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Home buyers to be at par with banks and other financial institutions for repayment by defaulting builders. Read on to know more.

Home buyers to get equal rights as banks with new financial creditor status

With amendments to the Insolvency and Bankruptcy Code (IBC) approved by the Union Cabinet through an ordinance, home buyers have now been given the status of financial creditors. They were earlier categorised as operational creditors.

This essentially means that buyers who have paid money to builders for buying a property will have equal rights as banks and financial institutions in the event of the project being stalled or in case of default by the builder. This is a positive move that strengthens the consumers’ position in recovering their money.

The ordinance will come into effect after it receives the President’s assent.

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How it affects home buyers

Currently, buyers rank low in the hierarchy when defaulting builders have to repay creditors. The first preference goes to banks and other financial institutions, then employees and other contractors, and so on. Buyers come into the picture only later, and get residual value after the others have been paid off. This amendment gives them legal rights to liquidation claim and the same preference as banks, cutting down their risk exposure.

According to India Ratings and Research (Ind-Ra), home buyers will form a part of the committee of creditors that approves a resolution plan, and their voting rights will be in line with their advances. However, the final contours of the code need to be seen for the smooth functioning of the committee, considering several home buyers and voting rights.

Ind-Ra is of the view that the probability of consumers initiating a case under IBC is lower than with financial institutions because of their emotional attachment with the property.

It further said this move will strengthen home buyers’ right and power in case of bankruptcy of the developer or any default in payment or planned schedule. It will increase the consumers’ protection and boost customer sentiment.

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How it affects financial institutions

This new amendment may not be in the best interest of lenders since they will have to share their priority status. The rating agency believes this could negatively impact lenders since the recovery proceeds will now have another layer of distribution, which was not factored in at the time of origination of the loan to the developer, as reported by The Economic Times.

Simply put, this means that having to share the money recovered from real estate companies increases the default risk for lenders.

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How it affects builders

This amendment enforces tighter control on builders. There will be more pressure on them as they will now be accountable to every buyer. Financial companies might go back to the table and re-price their lending rates, keeping the added risk in mind. This means the cost of borrowing from financial institutions will go up for builders.

At the same time, it doesn’t mean that the end cost of real estate will increase. This is because financing from banks and other institutions account for only 20-30% of the property’s total value. The rating agency believes that this move could affect the credit rating of top realty developers.

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Ind-Ra sees this move as positive for housing finance companies. Though not a direct beneficiary of the policy change, such companies could get some comfort as buyers’ rights over defaulting builders and cash flows on liquidation will improve. Eventually, with increasing customer confidence, there will be more takers for home loans, which can only benefit housing financiers.

 

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