“By refinancing through the “low start” I increased the loan. This became my contribution to acquire an additional portfolio - win, win”
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2. What types of properties are acceptable?
3. What is the lender’s interest rate margin?
4. How is the income cover and loan to value calculated?
5. Can I be certain of the rates quoted?
6. What is the minimum loan amount?
7. Can I increase the loan over time - substition?
8. What is the Treasury function?
9. Can I use the “low start” Market Maker for other currencies?
10. Is the lender likely to break the contract after 6 years?
11. What happens if the lender breaks the contract after 6 years?
12. What happens if the borrower wishes to break the 20 year contract early?
1. Why is the cost of funds so cheap at a commencing interest rate of 4.95% including lender’s margin?
The cost of funds is based upon the 20 year inverted yield curve of the swaps (fixed) interest rate market It will be seen that 20 year swap rates are considerably cheaper than, for example, 1 year rates.
see www.swap-rates.com a free access portal by CLP To this, we have structured a specialist Treasury function which incorporates a low start interest rate rising after 6 years. We have been able to reduce the costs of funds still further by providing the lender with a break option after 6 years.
2. What types of properties are acceptable?
The securities must have longevity – remember, as a 20 year fixed interest rate contract, the property must provide a secure income for the period as well as the property having a quality 20 year life.
The types of properties which are acceptable are as follows:
• Quality residential investment portfolios (including student accommodation)
• Modern student accommodation purpose-built blocks
• Quality well spread commercial portfolios
• Single assets let to quality tenants with long term (20 years plus) leases
• Housing Association and Primary Health Care Trust Portfolios
• Hotels and Leisure with long term tenant commitments
3. What is the lender’s interest rate margin?
The target lender’s margin is 0.85% over cost of funds (included in the headline rate of 4.95%). However, depending on size of loan, quality of income stream and location, this could be marginally higher – up to 100bps over cost of funds.
4. How is the income cover and loan to value calculated?
The loan amount is based upon an income cover formula which takes into account the uplift in interest rates after 6 years without relying on substantial increases in rental income (unless these are built into the tenant contract).
In addition, there is a maximum loan to value criteria usually up to 80%. There are circumstances where this loan to value is lower as well as special situations where one can do better. It all depends on the quality of the income stream and the locations of the property.
5. Can I be certain of the rates quoted?
Fixed rates can vary on a day-to-day basis and therefore the actual rate can only be fixed at the date of drawdown. However, notwithstanding catastrophes, it is believed that we are at the top of the long term interest rate cycle as evidenced below.
In order to keep the interest rate low, the Market Maker was initially marketed as a 30 year loan. As long term rates have dropped CLP can now offer similiar interest rates for a 20 year term.
6. What is the minimum loan amount?
Whilst the “low start” Market Maker has an official minimum loan of £5 million, there are circumstances where one can go lower but this is normally limited to investors who have substantial portfolios and are testing the market maker in the first instance. There is no official maximum loan.
7. Can I increase the loan over time - substition?
One can add securities to the initial advance over time but these should be in minimum tranches of £1 million. Also, as values and income increase over time lenders will consider further advances on the existing security. Substitution of security is available.
8. What is the Treasury function?
The Treasury division of the lending banks supporting the CLP “low start” Market Maker have dedicated teams who specialise in these types of contracts. Before drawdown they can often offer variables to the contract for the borrower to consider – at all times the market maker is kept as simple as possible. However, there is the ability to tailor-make contracts to meet borrowers’ aspirations.
One example of this is where the treasury were able to offer an arbitrage on the difference between Bank base rate and LIBOR lowering the borrowing costs still further to 4.59% including margin. This took advantage of the gap between base rate and LIBOR which of course can shorten and widen on a regular basis. This function was offered to and taken up by borrowers where there was more than sufficient income cover to minimise the risk.
9. Can I use the “low start” Market Maker for other currencies?
Unfortunately the UK is the only market with the inverted yield curve on long term fixed rates, therefore currently the treasury function does not work in other currencies.
11. Is the lender likely to break the contract after 6 years?
This depends on the fixed rate market after 6 years. If the fixed 14 year rate (the balance of the 20 year term) is higher then the lender is likely to break the contract so that it can be sold back to the market for profit.
If 14 year fixed rates are lower then the lender will leave the contract in place. n.b. However, the reverse could apply to the property market where, in a low interest rate environment, values tend to increase to a greater extent than in a high interest rate environment.
12. What happens if the lender breaks the contract after 6 years?
In these circumstances the lender will give the borrower the option of continuing with the loan either on a variable basis or by re-fixing the interest rate.
The borrower simply renegotiates the loan structure with the lender (but not necessarily the interest rate margin). This assumes that the borrower has met the terms of his mortgage obligations.
The borrower may contact the lender well in advance to be informed of the likely position (being aware of interest rate trends). This also gives the borrower the opportunity of considering competitive alternative funding knowing that if the lender breaks there are no redemption penalities if he wishes to refinance elsewhere.
13. What happens if the borrower wishes to break the 20 year contract early?
The “low start” Market Maker incorporates a profit and loss unlocking contract into the terms and conditions.
If, at the point when a borrower wishes to break the contract, interest rates are higher there could be a profit for the borrower, but only calculated up to the time of the lender’s only break after 6 years, after which the profit could go to the lender (depending on type of contract).
If interest rates are lower at the point when the borrower wishes to repay then the borrower could suffer penalties calculated on the balance of the 20 year term still outstanding. As one is entering the unknown CLP can only give an example by analysing the average fixed 20 year interest rate over the last 6 years based upon the cost of funds excluding lenders margin (see lender’s margin referred to separately). The average fixed rate assuming a borrower breaks after 10 years of a 20 year contract was 4.95%. For each 50 bps drop in the market at the 10 year point of redemption the unlocking cost would be circa £24,750 per million borrowed.
Two points to reiterate here:
1. The borrower should not consider entering into the loan only for the considerable short term cash flow benefit. The loan is not for short term gains, but for long term hold of quality investment properties.
2. In the event that a borrower does want to redeem early and the cost of unlocking is substantial, this will be because interest rates generally are low which could mean that these costs are offset by increases in property value.
This document is only a guide based upon information currently available and must not be relied upon. The actual structure will be contained within the lenders’ mortgage documentation. It is recommended that the borrower’s legal advisors should examine the documentation carefully and report to their clients. CLP gives no warranties as to the accuracy of any information supplied by it, now or subsequently, and can accept no liability for the actions of interested parties based on reliance of information provided by it. The rate is a function of the money market and can fluctuate daily.
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