ILS MORTGAGES FOR BORROWERS

There are two kinds of ILS Mortgages:

• The Defined Cost ILS Mortgage, and
• The Variable Cost ILS Mortgage

In both cases it is like paying rental except that it usually costs more at first and gets easier every year - maybe almost 12% easier every three years. Like this:

In all cases your payments will get easier every year, something like this. But the slope is less well defined for a variable cost mortgage. For a defined cost mortgage the slope and the mortgage term are negotiated at outset.
Source: Edward C D Ingram Spreadsheet showing a Typical Defined Cost ILS Mortgage .

DEFINED COST MORTGAGES: With the defined cost ILS Mortgage, the cost of every year’s payments is defined at outset. You know exactly what it will cost – not in money, but compared to a ‘standard rental’ index – but in terms of how fast your payments will drop relative to that index. On the above chart you are negotiating the slope. The standard rental index is a sales term to describe AEG% p.a. in a way that the customer can relate to. It assumes or implies that rentals will rise as fast as AEG% p.a. on average.

This means that if incomes are not rising at all, your mortgage payments would be falling.

“How does the total cost compare to other kinds of mortgage?”

“What if my income does not keep pace with the average?”

If your income does not keep pace with the average every year, every kind of mortgage and every kind of rental  that you might consider using will cost you more than you might hope otherwise. It makes little difference which way you choose to go. If you cannot keep pace with the average, everything may cost you more than average. But at least, with the ILS Mortgage, the cost of the payments will be falling compared with everything else, possibly by as much as 12% every three years.

VARIABLE COST ILS MORTGAGES: An ILS Variable Cost Mortgage is almost the same - it is like paying rent for a property, but cheaper overall, and getting around 4% easier to pay every year than a standard rental. It is cheaper overall because, unlike rentals, the mortgage payments eventually come to an end and you then own the house without any debt.

Typically, a rental for the same house would start at 70% of the cost of a 100% (zero deposit up front) mortgage. That is, if you paid no deposit to the bank. But that rental cost would overtake the cost of an ILS Mortgage after around 12 years - about mid-way through the 25 year mortgage repayment period. If you pay a deposit then the mortgage will be smaller so the cost to rent cross-over will occur sooner.

Unlike the traditional variable or adjustable rate mortgages, where the interest rate is fixed for a few years, an ILS Variable Rate Mortgage has no ‘jumping payments’. Compared with paying what we might call a ‘standard rental’, in which the rent cost rises as fast as average incomes rise, the ILS Variable Cost Mortgage gets cheaper every year. The worst that can happen, if interest rates rise too much, is that the payments will not fall quite as fast as originally scheduled.

If average incomes are not rising, ILS Mortgages will cost less money every year.

HOW MUCH CAN BE LENT?
Typically, about 3.5 times income can be lent which costs 30%  of income in year 1.
Exactly how much can be lent depends on the regulators  and the lender. 
The amount can be increased if:

• More than 30% of income can be afforded
• The rate at which the payments become easier is reduced 
• The total repayment period is extended

What if interest rates are very high or very low?

If inflation is high, say over 4% p.a. the ILS Method would usually be able to lend more than a traditional Mortgage, and without the need for any of the three special ways to achieve that as just listed above. An ILS Mortgage could still lend around 3.5 times income, unless other factors like the lender's inefficiency (high cost administration) or the risk to lenders was high, which sometimes it can be for certain classes of borrower or in some legal and economic environments. Another factor which remains to be explored thoroughly may be that the particular economy where you are living has a very high growth rate and money is being absorbed by equity or other investments with very high rates of return.

If Inflation is low and others are lending more - watch out! There can be risks to your financial health here. This is all explained later in this Blog. But there can be circumstances in which the ILS Mortgage can lend just as much, and much more safely than the traditional Mortgage. See the above list of ways to increase the loan size.

A MODIFIED TRADITIONAL MORTGAGE

It is possible to start you off with a traditional mortgage. But sometimes these can bite you very hard taking payments far out of your reach. In that case, as long as you have kept your payments up  to date, the lender may offer to take you into the ILS System and solve your problem. This is called a HYBRID ILS Mortgage.

HOW DOES THIS WORK?

It is easiest to say how the Defined Cost ILS Mortgage works. Your lender lends you, say three average incomes as a mortgage. You pay back a specified amount of average income every year. In total you agree at the start what the total will be and how much you will pay every month. The lender knows how much 'average income' will be repaid - maybe 3.9 average incomes in total with the most being paid in the early years.

How fast your payments can be allowed to reduce after you are switched over to the ILS System depends on a number of factors including the cost of funds and how much you still owe, nd whether or not it is decided to extend the total repayment period.