If we are looking at the loan book of a lender, chances are that the most shining asset would be the mortgages. It is no wonder that banks and housing finance companies are falling over each other to woo homebuyers.

Home loan rates have fallen by more than 250 basis points over the last two years and the race to acquire market share in affordable housing has only heated up more. This is all the more so given the government’s push to affordable housing.

To make the housing market more inclusive, the government has offered heavy subsidies on mortgage loans to buy what are now called affordable homes. And this has been the fastest growing slice of the mortgage loan pie since fiscal year 2016 (FY16). Under Pradhan Mantri Awas Yojana, the government offers interest subsidy of 6.5% to economically weaker sections on their home loans. These are individuals with income of up to Rs3 lakh and also the biggest beneficiaries of the interest subsidy.

But ironically, here is where the biggest trouble is as well. Over 10% of small-ticket home loans of up to Rs2 lakh have turned bad in FY17. About 4% of home loans of up to Rs5 lakh have slipped into non-performing category. Juxtaposed with the fact that the bad loan ratio in the overall housing loan book is a mere 1.1%, these ratios are worrisome.

These bad loan ratios could only worsen from here on, because the interest rate cycle has now turned. In FY19, the probability of home loans rates going up is very high and small mortgage borrowers will be hurt the most.

Property prices began falling in 2017, and have slipped even in mature metropolitan markets. A rising interest rate coinciding with lower property prices, together with a determined government push to housing for the weaker sections has the potential for making this India’s version of sub-prime housing loans.

No doubt, the subsidies are supposed to be a boon. Indeed, the interest subsidy of the government could be a palliative, considering that it reduces the burden on the borrower.

But that said, affordability increases only with increasing income and therefore, weaker income groups carry the highest risk to lenders. In fact, the subsidies could be a moral hazard as they tempt banks to lend to weak borrowers. The data on bad loans in affordable housing indicates that the side effects of subsidy may sometimes be negative.

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