India: A suggestion on Housing

We graduate college and enter the work force.  The income seems like a gusher and life is good...too good I guess because...the instinctual urges rear up (parents) and push us towards marriage, children and forming a family nest.  It is the last of these that I want to talk about.

Housing, rent or buy, is a huge decision and becomes monumental when you lean to the buy side.  Your equity will  be completely gone as down payment;  and your pay packet will be lighter by at least 30% when you make the buy decision..and then on-going expenses will keep the budget stretched for some time.  As you are faced with this decision, bankers and their agents enter and offer you lots of ways to get into trouble..I mean into a house.

In the last few years, a variety of housing loan options have been offered to consumers.  Just when you think you cannot afford a house, some new variety is offered up to entice another look..a lot of house owners have eventually chosen the floating variety.  Optimism says that affordability would go up as rates decreased.  Pessimists would say...ahh you are buying a house, this is no time for pessisim.  These borrowers have seen their EMI's shoot up as rates have risen.  Well, Reality bites.

Rising rates also put downward pressure on prices, so these buyers have seen costs going up at the same time that their equity has eroded.  A double whammy...always happens.  Remember, rates cannot go below zero but there is no upside limit..it is a stupid risk-reward for a housing borrower...it will take 15 to 20 years to pay the loan...rates are bound to go up in this time frame.

Government has a role to play here..no I am not a liberal when it comes to fiscal policy.  I just do not believe that providing choice is always the best way forward.

Specifically, I do not believe that a housing loan, a mortgage should ever have a plain floating rate of interest.  And if it does, the upper end should always be capped...one can attach an interest rate cap to the floating rate at a small price.

If a buyer cannot afford a house based on the fixed rate...then he/she should not buy the house...a home should not become a liability.  This is a harsh prescription which most people have a hard time accepting...after all the young know everything.  And it is hard to discuss something with people who know everything.

So, let us simply legislate that a housing loan/mortgage will always have a maximum rate...so it is either fixed or floating with a cap....and let us make this mortgage portable as long as the credit profile does not change.  If a house owner wants to move up the housing chain..then he gets to take his long term fixed rate mortgage along or he can pass the loan to the buyer as long as the buyer meets the Bank's credit standards.

This seems elementary...so why do we have floating rate mortgages?

Its those Big, Bad Banks.  They have to fund those fixed rate mortgages...and to do so they need to raise longer term fixed rate deposits.  There are lots of short term deposits at banks...savings accounts being a case in point.  These are the same as floating rate liabilities.  To avoid a mismatch of interest rates, the banks encourage floating rate housing loans to match up with their floating rate deposits.

With the growth of alternative investment vehicles, like mutual funds, the depletion of term monies has grown...and while short term money is available in the money markets, the market of wholesale term money is not deep and there are lots of competitors like Pension Funds and Life Insurance companies.  So the Banks take the easy way out..they pass the risk to the consumer.

The next time a banker shows you the virtues of a variable rate mortgage, remember it is not altruism at work..its his variable rate deposits.  When you ask a fruit seller if he recommends the apples or bananas and he says bananas, you know he has extra bananas to sell...

In my opinion, we have this ***-backwards.  Banks are in the risk and risk management business...we are putting a home buyer into the risk management business instead.  There is no long term upside for anyone in this scenario.  We could legislate a warning on documents 'Variable rate mortgages can be hazardous to your financial health'.

Let us change the paradigm...choice is not always good...say it again.  If you don't say it again, I will start talking about the US and UK banking systems.  And you DO NOT WANT that.