We got a feedback from some of
our readers that our last post Ownership
- Holding a RealT was a bit too
much complicated to understand for a beginner. Totally respecting their valuable
comments, we have tried to mellow down this post on RealT Financing (although
the topic is way more complicated than the last one :-/).
The whole idea of Mortgage Broking is depicted in the above figure. Few points about this process:
What is Financing?
So coming back to the main business, the second level of Value
Chain in Real Estate circumference – Financing. Just as you
require money to pay for your household items, you need money to pay for your
house (realty property) too. But financing a RealT deal is not as simple as
buying vegetables down the street! More often than not, realty buyers need a
proper plan, strategy and an agency to finance their dream projects. This is
where this post originates J
How is Financing classified?
There are several ways in which a RealT deal can be financed. Typically
all the ways can be classified under 2 heads – Equity & Debt.
To start with, we will cover the Debt portion in this post and try to
explain the various options to raise finance through debt.
Debt
Debt, in literal sense means – “raising money from the market for a
particular time horizon, at some interest rate”. Due to the advancement in the
financial markets, many instruments have been developed to carry out this
function. These instruments, if used rationally can benefit both lenders &
borrowers, but improper use of such instruments can even lead to catastrophes
like ‘Sub-prime crisis of 2008’.
Bank Loans
Raising money from a commercial bank is the
easiest way for an individual investor. Banks offer attractive interest rates
to the borrowers and are easily accessible. But this may not be the most
effective way to finance a real estate deal due to the following reasons:
- Banks disburse loans for short-term
- The amount of disbursement depends on various factors like – individual’s net worth, MPBF (maximum permissible bank fund), income statements, securitization etc.
- Indian Banks generally do not grant loans to a new real estate developer
- Banks generally do not grant loans on ‘land’ alone
Mortgages
Mortgage typically means taking loan from a
party by pledging your property as a collateral against the loan. The mortgagee
reserves full right to take a control over the pledged property in case of
foreclosure (default, in simple terms).
Whatever you will read after this point is a
bit complicated, but we have tried to simplify the concept as much as possible.
Let’s see how much sense it makes. So, mortgages can be carried out in 2 ways:
Mortgage Broker:
The whole idea of Mortgage Broking is depicted in the above figure. Few points about this process:
- Brokers are independent agencies, having tie-ups with fund providers
- Fund providers generally prefer these brokers so that the borrower is already researched for credit worthiness
- Mortgage brokers are generally not involved in ‘loan servicing’
- They don’t use their own capital to fund the borrowers
Mortgage Banker:
These are specialized agencies which provides
mortgages directly to the borrowers, using their own capital. These agencies do
not accept deposits from the public, rather makes money from the loan
origination fees & servicing fees.
They typically packages the loans & sell
them to the institutional buyers or government sponsored enterprises in secondary
markets. In US, there are Freddie Mac & Fannie Mae to carry out these
functions while in India there is no such institution yet for this function.
The nearest equivalent that can be thought of is Mortgage
Risk Guarantee Fund.
We know that this has become a bit too much
complicated to understand, but the following diagram may relieve our brain
nerves a bit ;-)
So the whole process of Secondary
Markets is depicted in the above figure. It shows step by step process followed
by the loans to finally reach the borrower.
Note: We understand that this post has been a bit too much complicated.
Please feel free to write to us in case you need any explanations on any of the
above topics. The remaining portion of financing by equity will be covered in
our next post. Stay tuned!!
----- Keep Reading RealT Horizon J
-----
