder, as soon as the buyer receives the possession.

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How is EMI calculated in a construction-linked payment plan?

A great deal of confusion prevails, with respect to the payment in CLP plans. First of all, the buyer must be aware that these are not akin to subvention schemes, under which they do not have to pay any EMI till they get possession of their homes. In a CLP plan, the EMI starts right after the bank issues a certain portion of the loan amount to the builder. The EMI continues to increase, in proportion to the increasing disbursement of the loan from the bank to the builder.

Difference between subvention schemes and CLP

In order to boost sales, builders came up with the idea of subvention schemes. These attracted buyers, as they did not have to make any payments till they got the keys of the house. This arrangement, which looked quite promising, however, had inherent issues, considering that there was no respite to buyers from paying the money despite project delays. Eventually, subvention schemes were banned in 2019, after the National Housing Bank asked housing finance companies to ‘desist’ from offering loans under such schemes.

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Sales volumes in under-construction properties declined after subvention schemes were taken down, despite the many recurring appeals from developers to lift the ban. “It is obviously a welcome move, but the side-effect will be further drying up of funds for projects. It will also impact home buyers who do not want to or are unable to bear the burden of paying both, EMI and rent, during the construction of the house they have booked,” NAREDCO president Niranjan Hiranandani said, after the ban was imposed in July 2019.

Nevertheless, the ban did not come into effect retrospectively. This means, buyers who purchased homes under subvention schemes prior to the ban, will continue to service their payments according to the terms and conditions in the builder-buyer agreement.

Sample of CLP plan in builder-buyer agreements

Let us assume that the value of the property is Rs 50 lakhs.

Drawbacks of construction-linked payment plans

Even though CLP plans seem like a win-win situation for all parties involved in the transaction, previous instances have highlighted its lacunae. While colluding with builders, banks often disburse a large part of the loan amount, as soon as the basic structure of the project is complete. This is typically done within one or two years of the launch of the project and it gives developers access to cash. However, if previous cases are any example, they fail to use this money for the completion of the project – this is evident from cases such as Amrapali, Jaypee, Unitech and 3C Company.

Should buyers opt for CLP plans?

Each builder-buyer agreement is unique and has its own set of terms and conditions that each party engaged in the contract has to honour. Although instances of agreements being entirely tilted in favour of the builder have reduced, since the introduction of the real estate law, buyers must read the fine-print of the document. Various plans are being sold to buyers using the same name and it is advisable to consult a property lawyer or a financial expert, before you sign up for such a plan.

Ensure that the agreement specifies the terms of payment, in case the project is delayed inordinately. If the buyer is not careful, he may end up paying EMI, even if the project is delayed inordinately.

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