27 Feb 2016

Better Home Loans

If you default on your home loan, it shouldn’t be reported to the credit information bureau and it shouldn’t affect your credit score. A home loan should be an option, in the financial sense — as long as you pay a certain amount of money, you get to own a house. But you should be able to opt out at any time without being penalised for it, any more than you get penalised if you discontinue your phone service or stop investing in a mutual fund.

This means that the bank probably wouldn’t want to lend more than the going rate of the apartment in that area, as per the bank’s assessment. If the bank thinks an apartment is worth 50 lacs — if they can find another buyer for that price — they would probably want to lend no more than 50 lacs, to avoid losing money. And this should be conservative — if a certain apartment is worth between 50 and 55 lacs, better to lend no more than 50 lacs. (Or even 45 lacs, to add a margin of safety.)

If the builder wants 90 lacs and the bank is willing to lend only 50 lacs, the buyer will have to come up with the remaining 40 lac, or the sale won’t go through. This will, in turn, force builders to reduce the price to an affordable level, which is good. Or to build affordable rather than high-end apartments for the 1%, which is also good.

This will increase choice for the buyer — if a downturn occurs and the buyer is underwater, they won’t be stuck with having to make more payments than an apartment is worth. They will be able to walk away, and buy another apartment at a more reasonable price. Buyers are better insulated from downturns. In other words, this is a form of consumer protection. This will also create more competition among builders and amongst banks, which is again good. Maybe the bank can reduce your EMIs or give you more time to repay them, to incentivise you to continue to own the house.

Strategic defaults won’t be a problem. I dislike the moralising that comes with strategic defaults, and branding people wilful defaulters. As an objective description, that’s fine. But when people claim that it’s somehow wrong, it doesn’t make sense. Why should anyone be obligated to increase the profits of a bank? Is the bank trying to increase your income? The bank is acting in its own best interests, and so should you [1].

Making loans [2] an option will clarify and codify this in law, which will also have the side effect of clarifying everyone’s obligations. If it says in bold print that the customer can walk away at any time without being penalised (by having their credit score reduced), and if both parties agree to it when they sign the agreement, there’s no legal or moral confusion afterwards.

When a loan is an option, banks no longer need other criteria to determine creditworthiness such as loan to value ratio, or loan to income ratio. You should be able to get a loan for 100% of the value of the apartment, and for any multiple of your salary.

Making loans an option will be fairer and simpler to buyers.

[1] Home loans should, at the minimum, be non recourse. Banks shouldn’t be allowed to take away your other assets if you default.

[2] Maybe other kinds of loans, like car loans, should also be options. The bank would ensure that the outstanding amount due on a loan is always less than the market value of the car.

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