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Commentary

Can't Outsource Due Diligence on Homes to the Financing Bank

A new ICICI Home Finance advertisement on TV (no link) shows a young man telling his dad about his decision to buy a house. The father wisely tells the son about the scrutiny, background checks and legal work required to ensure the property is all ok – the son says “ho gaya” (done) and points to an executive sporting an ICICI badge.

SBI Home Finance, in a recent ad, also promises “security” of knowing the correct background work has been done by the very stable.

This is a horrible image to sell to customers, when the reality is in fact very different.

First, note that all home loans in India are full-recourse loans. Meaning, if you default then they can sell the house – if the sale yields less than the loan amount, they can take other assets from you.

This means you can’t just mail in your keys and say goodbye to the loan (like the US allows). This also means banks have not enough reason to do “background checks” or scrutinize the property you have taken a loan for. If the collateral gets stuck because of some legal issue, you’re still liable for the loan. They can take something else you own, like your car, and FSM forbid, your cellphone.

The incentives are just not there for a bank to really investigate a property they lend against – and it shows. Recently, I noted how ICICI double lent against the same property – they gave two different loans against the same underlying property – is that enough “legal scrutiny” for you? Of course, that case was even more zany because they had originated the other loan also, making an even bigger mockery of their “scrutiny” process that the good son in that advertisement was relying on.

Banks tend to charge “legal costs” during the loan process – in Bangalore, it used to be 10-15K per flat. Still, the work is shoddy because of misaligned incentives again, as the person who is doing the work (the lawyer) isn’t accounting the person who is paying (you). If you hired a lawyer yourself you might get a better investigation done.

The correct thing to do would be to ignore these ads and do the right amount of due diligence yourself. In the US, banks tend to have no recourse other than the property so they must scrutinize the loan properly; even then they found the bubble in securitization was enough to palm off the risk to other buyers, and “loosened” scrutiny for both the underlying homes (inflating quotes) and borrowers (allowing very low quality creditors in).

In India, they have full recourse, so if you’re a rich buyer they won’t care about the property so much. Some banks even take “guarantors” apart from property papers; if the property isn’t enough, and you vanish, they will go after the guarantor. So the only thing that hurts the banks is a slow legal system; but that’s starting to change. And it WILL change for the “faster”, in the 20 year tenure that you pay your loan on. So if the banks get to foist a bad property on you, it will be your problem; so do the diligence yourself. You don’t want to be in a situation where you get a big loan on a property, the property gets stuck in a legal case, and the bank comes running to seize your other assets. You can’t say, “But you did the scrutiny” – the bank will somehow develop amnesia.

(As for exactly what kind of diligence: Ranges from getting full ownership history of the property, various government approvals, any court cases, appropriate copies of Powers of Attorney if any, builder history, running advertisement for x days soliciting no-objection etc. A laywer will know best)

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