A Simple Trick to Eliminate Risk in Home Loans: Banks Need to Start Doing This Now
Imagine this: a borrower wants a R1 million mortgage to buy a house. They go to the bank for a loan. The bank agrees, requiring just a 20% down payment upfront, with the borrower putting down R200k of their own money, and the bank funding the remaining R800k.
Risks abound for the lender in this scenario. If the borrower defaults and stops paying, the bank must evict them, foreclose on the home, and sell it at a loss. Distressed auctions usually get 30-40% below market value leaving the bank with loss.
Let's lay it out:
Purchase price: R1,000,000
Borrower equity: R200,000
Loan to Value ratio: 80%
Bank loan: R800,000
But if a distress sale occurs 4 years into the deal and the bank must sell at a 40% discount, they're left with R757,811.
So the bank's position is:
The home increases at 6% per year, and after 4 years = R1,263,019
Distressed auction value (40% below market value) = R757,811
Bank exposure is auction value less initial loan amount (R800k – R757,811) = R42,188 loss
But what if, instead of a regular loan, the bank bought R33,300 of Bitcoin with part of the borrower's R200k down payment? This is a stunning insight.
Bitcoin investment: 3.33% of home value (R33,300)
Historic worst-case return on Bitcoin over four years: +27%
Bitcoin value after four years: R42,291
This works out brilliantly in the bank's favour. Even if the borrower defaults and the home must be sold at a loss, the bank comes out way ahead.
It’s actually better than this, for the bank, as the homeowner has paid his premiums for 4 years and the bank’s loan amount is slightly lower.
The 27% return on the Bitcoin is the worst it has performed over a 4-year period. The second worst return is 57%, and now the bank is making money.
This buys time for both parties to negotiate a new arrange to avoid the costs involved in evictions and auctions.
This is a massive innovation. Banks should be doing this right now. It's cheap insurance against defaults. It protects the homeowner too. Win – Win
