Monday 20 June 2011

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.

9 comments:

Lola said...

Thank you MW for putting this together - saved me the bother.

I posted on the 'Introducer Toady' comments and included the url.

see here:

http://www.introducertoday.co.uk/News/Story/?storyid=4393&type=news_features

Anonymous said...

I thought that the Super Casino issue was put to bed during the last government and that this Government thought, then, that it was a bad idea.

Mark Wadsworth said...

L, thanks.

Anon, the Tories didn't complain about Labour playing at the casino as such, they complained about Labour playing at the casino AND LOSING. The Tories now reckon that they can play at the casino AND WIN (which seems highly unlikely).

AntiCitizenOne said...

What if they decide House should vastly increase the number of chips...

Mark Wadsworth said...

AC1, the government/banks ARE the house and they do keep increasing the number of chips.

Anonymous said...

It's not just the investors who will be taking a huge gamble here. the gullible householders will too:

"after a set period must repay the loan plus 40 per cent of any rise in value"

If the value has fallen, OK, they won't need to repay any extra for the rise in value. But they'll still need to repay that original loan, and won't have any equity to raise new funds to do so.

Hopefully they won't find too many gullible fools to take their loans.

Mark Wadsworth said...

AC, yes, that's the beauty of credit bubbles - somehow the actual loss (the fall in the value of the house) ends up being doubled, both the lender and the borrower suffer.

Castle Trust said...

Thank you for your comments. We would like to note some important product features which couldn’t be fitted into the Daily Exress article referred to above.

The Partnership Mortgage has been carefully designed to be very different to previous shared equity offerings. It is only for responsible homeowners who already have a 20% deposit who are under the age of 55 years - both those buying a larger home and first time buyers. A Partnership Mortgage will reduce the size of the traditional interest paying loan, and the interest rate on that loan, which means in total it can reduce monthly payments by a third. In return, the homeowner shares 40% of any increase in the value of the property, when they sell their home or at the end of the term of the loan (up to 25 years). The reason that the homeowner shares more than 20% is because they are not paying interest on the Partnership Mortgage during the life of the loan, nor are they paying rent for the 20% of the home that Castle Trust funded. The Partnership Mortgage is NOT available for those with a poor credit history or those who self-certify their income.

Castle Trust uses the returns from Partnership Mortgages to pay HouSA investors returns greater than the Halifax House Price Index, which means that we can help first time buyers get on the property ladder who otherwise wouldn’t be able to (minimum investment size is £1,000 which is much smaller than the amount needed for a deposit). HouSAs are also available in an ISA or SIPP, which means that investors can invest in housing in a tax-efficient and hassle free manner (unlike buy-to-let). People obviously have differing views on the housing market, but 60% of people believe that housing is the best way to save for retirement, and HouSAs provide an easy way to do this with higher returns than the HHPI.

Further details, including worked numerical examples of both how the Partnership Mortgage and the HouSA works can be found at www.castletrust.co.uk

Lola said...

Christ on a bicycle. It's even worse than I imagnined. they are allowed to promote this crap throuh ISA and, very worryingly, SIPPs. In other words honest saving buyers not using this scheme will competing againt investors getting tax relief. In other words the legit buyers are subsidising the 9in my view) illegitimate ones.