If borrowers fell into negative equity, they could recoup the difference from the fund, while if prices rose homeowners wouldn’t particularly benefit as the gains would be offset by losses from the fund.
The authors of the paper suggested that as most people purchase a property in which to live, rather than as a speculative investment, they may prefer this “risk averse strategy”.
Short sighted rather than risk averse
James Mole, independent financial adviser at Gingko Independent, said that he couldn’t see the need for such derivatives, arguing that if house prices go down this only really affects homeowners if they need to sell.
He continued: “So long as lender and regulators are taking sensible precautions with stress testing rules and the like, we shouldn’t be concerned with negative equity as the homeowner will still need to live somewhere. I also think that most people with a mortgage would have a harder time paying sky high rent than making often lower mortgage payments.”
Mole also pointed out that people who bought an averagely-priced home 25 years ago would today have a property worth four times what they originally paid for it.
He added: Why would any logically minded home owner give up that return on investment? There is being risk averse and then there is being short sighted.”
Borrowers not hugely concerned by prospect of negative equity
Andy Wilson, director of Andy Wilson FS, agreed that it was unlikely that homeowners would be willing to forego the gains made on the price of their home, their biggest asset, in order to protect against what they will likely see as unlikely losses.
He continued: “Most of the mortgage clients we see do not feel that negative equity is a major concern. In my business we counsel our clients over the possible effects of prices reducing, and point out they if this happens they may be stuck in their home for a number of years, unable to move equity to use as a deposit. However, most are satisfied to take the risk. They know that as long as they can afford the mortgage, they will at least have a secure home to live in.
WIlson added that while the theory behind such a derivative may stack up, selling it to house-hunting borrowers is another matter. “I don’t think they will go for this in any shape or form,” he concluded.
Buying for capital gains and somewhere to live
James McGregor, director at MESA Financial Consultants, suggested that people in the UK buy property both as somewhere to live and as an investment.
“Although this is not the correct way to see your home, it is certainly ingrained in our culture,” he continued.
McGregor went on that with a housing shortage and growing population, property as an asset should increase in value over a prolonged period.
He added: “I believe this wealth will just be spread across the country over the next 10 years instead of only being in London. This essentially makes the theory obsolete.”
