Wednesday, April 04, 2007


Re-thinking Collateral

New mortgage products on the horizon.

Did you take a close look at your banker, lately? Did you notice how skinny he or she has become? That is because, following the spike of house prices and the subsequent downturn in Real Estate, the carnivores have had a real hard time finding new flesh to feed upon. Things, however, seem to be changing now. As property values have risen dramatically in recent years and the pool of buyers ready, willing and able to purchase real capital assets has dwindled, lenders are beginning to re-think collateral.

Financial theory postulates that it makes little sense for market participants to borrow a lot to invest on a single assets class. But this is exactly what homeowners, investors and speculators in real estate markets all across North America and Europe had to do as a direct and proximate result of rising property values. High prices in many nations have forced many buyers to take on debts that are substantial multiple of their incomes. This has turned houses for most homeowners not only into their biggest single financial asset, but also into their biggest single financial liability as well.

To obviate this problem, banks in Europe are beginning to offer a new mortgage product, which is sure to reach North American shores very soon. Zurich Cantonal Bank ( is now offering a type of mortgage that links the value of the loan to that of the property.

This package comes in two versions: the first includes a ‘put-up option', that is a kind of insurance linked to Zurich's house-price index. At a cost of approximately 0.5 percent per year, this option ensures that if regional house prices fall, the size of the loan will decline in tandem. The second version, instead, links the level of the mortgage rate to the house-price index.

This new type of mortgage is designed specifically to shield market participants from the fluctuations of real estate markets, as well as to partly protect the same market participants from the affordability crisis, a problem rampant also in Europe - not only in North America. The primary culprit and cause of the crisis is the ratio between wages and real estate market values. This ratio is entirely skewed to values. Whereas market values in metropolitan areas in North America have appreciated an average of fifteen percent per year for the period from 2000 through 2005 - or a total of seventy-five percent, salaries have increased an average four percent per annum - or twenty percent total. The problem is even worse in Europe. There is, therefore, a fifty-five percent gap, which accounts for the problem buyers on this side of the Atlantic are facing today when it comes to go to the bank and qualifying for a loan. This gap is even larger in Europe.

By putting the principal balance of the loan on a sliding scale linked to the house-price index or by tying rate fluctuations to the oscillations of house values, Zurich hopes to attract a fresh pool of buyers and, at the same time, offer a better refinancing option to existing property owners. The flip side of the coin, of course, is to see how many buyers will actually be willing to pay more for their loans in times of market expansion.

In Britain, on the other hand, Advantage ( - the marketing arm of Morgan Stanley - has unveiled a mortgage product named ‘Flexishare Home Ownership Plan', with the following highlights:

[ ] Gives borrowers greater purchasing power.

[ ] Borrower owns 100% of property.

[ ] Part Residential Ownership Loan, part Conventional Mortgage.

[ ] Advantage shares proportionally in appreciation and depreciation.

[ ] Overpayments and buy back of Advantage's Share allowed.

[ ] Flexible amount of Advantage participation.

[ ] Choice of two stepped fixed rates.

[ ] Portability allowed (not committed to any additional lending).

[ ] Affordability based.

[ ] No Higher Lending Charge.

[ ] Fees may be added over 95% LTV.

[ ] Minimum 5% deposit.

[ ] Available in England, Wales, mainland Scotland and Northern Ireland.

Under this plan, the value of part the loan rises and falls in line with the house price. In return, Advantage charges a lower interest rate only on the fluctuating part of the loan, and hopes to raise the balance by packaging up such loans and sell them on the capital markets, where they might be a viable alternative to index-linked bonds. Again, though, there is a flip side to this type of scheme: in England, just like in America, homeowners are mainly accustomed to property values going higher and higher in the long run, and may not be willing to give up some of the potential rise in house prices by paying a higher interest rate, in order to insure a downside.

Both the foregoing products have the ultimate goal of allowing real estate purchasers and current homeowners alike to buy or otherwise refinance real capital assets using both equity and debt, and it will be interesting to see how successful and popular they will become. But aside from how welcome they will be in Real Estate, it would certainly appear that your friendly, neighbourhood Tyrannosaurus Rex is getting ready yet for another feast - wherein you are going to be once again the main entrée ...

Luigi Frascati

Real Estate Chronicle


It is nice to see the banks letting us borrow more money. Owing a bank for all my life sounds great. What is the benefit of paying a mortgage on a property you will never own?
Good evening Bart,

first of all let me thank you for the nice article on the Real Estate Chronicle you posted on your blog some time ago.

The benefit of paying a mortgage (only the interest portion of the periodic payment, that is) is to be found on the Future Value of the property. It is the appreciation of the real capital asset.

Real estate properties are a particular class of tangible goods that tend to increase in value over time (like wine, so to speak - the older, the better). Consumers contract out mortgages with the final idea of reaping profits at a later date. The net proceeds they realize when they sell are, of course, offset by the cost of owning: property taxes, monthly fees in the case of strata freeholds and the interest portion of mortgages.

In fact, so long as the interest rate is not disproportionate, there is no real benefit in paying off mortgages as I pointed out in my post of February 8, 2007 entitled "American (or Canadian) Dream 2007: Keep Those Real Estate Properties Financed!".
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