After last year’s bribery-for-loan scam involving LIC Housing Finance Ltd and some public sector banks, the Reserve Bank of India has asked banks to set up an escrow mechanism to keep a watch on loans to real estate developers meant for project development.
What is an escrow account?
An escrow account is opened specially for a particular project. This account ensures that money borrowed by developers from banks for the purpose of development is not diverted for any other purpose. Accordingly any payment related to development of the said project is disbursed from this account. Even homebuyers are directed to deposit money in the escrow account so that the money is not diverted until final possession of property is handed over.
Why such an account
Apart from the recent bribery-for-loan scam, it has been observed in the past that developers siphoned off the borrowed money to various accounts and utilized the same for other projects also. As sales went down during the slump, developers were not able to generate more funds for the remaining construction. This stalled and delayed various projects.
An escrow account safeguards the bank’s interests from repayment defaults and helps in monitoring the end use of funds. It also helps the developer to meet obligations such as loan servicing and repayment of loan.
What it means for you
Usually it takes at least two years to complete construction and hand over the possession of an apartment. If you plan to book a property in an under-construction project, bank’s funding would mean timely completion of the project as the escrow mechanism will ensure that the flow of funds is based on pre-agreed milestones.
For instance, after the developer has got necessary approvals, just before the start of the excavation work on the site, the bank will release 20% of the total amount. The bank may again release some amount for construction of the first level and landscaping of the area. The remaining amount is disbursed in parts, and the developer needs to show the construction on ground to get further loan. Even if the developer is under huge debt, this mechanism will ensure that the project is completed on time.