Is India Heading Towards a Home Loan Crisis?

At the height of the property boom in the US three years ago, banks and mortgage financiers offered dirt-cheap loans to entice customers. But they were cheap only in nomenclature. In structure, they were time bombs. Not surprisingly, the bombs went off in 2008, and the ensuing global crisis raised the cost of credit to astronomical levels. The home loans offered to the customer were short-term fixed, but long-term floating.

Short-term rates were low in the US because the Federal Reserve kept monetary policy loose and did not tighten regulations on lending practices. Home buyers were lured by two factors:cheap and easily available home loans; and, the prospect of property prices going up. But when the property market busted and cost of credit rose, home owners were left with assets far depleted in value on one hand and higher interest costs on their so-called cheap loans on the other.

After that, the loan turns floating, and will be priced based on the prime lending rate prevailing then. Here's the deja vu: A customer who takes the loan now is in the exact same situation as the US home buyer was a couple of years ago: loans are cheap and property prices are rising. The moot question is, is the loan buyer fully understanding the risk he is taking with such loans. Is he aware that there is a possibility of decline in property prices and a rise in interest rates three years down the line? If the current trend of home loans gains momentum, there are good chances of a property and a credit bubble forming --and then bursting.

After that, the loan turns floating, and will be priced based on the prime lending rate prevailing then. Here's the deja vu: A customer who takes the loan now is in the exact same situation as the US home buyer was a couple of years ago: loans are cheap and property prices are rising. The moot question is, is the loan buyer fully understanding the risk he is taking with such loans. Is he aware that there is a possibility of decline in property prices and a rise in interest rates three years down the line? If the current trend of home loans gains momentum, there are good chances of a property and a credit bubble forming --and then bursting.

Good credit in good times becomes bad credit in bad times, especially for customers who go for the type of loans being peddled today. And there is no hedge to these loans except foreclosure. Property prices, as we have seen, are volatile and can remain depressed for long periods of time. When the previous bubble in India burst in the 1990s, prices took almost a decade to recover.

The banking regulator should ask the sellers of such loan products to prominently place risk factors to such loans. Better still, the worst-case scenario for cash flows should be announced or explained so that buyers of loans will know the extent of their liabilities when interest rates move up sharply. The best case, of course, would be to avoid teasers.

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