Housing finance stocks are turning a corner. Time to look?

Summary: A sharp correction has reset valuations in housing finance stocks. Now, early signs of recovery are emerging. Our deep-dive unpacks what’s really changing, and what investors must watch next.

Shares of housing finance companies—Aadhar Housing Finance, Aavas Financiers, Aptus Value Housing, Home First Finance and India Shelter Finance—focused on the affordable segment have had a bruising 18 months. A correction that began in mid-2024 has pulled valuations back to earth, with price-to-book multiples cooling to two to three times from euphoric peaks of six to seven.

The trigger was twofold. Loan growth slowed from blistering 30-plus per cent to a still-healthy but less exciting 20 per cent (roughly across the board). At the same time, collections came under strain as informal borrowers, core to this segment, began missing payments.

Those pressures are now beginning to recede. Profitability is inching up again, suggesting the worst may be behind. The market, having already deflated valuations, is now confronted with improving fundamentals. That combination makes the sector one of improved expectations and reviving economics, worth a closer inspection.

An industry with superior return metrics

Affordable housing lenders operate in a part of the market where competition is structurally limited. Unlike large housing finance companies (LIC Housing Finance, Bajaj Housing Finance, etc.) and banks that dominate the Rs 50 lakh-plus segment catering to salaried borrowers, these players lend to self-employed customers—small traders, vendors and daily-wage earners—typically for loans below Rs 25 lakh.

Margins on the mend

The first sign of a reversal today is the sector’s improving net interest margins. As the Reserve Bank of India’s (RBI) rate cut cycle began, these lenders passed the benefits (lower rates) to borrowers before their own borrowing costs had reset. This kept margins under pressure. Now, as the lag is settling, their cost of funds (what it costs them to raise borrowings from banks) is on a decline, giving way for margin expansion. 

The gap between the repo rate and cost of funds also suggests this tailwind is not yet fully played out. Since Q3 FY25, the repo rate has fallen by 125 basis points, while the cost of funds has declined by only 40–50 basis points so far. More easing, therefore, is likely to flow through earnings.

Differences across companies remain driven by borrower mix. Home First, with a higher share of salaried urban customers, competes more directly with banks and runs thinner margins. In contrast, Aptus and India Shelter, which focus on self-employed borrowers in smaller towns, retain stronger pricing power, reflected in NIMs of 12–13 per cent.

Asset quality: Tested, not broken

Asset quality has softened, but not in a way that signals structural damage. Gross NPAs have inched up by 10-30 basis points over the past yea,r largely due to the seasoning of loans disbursed during the rapid growth phase between FY21 and FY24, along with temporary cash-flow stress among borrowers.

Over a longer period, average GNPA levels for these lenders have typically ranged between 1 and 1.8 per cent, a comfortable band given the borrower profile.

Equally important, credit costs remain contained at 16–60 basis points, well below 1 per cent. That indicates lenders are neither seeing widespread stress nor being forced into aggressive provisioning.

The picture, therefore, is one of steady holding up but not deterioration.

Easing of sectoral headwinds

The factors that drove the correction are also easing.

A key pressure point was the overlap with microfinance. Many borrowers juggle both microfinance and housing loans. When microfinance lenders tightened credit and intensified collections, borrowers prioritised those repayments, delaying housing loan instalments.

Compounding this, certain state-level policy interventions—particularly in southern markets—restricted recovery practices, further disrupting collections.

Both pressures are now receding. Microfinance stress is moderating, borrower leverage is easing, and regulatory restrictions on recoveries have been relaxed. Collections accordingly are normalising.

Growth outlook

With operating conditions stabilising, credit rating agency CRISIL estimates loan book expansion of 20–21 per cent through FY27—lower than the peak years but still robust.

The sector’s expansion plans support this. Lenders are steadily adding branches and deepening their presence in tier-2 and tier-3 cities, which already account for over 60 per cent of home loan volumes. Aavas is expanding in Southern and Northern India, Aptus in Maharashtra and Odisha and Aadhar and India Shelter are adding 40-60 branches a year. 

Risks: the other side of the equation

The improving narrative should not obscure the risks embedded in this sector. 

First, the very source of high returns is also the core vulnerability. These lenders operate at the riskier end of the credit spectrum. Their performance is tightly linked to the health of informal incomes. When cash flows weaken, repayment capacity follows. Even with collateral backing, delinquencies can rise meaningfully in downturns.

Second, the business remains acutely sensitive to interest rate cycles. The same funding dynamics that are expanding margins today can reverse if inflation resurfaces and rates move up, compressing spreads just as quickly.

Third, strong returns rarely go uncontested in financial services. Periods of high growth and profitability often attract new entrants, and history suggests that competition in such phases can dilute underwriting discipline.

To sum up

The sector appears to have moved past its most difficult phase. Margins are improving, asset quality is holding, and external pressures on borrowers are easing. Growth, while moderated, remains healthy.

Valuations, too, are no longer stretched. They reflect a reset in expectations rather than a collapse in fundamentals. But this is not a straightforward recovery story. The same factors that enable high returns, limited competition and riskier borrowers, also make outcomes more cyclical and less predictable.

The sector, therefore, is better positioned than it was a few years ago, and current valuations may justify a closer look. Yet the durability of their return ratios will hinge on how carefully lenders balance growth with credit discipline.

In a segment where upside can be strong but downside is never trivial, the difference will lie less in the opportunity itself and more in how it is executed.

In sectors like this where growth and risk move together, the choice of businesses makes all the difference.

This is where a research-led approach becomes essential. Value Research Stock Advisor identifies durable businesses and tracks how their fundamentals evolve across cycles. If this is a space you are evaluating, having that layer of ongoing insight can be the edge between merely participating and investing well.

Try Stock Advisor today