Saturday, August 11, 2007

Would you sign up to equity release with this Swiss bank ?

I have just been leafing through the glossy Riviera Times, an English language periodical which circulates in this part of the world, including Monaco and the Italian Riviera.

It's an Aladdin's cave stuffed full of useful tips for expats, listing of forthcoming events etc. Its cover price is €2.50 but it depends heavily on advertising.

How effective are those ads, one wonders, in attracting new custom? One assumes the paper would never permit discussion on whether the goods or services on offer are a sound investment . What about independent bloggers ? Should they feel any inhibitions about expressing an opinion on what they read ?

Certainly not this one, your fearless man in Antibes.

Where the owners and editors are concerned, a blog post of this nature has an upside and a downside. Firstly, what follows will prove that readers do look at the ads. The downside is that some of us look at them , especially those making a financial pitch, and begin to speculate about what kind of folk rush to the phone, asking for more details.

It was the full page ad, hastily photographed above, placed by a Swiss bank (whose name is prudently just out of the picture) that caught my eye, under the heading "Your home equity". Well, anyone with a garret or two to their name is interested in home equity, so I read on.

Immediately under the title were the words: "... a valuable factor when you wish to optimise your capital."

Mmm. Personally, I would have thought the best way to optimise capital tied up in a house is to live in it, rent-free, wait till one had a decent equity stake, and then sell, moving into a smaller property, or an equivalent one in a cheaper location.

There's the Anglo-Saxon solution, admittedly somewhat derided, which is to re-mortgage with a lender that is relaxed about leveraged buy-to-let investment, allowing one to recycle equity released as a downpayment on a second home, or even to finance something more ephemeral, like a Caribbean holiday or a BMW.

However, this is France, in which the property market is more conservative, with less fierce competition among mortgage providers (which may help to protect it from the current meltdown in world markets).

When Jane and I enquired about re-mortgaging one property to buy another here in Antibes the reply was somewhat peremptory, along the lines of "that's not how we do things".

"How we do things" is apparently to win the lottery, or wait for a relative to die, leaving you property in their will. The system does not encourage those of limited means to become property speculators.

So that leaves the field wide open for enterprising Swiss and other banks to assist folk who are desperate to release equity from their property, but on terms that we in the UK might find intolerable. I leave you, the reader, to judge for yourselves, based on the following précis.

The scheme imagines you own an upmarket property valued at 1,000,000 euros, on which there is no outstanding charge or mortgage. They clearly don't wish to deal with riff raff.

Using the property as security you are allowed to take out a loan for a maximum of 80% of the value of the property, ie €800,000.

But there are strings attached. You are only allowed to take 20% of the loan (€160,000) as a cash sum, with which to buy your yacht or Porsche. The scheme requires that 80% of the loan be invested in a mix of bonds and equities. The composition of the portfolio appears to be of the bank's choosing.

Secondly, the period of the loan is 30 years, no less (!), and the first 10 years operates on an interest-only basis. The total one pays in interest is not given, but must be hair-raising.

One might have expected a fixed rate of interest, but no, it's only fixed for a year at a time. It's presently 4%, low by UK standards, but times they are a changing. Just wait till Nicolas Sarkozy seizes control of the ECB, assuming Angela Merckel lets him, and runs up the borrowing and budget deficits in Europe as a means of stoking up the French economy !

But there is worse to come re the scheme - much worse- when one looks closely at the setting up-fees. (They are at least clearly set out, so no one can complain they were sold a pig in a poke). They come in at an eye-watering €15,500 for a €800,000 loan.

€2,300 of that is an administration fee, a further €800 is brokerage (why isn't that included in the admin fee?) .

It was spotting the final item that inspired me to write this post, touching as it did a raw nerve. It was a so-called "notarial fee" , ie a fee for legal charges, of, wait for it, €12,400 !

Clearly we are all in the wrong jobs - we teachers, scientists, journalists, translators whatever. If you're a lawyer dealing with loans based on property you are in clover.

I don't pretend to know the current hourly rate for lawyers who are not involved in litigation. Let's say it's €300 an hour for perusing documents, making sure that the claimed owner has title to the property, there are no restrictions or covenants on its sale, no outstanding charges etc, no defects that would reduce its market value etc. How long to do all of that - maybe a maximum of 5 hours ? That comes to €1500, not €12,400. Valuation fees, insurance etc add to the total, maybe a thousand or two. So how can that astronomical total possibly be justified ? How much is actually paid to the notaire, one wonders ? How much is in reality another of those lucrative upfront charges ? Let's not forget: in this case the property is not even being sold - merely used as security.

The rest of the figures in the ad are intended to show how those compulsorily-invested funds generate an income that, at least in the example given, more than covers the loan repayments. One can imagine the salesmen making a big play on that, so let's look at the figures in more detail.

The example supposes that none of the loan is taken as cash (unrealistically in my view), that all €800,000 is invested, generating a total of €190,604 in dividends after 3 years. (We are not told why 3 years are chosen, rather than 30).

From that sum is deducted the following charges: the hefty setting-up fees, already mentioned, investment charges - another whopping €15,690 , and interest payments on the loan of €118,980. That leaves a surplus of €40,434. It's not clear if that can be taken out, or has to stay in the fund. Irrespective, it's a modest amount for 3 years investment, seen alongside the property value. Imagine the property were sold for €800,000, and that sum was invested at 5%. That would yield €40,000 a year - 3 times as much income, and virtually risk-free.

Ah yes, there is the small matter of risk. The equity release is based on servicing a loan at a mortgage rate that can vary from year to the next , while relying on investments to perform better.

Suppose one had signed up to this scheme last week, and then, just as the ink had dried on the contracts, one watched helplessly as equity prices head south, and mortgage interest rates in t'other direction.

The worked examples mention only "expected" yields from the bonds and equities, and is silent on the matter of their underlying value, and how that could play havoc with the gamble one was taking.

But if everything goes pear-shaped, they, the Swiss bankers, not only have the deeds to your house. They also have the share and bond certificates. If you defaulted on repayments, they could, and probably would, take you to the cleaners.

The arithmetic looks even more precarious if some of the loan is taken as a cash sum. There is then correspondingly less to invest, a lower dividend income, but the same hefty monthly mortgage outgoings. This equity release scheme could quickly become a financial quicksand, with a millstone around one's neck.

This scheme might attact someone who has inherited a property, and who wants to release a cash sum without having to sell it (incurring capital gains and other taxes and fees). To be told that dividend income "should" more than cover loan repayments would be music to their ears.

So what is the French, I wonder, for "sailing close to the wind" ? What is the Monégasque for "it could all so easily end in tears" ? What is the Italian for "rather you than me, chum ".

What's the Swiss-German for "laughing all the way to the bank?"


Graff said...

Really a nice blog, written in a very gud manner and also very informatic. All information on
>equity release
is their in this blog. So very help full for visitors

ColinB said...

Hi there Graff

I'm glad you found it useful.

I gather from your blog that you've recently set up in business on your own account. Here's wishing you success!

Graff said...

Hi colinb

Really man you wrote in a very good manner and i am impressed from your writing skills . i Would more appreciate if u can write sumthing on Rent Back

ColinB said...

Well, I'm no financial expert, Graff, but I don't mind sharing my thoughts about anything and everything, which is what blogging is about.

The rent-back option could be a good one for folk who are facing some kind of financial or family crisis, as the ad makes clear. The important thing to remember is that it's going to cost you dear, and while the ad says there are no fees, you need to take that with a pinch of salt. Mark my words, there will be hefty fees, but they may be concealed.

For example, suppose someone has a house that they reckon is worth £200k.

They should not be surprised if they are offered £170k or less, because that's how these people earn their crust. At least you would save on estate agents' fees.

Then there's the rent. What's the expected yield for a landlord these days in the UK ? 6% ? So don't be surprised if the rent is £12,000 a year, or £1000 per month.

There has to be fees somewhere - legal, valuation, setting up, insurance etc etc. The devil is in the detail.

Don't be surprised if there's a hefty security deposit, especially if signing up to a long-term tenancy. It's good for them to have a steady rental income coming in, but they would look a bit silly if the tenant suddenly did a runner - thus the deposit as a deterrent.

If you want to get a detailed breakdown from these people, similar to the one supplied by the Swiss bank, I'd be happy to give it a quick once-over.

It's never a bad thing to have this kind of thing out in the open for all to see and comment upon, given what's at stake (homes, people's lives)

ColinB said...

Update Sunday 2nd Jan

See item on BBC online about sale and rent-back. It quotes examples of folk who were paid a half or less of the value of their home, and considers 65% not atypical. So my 170k above may have been hoplessly optimistic
(representing as it does 85%).

Irrespective - you stand to lose a lot of money going down this road.

ColinB said...

Sorry, read Sun 2nd Sep

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Tony said...

Equity release schemes – also called lifetime mortgages, home reversion or home income plans – are a way of releasing cash, whether to buy that new car, to pay for a holiday or home improvements, or simply to make daily life more comfortable.