Equity loan not equal for all
John Collett, 4 April 2007Shared equity mortgages are about to become big business. Much has been written recently on their virtues but be warned. If the home buyer enjoys even modest capital gains they will be better off with a standard mortgage.
With Rismark International's Equity Finance Mortgage, the home buyer borrows up to 20 per cent of the value of the property using the equity loan. Another 75 per cent is funded by a standard mortgage (the other 5 per cent is the minimum deposit required by Rismark's partner, Adelaide Bank).
An important feature of the product is that home buyers always retain ownership of their house and the equity mortgage can be repaid in full at any time.
Borrowers do not make any interest repayments on the equity loan. By using an equity product to fund part of the purchase, the home buyer pays less in mortgage repayments. That allows the buyer to borrow more and buy a higher-priced property than they otherwise could.
When the house is sold, the home buyer must repay the equity loan plus up to 40 per cent of any capital gains. Rismark also wears up to 20 per cent of any capital losses.
It seems a reasonable assumption that house prices in Sydney and Melbourne will grow by an average 5 per cent a year over the next several years. After the house price boom that ended in 2003, and with higher interest rates on the way, it's hard to see house prices outstripping wages growth.
Dennis Orrock, general manager of researcher InfoChoice, has run some figures to see how home buyers will fare.
Although the buyer must give up to 40 per cent of capital gains, he or she saves on the interest costs of the equity mortgage.
Orrock assumed a 25-year mortgage with an interest rate of 7.5 per cent. He assumed the interest saved on the mortgage was invested at 6 per cent.
On a $550,000 house that grows in price by an average 5 per cent a year, Orrock says, on selling the house for $705,800 after five years, the owner will be about $15,000 worse off going the equity mortgage route. In 10 years he or she will be $31,000 worse off.
But at lower growth rates over fairly short time periods, home buyers using the equity mortgage will be ahead.
With the same $550,000 house, but with an average annual price growth rate of 3 per cent, the home buyer will be $12,000 better off going the equity mortgage route after five years. If the house is sold after 10 years the home buyer is $34,000 better off.
The point is home buyers whose house prices grow by less than 4 per cent a year over five years are likely to be better off taking an equity mortgage.
For home buyers who experience price falls that is unequivocally the case, as Rismark wears 20 per cent of the loss. However, anyone expecting to do a better than average annual growth rate than that may be better off sticking with the standard mortgage.
But, if you are pessimistic on property prices, then the equity mortgage is free money, because no interest is charged on the loan.
Also, the higher the interest rate paid on the mortgage, the less there will be in net capital gains and the more favourable to the home owner the equity mortgage becomes.
The equity mortgage is a flexible product and the risks are clearly explained. Those who take the option can switch out of it at any time.
It will be of benefit to those struggling to enter the property market as its boosts their buying power by up to 25 per cent and that means higher capital gains than they would otherwise have. As the managing director of Rismark, Christopher Joye, says, if the expectation of house price growth in any particular property market is, say, 4 per cent a year, by definition, nearly half of home buyers will be experiencing price rises of less than that and could be better off using an equity mortgage.
In any financial product, complexity is itself a potential hazard for consumers. Anyone thinking of taking out an equity mortgage must have a very clear understanding of how it works.
Rismark's product is available only to those buying established houses in large metropolitan areas. The equity loan must be paired with an Adelaide Bank loan, at least initially, but the latter loan can be re-financed later.
Any fees that apply, such as deferred establishment fees on switching lenders, must be scrutinised closely.
But the real sting in the tail of Rismark's loan product is the handing over of up to 40 per cent of any capital gain. It will be interesting to see which aspiring property owners Rismark takes on board and which it knocks back.
Perhaps, if it is overly keen for you to come on board, that may be a sign you should be contemplating other options and keep 100 per cent of the capital gain to yourself.
Wayne
Mortgage Adviser
Email
http://www.alphamortgagesolutions.com.au
Free March News Letter now availableWayne
Mortgage Adviser
Email
http://www.alphamortgagesolutions.com.au
Free March News Letter now availableMy gripe with all these 'exotic' finance products is they are designed to make it possible for those who normally can't afford to get into the property market. With affordability at an all-time low, the finance companies and the banks are looking to invent new ways to get people into the housing market, and the M.B's are gunna push them as they get paid when they sign up a punter.
I.M.H.O, it is a similar situation to the F.H.O.G, where the first home owners weren't any better off as they all had an extra $7k (some had $14k) to play with, thus they could bid higher for their house, and did. The prices went up and absorbed any benefit pretty quickly. The same will happen in time as a result of products like these Shared Equity Loans.
The underlying cause – affordability (or lack of) will still be bad as the newly qualified buyers compete for the remnants of the cheaper housing to be had, thus forcing the prices up a little more and keeping the affordability low for a bit longer until another new miracle finance deal is invented.
It's all great for me; the cheaper properties go up, which forces the values of mine up, but the poor first timer will still struggle.
I agree Marc I do not use this product the article was in support of what you say, that maybe it is not as rosy as what it seems
It will be interesting to see the 'fallout' from this product in about 3 years.
As you are probably aware Wayne, the market here in the US has just begun to see the ramifications of weird and wonderful and 'creative' finance products taken on by borderline qualifiyers a few years ago.
My worry is it will happen back home in Aus. Glad to be wrong.
Quote:It will be of benefit to those struggling to enter the property market as its boosts their buying power by up to 25 per cent and that means higher capital gains than they would otherwise have.What nonsense!
They get 25% more capital gain, but in return they promise to give 40% of all their capital gain to the 'equity partner'!
Without the equity loan, they get $0.01 in capital gain from every $1.00 purchased (with $1.00 outlayed) for every 1% growth in the property price.
With the equity loan they get $0.0075 in capital gain from every $1.25 purchased (with $1.00 outlayed) for every 1% growth in the property price.Am I missing something here?
F. [cowboy2]
No F; I don't think you are.
As usual, you are the number cruncher who reveals the real truth.
I remember reading a book by John Burley ("Money Secrets of the Rich" – every high school student should have to read it I.M.H.O), where he was talking about Banks.
He said that if a Bank comes up with a product, and also advertises it heavily, then you can be sure that they are making money out of it, and probably lots of it.
Of course; they will always present it in such a way to make it look like they are doing you a favour, but we all know better… don't we?And the absolute terrifying scenario is for someone who gets sucked into one of these loans, and lets it run for its 25 year term. Just do the sums and you will see what the poor cows will be up for then. I wonder how some banks (and brokers) sleep at night…..
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