Mark Wadsworth

This is a spare 'blog in case my main 'blog at markwadsworth.blogspot.com isn't working

Another day, another reckless throw of the dice (42)

From The Daily Express:

EX-cabinet minister Lord Deben, formerly John Gummer, is among the directors of a new investment and mortgage business promising “to breathe new life into the housing market”.

Newly formed Castle Trust will offer investors the chance to make returns based on house prices. Funds raised will provide householders with loans known as a “partnership mortgage” of 20 per cent of their home’s value. They will not make monthly repayments but after a set period must repay the loan plus 40 per cent of any rise in value. Castle’s key backer is the US private equity firm JC Flowers.

Its seven part-time directors include Gummer, former Financial Services Authority chairman Sir Callum McCarthy and former National Consumer Council chairman Dame Deirdre Hutton.

As I commented over at HPC, These people really are gambling on there being people with a lot more money than sense.

Logic says that

A. Any FALL in house prices will be borne 100% by the people who lend the top twenty per cent of the value of the house – if prices fall 20%, then their “deposit” is wiped out, therefore, depending on what probabilities you ascribe to prices rising or falling and if so by how much, they ought to be asking for nearly 100% of any price increases.

B. Then there is the phenomenon that an 80% mortgage costs (say) 4% interest but a 100% mortgage is (say) 7%, so the effective interest rate on that top slice of 20% is actually (say) 19% (formerly known as Higher Lending Charge). Using a £100,000 house as an example:

£80,000 x 4% = £3,200
£100,000 x 7% = £7,000
By subtraction, the top slice of £20,000 costs £3,800 interest

So we can actually split that 100%/£100,000 loan into a 4% loan for the first £80,000 and a 19% loan on the rest, i.e.
£80,000 x 4% = £3,200
£20,000 x 19% = £3,800
Total mortgage £100,000, total interest = £7,000.

C. Therefore, if you were willing to invest money in this scheme and assumed that there are equal probabilities that house prices go up, stay the same or go down, you ought to be looking for an annual interest of 19%, plus 100% of any increase in house prices, and not be fobbed off with a mere 40% of any price rises (and an unknown fraction of price falls).

For the house on which your investment is secured to cover the whole of the loan, prices would have to be rising by at least 4% a year to cover the £3,800 compound interest in the interim, which pushes the chances of this investment paying off even further into “unlikely” territory.

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