Question 2:
Appendix A.pdf. This file contains information on a mortgage product provided by Barclays, named Family Springboard (FSB) Mortgage. This information is from the Barclays website. Please read it as you will need it to answer this question.
The FSB mortgage allows homebuyers to borrow up to 100% of the purchase price of the house. A family member of the homebuyer provides 10% of the price as security for five years. More precisely, the family member deposits 10% of the purchase price in a deposit account with the lender, entitled Helpful Starter account, which earns interest at an annual rate of 1.6% paid monthly, or an annual equivalent rate of 1.61%. The deposit is returned to the family member after five years if no mortgage payments are missed. Otherwise, the deposit may be at risk. All the cash-flows occur at the end of the month, except the initial amount borrowed and initial family member deposit.
- Why do you think that Barclays has come up with this product? What are the benefits of the different parties involved? Please explain having in mind the evolution of residential real estate prices, interest rates, and household incomes over the last decade (maximum 15 lines).
- A borrower decides to purchase a house of price £200,000 using an FSB mortgage with an LTV of 100% and a 10% deposit from a family member. The interest rate on the mortgage during the first five years is fixed at 2.95% and the following on the rate (i.e. after these five years) is variable and currently equal to 2.74% (as per the information in Appendix A). The maturity of the loan is 25 years. Please use a spreadsheet to calculate the monthly cash-flows for each of the parties involved (i.e. the homebuyer, the family member, and Barclays). You may assume that the family member withdraws the interest paid out of the account in each month, the deposit at the end of five years and that the mortgage is held to maturity.
- Please evaluate quantitatively the risk that Barclays faces, over the life of the loan, in the product in part (b) compared to a standard mortgage (i.e. a mortgage without the deposit of the family member), with zero fees, an LTV of 90%, an annual interest rate of 2.8% over the life of the loan, and a maturity of 25 years (for the purchase of the same house of price £200,000). Please explain briefly (maximum 5 lines).
- For all the mortgage products considered so far in this question, including the FSB mortgages and the standard mortgage in part (c), the initial product fees are zero. Please compare the following two standard mortgages (i.e. mortgages taken without the family member deposit) used for the purchase of a £200,000 house:
Mortgage d1: Product fees of £0, LTV of 90%, the annual interest rate of 2.8%, and maturity of 25 years. This is the standard mortgage in part (c).
Mortgage d2: Product fees of £500, LTV of 90%, the annual interest rate of 2.7%, and maturity of 25 years. (You may assume that the product fees are added to the loan balance at the initial date.)
Please compare the cost of each of these products for (i) borrower A, who expects to repay the loan in exactly 2 years; and (ii) borrower B, who expects to repay the loan in exactly 5 years. Please explain which of the mortgages each borrower would choose, and why it may be beneficial for lenders to offer products which differ in such a way (maximum 5 lines).
