Financial Stench

There is a new financial product on the market that makes the “liar’s loan” bunch look absolutely saintly. It’s a deal whereby you are paid an amount of money to surrender a portion of any future increase of equity in your home. It’s adamantly claimed not to be a loan, as in you don’t pay until your home is sold, at which point what you pay is the agreed portion of the amount that your home has increased in value between the time you were paid the money and the time of the home sale.

It turns out, however that the money does get repaid, along with half of any appreciation realized by your home. That might be a good deal in today’s market, where home values are actually declining, but when they begin to recover that loan (which is what it actually is, even when they call it by another name), could get really expensive.

Suppose you bought your house for $500,000 and you take out one of these products for $50,000. If you then sell your house for $700,000 you must pay back the original $50,000 plus half of your gain on the house, for a total of $150,000. That’s a pretty good rate of return for the lender.

If you sell in less than five years, regardless of reason, you not only have to pay back the $50,000 but you can get hit with some astonishing penalties.

There also tend to be some restrictive clauses in the agreement about the “maximum indebtedness” you can incur and something about “deferred maintenance adjustment” costs. And because these are all very new, so new that no name seems even to have been invented for them yet, there is no government regulation of them at any level.

There is a distinct odor to these products; one that smells like things which can be sold by brokers and then packaged into financial instruments which are resold to investment houses and finally resold as derivatives. Bear in mind, they were invented and are being sold in in a market in which home values are declining with no real end in sight.

Haven’t we been subjected to this type of stench before?