Thursday, May 17, 2007

The last thing homeowners need-another way to over-borrow

The linked article at SeekingAlpha describes a new financial product that is now being marketed which allows a homeowner to essentially place a bet on the future appreciation of their home, without incurring interest costs along the way. The product is the creation of "REX & Co, backed by a subsidiary of American International Group, Inc. (AIG), (which) has a new product that lets homeowners tap the value of their homes without taking out a loan."

SeekingAlpha poster Todd Sullivan comments that "the novel product gives homeowners cash for their equity in return for a portion of the proceeds from the eventual sale of the home. For instance, a homeowner who has a $500,000 home can extract $100,000 of that by giving REX 50% of the change in the home value. So, if the home is sold in five years for $750,000, REX receives half the increase, or, $125,000. If it sells for $600,000, they receive $50,000."

What it amounts to is the equivalent of a zero coupon bond which hit Wall Street years ago. The obvious risk is if the homeowner borrows a specific sum based on their forecast of the appreciation in their home and the home fails to appreciate enough to cover that borrowing then the borrower will be upside down at the note's due date. Also, I haven't bothered to do the effective interest rate calculation for some scenarios using this product, but it is likely to be expensive. It seems to me like another way for unsophisticated borrowers to hang themselves.

It is a creative new financing option which if used properly is a nice addition to the range of credit options available to consumers; but at this point it is just an attempt to keep the housing lending market afloat.

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