NEW MORTGAGE PRODUCTS – Innovative offers reducing debtor vulnerability are creative, but can consumers, who are generally seen as having limited financial knowhow, really be expected to understand the sophisticated loans being sold to them by corporate finance experts? COLLATERAL THINKING (Sep 21st 2006 from The Economist ) AS PROPERTY VALUES RISE, LENDERS LINK LOANS TO HOUSE PRICES FOR most homeowners, their house is their biggest single financial asset and their mortgage is their biggest single liability. House-price inflation has normally made this a good bet. But it makes little sense in financial theory for investors to borrow a lot to speculate on a single asset class. This is particularly true when high house prices in many nations have forced many buyers to take on debts that are a substantial multiple of their incomes. The answer, according to Zurich Cantonal Bank, is to link the value of the loan to that of the property. On September 18th it launched a new product that offers two ways of doing so. One version includes a put option (a kind of insurance) linked to Zurich's house-price index. At a cost of around 0.5% a year, this option ensures that, if regional house prices fall, the size of the loan will decline in tandem. The second version links the level of the mortgage rate to the house-price index. This is not the first product of this type. In July, Advantage, the British lending arm of Morgan Stanley, an American bank, unveiled a mortgage called Flexishare. Under this deal, the value of part of the loan rises and falls in line with the house price; in return, Advantage charges a lower interest rate (2.99%) on that portion of the loan. Morgan Stanley hopes to package up such loans and re-sell them on the capital markets, where they might be an attractive alternative to index-linked bonds. On the surface, it certainly seems sensible for a homebuyer to finance a purchase with the equivalent of both equity and debt; that is what the corporate finance experts advise businesses to do. But there are some obvious caveats. The low-interest portion of the Advantage mortgage may entice homebuyers who are struggling to afford their regular payments, thus tilting the loan book towards the least creditworthy part of the market. The structure also sounds a little like the “negative amortisation” loans (under which interest payments are added to the capital) recently introduced in America, which are seen as a sign of a housing bubble. And in Britain, home-equity schemes (which allow the elderly to release some of the value locked into their properties) have not enjoyed a great reputation. But the big question is whether buyers will be willing either to pay a higher interest rate (in Switzerland), or to give up some of the potential rise in house prices (in Britain), in order to insure against the downside. British homebuyers, like their American counterparts, are mainly used to house prices going up. Significantly, while Advantage says it has seen interest in its Flexishare deal, it has so far had no actual takers. ID: 38620 Author(s): iff Publication date: 28/09/06

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Created: 28/09/06. Last changed: 28/09/06.
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