Tim was on about a mortgage which automatically increased in line with RPI, and where the mortgage debt would also increase in line with RPI. You'd pay the difference between the interest rate and RPI (in this case, nothing!).
"Andy Pandy" wrote
Well, not quite. The mortgage payments are allowed to increase over time (not necessarily at RPI, but could be).
"Andy Pandy" wrote
The mortgage debt would increase with interest, and decrease by payments (as normal). This *might* lead to the debt increasing in line with RPI, or might not!
"Andy Pandy" wrote
Yes, you could have zero payments and leave the debt to increase at 20%pa (interest), with house value increasing at 20%pa, leaving a constant "equity" around zero.
Was he? I thought Tim meant that the monthly payments were supposed to increase in line with the borrower's salary (not just due to general salary inflation but also due to career advancement), which would hence rise faster than inflation.
This does not mean the mortgage debt increases "in line with inflation". If payments start at a level substantially lower than what interest-only payments would be, then it will involve the debt *initially* increasing (but at a rate much less than the interest rate, in fact at a rate roughly equal to the *difference* between interest rate and the initial ratio of payments to the debt), but if payments increase at a rate well in excess of the interest rate, then they will soon overtake the interest-only break-even level, at which point the debt reaches its peak and will then start to decay, and will soon fall more and more steeply as the payment size keeps on increasing. And all of a sudden, it'll be paid off!
Or have I misunderstood?
Except that a bank investing in property, which is what it is essentially doing here, would want some rent in addition to the capital growth.
Yes. I think Tim is missing the point that if the bank were to rely on house prices increasing in line with salaries, with RPI, historical averages or whatever, in order to maintain their security for the loan, then they would be taking a much bigger risk. And so they would need to charge a higher interest rate. Negative equity can, and has, occurred with normal mortgages, so with mortgages that increase in value they'll be much more likely. I'd avoid investing my money in a bank that lent in this way.
"Jonathan Bryce" wrote
NO! The bank doesn't own the property, they just give a loan secured on it. So there is no question of either rent or capital growth for the bank - they simply receive *interest* on the loan.
(1) With a standard repayment mortgage, the loan amount decreases over time. (2) With a standard interest-only mortgage, the loan stays the same but LTV decreases. (3) In the above type, the loan increases but the LTV stays the same.
Why do you think that the third option above is "essentially ... a bank investing in property", when options (1) and (2) are not?
"Ronald Raygun" wrote
Exactly...
"Ronald Raygun" wrote
Nope - you're spot-on, RR!
"Andy Pandy" wrote
You'd avoid saving your money in a bank that paid a higher interest on your savings?!
Yes, because they are gambling my money to a much greater extent than banks who operate normal mortgages. If I wanted to gamble on property prices increasing I'd BTL.
"Andy Pandy" wrote
That's be a whole different ball game of risk.
Also- do you know how the other banks paying "leading rates" on savings, actually manage to pay that much?
Do you know of any careers where this is guaranteed?
That depends on the salary multiple borrowed. Tim was talking about 10x salary mortgages.
All of a sudden???
Using Tim's assumptions of interest rates 2% over salary increases (which is probably reasonable, given that the bank is taking a much bigger risk than with normal mortgages), and a 10x salary mortgage (remember the higher multiple is the whole point of this type of mortgage), and your assumption that net pay = 2/3 gross, then I calculate it would take about 45 years of paying half your take home pay in mortgage to pay it all off!!
You have a odd definition of "all of a sudden"!
But you were on about a mortgage that you pay off when you die (and have to continue paying in your retirement!).
Usually by ripping off loyal customers who couldn't be bothered shopping around.
For instance they'd launch a new account with "leading rates", attract a lot of new money, make a loss on the account but then gradually reduce rates. Most people wouldn't keep an eye on rates and move their money, so they milk those people while lauching a new account which is basically the same, but with a different name and very slightly different T&C's, attract a load of new money, the gradually reduce rates... and so on.
Yes, a 'Shared appreciation mortgage' is a type of (3).
I dont think any SAMs are currently available but when they were the majority, although offered by banks' were actually funded by separate investment funds, not by the banks' main pool of lending dosh.
Who said anything about guarantees? If you had those, there would be no risk. But many "career" jobs (civil service, say) do award automatic annual increments on a pay scale, with bars you can only cross when you get a promotion. Not everyone expects to get to the top, but most get at least halfway before they retire. The whole pay scale is also regularly adjusted for inflation.
No it doesn't, it's a general observation. What depends on the multiple is just *how* "soon".
So that's what, between 2 and 3 times normal mortgages. Most people on normal mortgages these days (because of low interest rates) can easily afford to pay more each month than a standard 25-year constant-amount plan has them paying each month. That is to say if they can't "get" a mortgage, the factor which scuppers them is not that they can't afford the repayments, but that they fail the salary multiplier test. If you could afford to pay twice as much but go and borrow three times as much, this would make your payments 50% more than you can afford (to start with).
If your salary goes up by, say, a conservative 8% each year (4% wage inflation plus 4% annual increment), you will be able to afford 50% higher payments within a little over 5 years. By then your debt will have grown a bit, of course (initially at 1/3 the rate of interest), but after 5 years it will still be a lot short of 150% of what it was at the outset. So you can see that progress is being made, and the debt peak will be reached probably before the next five years are up. Then it's downhill all the way, and the loan will be paid off very quickly.
Yes, all of a sudden. Whereas, as you know, the debt profile over time of a normal repayment mortgage has a permanently downward slope which is initially very shallow and gets steeper as time goes on, in one of these "special" mortgages, the profile slope is initially upward, may get steeper for a while, then shallower, then comes to a peak, and then slopes downward, getting steeper again.
My "all of a sudden" was focusing on the part from the peak to the end and observes that the "getting steeper" during the latter part of the term happens rather faster than in the normal level-payment plan.
I expect this model is highly sensitive to the parameters. I'm not so sure a 10% interest rate is all that reasonable for an expected 8% salary increase.
Not really. In your calculations, can you say where in those 45 years the debt peak is? I'll bet it's a lot closer to the end than to the beginning.
What?? Conservative my a***.
My company is offering new graduates a 23,000 starting salary. The average 61 year old who graduated 40 years ago, is not on 110,000!! (23,000*1.04^40). They are on more like 40k, ie 1.5% salary increments over and above general wage inflation.
There may be some careers where your final salary can be expected to be over
100,000 in real terms - but most certainly aren't.
OK... so you may have to wait for 40 years for "all of a sudden" to happen. But you'd better not have retired or "all of a sudden" may take longer....
In todays terms, I'd say a 5-6% salary rises and 7-8% interest rates would be reasonable. The extra risk would require a higher interest rate than normal mortgages.
Anyway even with interest rates just 1% above salary increases it'd take 35 years of spending half your take home pay on your mortgage to pay it off.
No because I used the "real terms" (or "salary terms") value of money to work it out! Simply shove the rate difference into the standard repayment formula.
[OK that is cheating slightly, you should really use 1 - (1+interest rate)/(1+salary increases)]
Well, my starting salary in the late 70s was approximately £3700 and when I left some 23 years later I was on about £27k. That's 9%.
Admittedly the increments come faster earlier on in the career, and may even stop later as they get stuck at a bar. So the model may need to be tuned to use 8% for only the first 25 years and then maybe 5-6%.
I strongly suspect that method is so oversimplified that it cannot be relied upon to provide a useable answer.
No, just because SAMs exist(ed), doesn't mean that option (3) above is a SAM. It is not!
Under (3) the bank does NOT share in any appreciation. It is a straight loan, increased only by interest charged (although the payments made to it initially are less than they would be under a "flat" loan).
I agree, which is why I didnt say 3 was a SAM. I said a SAM was a 'type' of (3).
and that interest is linked to the property value by way of the fixed LTV.
With a SAM. The 'growth' is actually interest which is why they quoted APRs (ridiculously high ones as well!)
Well yes! Because average inflation was high in that period!
According to:
So your 9% is 1.5% above general wage inflation, exactly as I wrote above!
The last 10 years has seen wage inflation of 3-5%, average 4%, and also low interest rates. So 5.5% is reasonable if you use the last 10 years as your benchmark.
If you use the last 30 years as the benchmark then you'll need to use a higher interest rate to refect the much higher mortgage rates during that period.
Of course it can! Think about it. Think about the mortgage debt and payments in terms of "hours work" instead of pounds (like a separate currency). It is slightly simplified in that it will assume smooth continuous salary increases rather the likely reality of annual increments, but apart from that it will provide an accurate answer.
Work it out the hard way if you don't believe me.
"John Boyle" wrote
Yeh, I know. I'm saying that *no* type of (3) has any "shared appreciation", so a SAM is not a type of (3).
"John Boyle" wrote
Not quite. In my type (3), the LTV isn't exactly *fixed*.
The loan increases by interest, but payments are less than under a "standard loan" so the loan amount rises. On average, the LTV stays *about* the same, but does fluctuate as house increases fluctuate around their average.
"John Boyle" wrote
Did that interest rate vary with house price increases? If so, then it is *not* a type of my option (3). If not, then they don't share the appreciation, do they?
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