The RBI's gift to home buyers

Are you looking to buy a house in a Tier-II or Tier-III location? The reduction in the risk weightage on home loans up to Rs 20 lakh (Rs 2 million) from 75 per cent to 50 per cent in the Reserve Bank of India's (RBI) Annual Policy 2007-08 could be a boon for you.

Risk weight and home loans

What is risk weightage and how can a fall in it make home loans cheaper?

Explains Jayant Varma, executive director (north), Knight Frank (India), "As per norms, banks need to keep a capital of Rs 9 for every Rs 100 they loan out. When the risk weightage was 75 per cent, the figure came to Rs 6.75. With its reduction to 50 per cent, banks will need to keep Rs 4.50 as capital for every Rs 100 loaned out."

The lower capital requirement for banks will bring down the cost of loans and the benefit should get transferred to the customer. Union Bank of India has taken the lead in doing this by reducing interest rates on home loans up to Rs 20 lakh by 50 basis points with effect from 7 May.

Since 2005, prospective homebuyers have had to deal with the problems of rising property prices as well as rising home loan rates. The trend even triggered concerns that it was just a matter of time before the property bubble burst. The RBI, on its part, tried to control the overheating property market by increasing the risk weightage on home loans.

With property prices in Tier-I cities reaching very high levels, the reduction in risk weight would impact home-buyers significantly in Tier-II and Tier-III locations.

The rationale

According to the RBI's policy statement, the move to reduce risk weightage is in line with the standardised approach for credit risk under Basel II norms, which prescribe that the risk weight on residential property fully secured by mortgages should be 35 per cent (subject to the fulfilment of strict prudential criteria).

The reduced risk weights will be reviewed after one year keeping in view the default experience of banks and other relevant factors.

Experts believe there's a second reason for the RBI move. The overheating in the residential property market, they say, was limited to the higher price brackets -- typically to units costing Rs 50 lakh (Rs 5 million) and above -- but the old risk weightage rates did not discriminate between big budgets and smaller ones.

"There is also a strong lobby for providing housing to the middle and lower-middle sections of society," points out Abheek Barua, chief economist, ABN Amro Bank. "This could be termed as a populist measure."

What does it mean for you?

The RBI's decision will not make much of a difference if you plan to buy a house in a Tier-I city by putting up the 15 per cent margin money that banks and home financiers typically ask for.

However, you will stand to gain if you are thinking of buying a house in Tier-II or Tier-III cities as the intrinsic value of residential units in these locations is comparatively low (See below: Getting Closer to Home). Among such cities are Amritsar, Ludhiana, Jaipur, Bhiwadi, Dharuhera, Zirakpur, Bhubaneswar, Mangalore, Indore and Kochi.

There are options in suburbs too. "Peripheral development in the suburbs offers 2-bedroom options for Rs 24 lakh (Rs 2.4 million)," says Varma. For example, in the NCR region, one can find properties in that range in Ghaziabad and Faridabad. Some areas in Kolkata offer a similar deal, as do Mumbai locations like Andheri (East).