Bank mortgage stream

Purpose

The Bank Mortgage (BM) stream is necessary if (as seems likely) the participants of the scheme do not have sufficient capital to fully fund the land purchases and building works themselves. If they do, the group can skip straight to the Transitional Equity (TE) stream, but it’s always possible to utilise the BM stream at any point in the collective’s growth even if it is not needed for the first house.

Taking out a mortgage loan is a very common way to buy land (or fund improvements to existing land). In this case it is the collective legal entity that takes out the loan but repayments work in a similar way. They are high, they include a large interest component, and they must be paid or the collective risks foreclosure (forced sale of the land).

Due to the high interest burden of a mortgage loan, having a large part of the collective’s assets mortgaged massively diminishes the ability of the collective to offer affordable housing, and flexibility for changing financial circumstances. It is the goal of the T2S model to move as quickly as possible from the BM stream to the TE stream.

It is critical to the application of this model that mortgage loans undertaken have the ability to be paid out early, and to either have a loan offset or redraw facility.

Regular financial contribution

The regular monthly contribution under the BM stream must cover the required mortgage repayments, plus the non-mortgage operating costs. A collective might choose any method for apportioning this amount between residents. It could be based on room size, income level, or even a formula combining several key attributes. Costs and mortgage can go up, so it’s better if an individual’s expected regular financial contribution is expressed as a percentage of those costs, not as an absolute number.

Since financial contribution can be dragged up by the required costs, it’s quite possible that it could reach a level that causes housing affordability stress. Our main options for avoiding this are:

1. Increasing the ratio of occupants to land/building cost. The land/building costs should be kept as modest as possible during the early stage of a new collective, but will quickly become fixed (it’s very difficult to back out of an expensive property purchase and buy a cheaper one). If costs are becoming stressful, increasing occupancy on the site is the most likely way to reduce them, albeit at the cost of introducing other kinds of living stress instead of financial stress.
2. Taking in regular financial contributions from non-residents. If non-residents choose to make regular financial contributions then they can be put towards the mortgage and non-mortgage operating costs, but doing so will only earn transitional equity at the rate of regular financial contributions (explained in the TE stream). Such payments from non-residents represent a powerful act of solidarity, and can be very useful in the first year or two of a new property purchase.
3. Reducing the debt burden. The main goal of the BM stream is to pay off the mortgage as quickly as possible by encouraging the move to transitional equity through additional financial contributions. The more additional financial contributions received, the faster the collective is able to reduce the principal of its mortgage loan(s). Reducing principal has an immediate impact on the loan interest, causing future required payments to be less.
4. Re-financing. As something of a last resort, a loan that has been partially paid off could be refinanced to go for a longer duration (back to the original 30 years) thus reducing payments. This does not drive the model in the right direction and should only be used if there are no better options.

Affordability metric

The collective should choose an affordability metric for the BM stream that creates strong financial pressure to get the mortgages paid off, much as individuals and families do when they take out a mortgage. A recommended default for covering operation costs is 40% of the gross income of all residents. (As detailed earlier, this will be unaffordable for some potential participants at an individual level and the distribution of contributions can be approportioned as appropriate. The goal in this stream is to pay off the mortgage as soon as possible so that we shift towards those streams where we are able to reduce collective costs to levels that are genuinely affordable).

Changing financial circumstances

The regular contributions required under the BM stream are not terribly flexible, as the total payments of the group must cover the required operating costs. If someone is unable to afford their portion of the payments, they have the following options.

1. The group should have a buffer to grant hardship relief, and a process for accessing that buffer. This is likely only helpful for very short periods.
2. The group could decide to restructure their regular financial contributions to reduce the contribution of someone experiencing stress by increasing it for others.
3. The person experiencing financial stress can use any Transitional Equity they have amassed to pay their contribution, providing that doing so fits within the group’s immediately available liquidity (see the Transitional Equity stream below for more details).

Shelter provision

The housing collective exists to provide secure shelter (housing). Under the T2S model, that housing comes with a lot of autonomy of use, similar to ownership (although collectively governed).

Under the BM stream, shelter is contingent on being able to continue to pay monthly contributions, to offset those contributions by spending transitional equity as allowed above, or to receive payment relief for emergency hardship. The BM stream makes little concession to true affordability. The total amount of monthly contributions received by the collective must cover all loans and costs, and so could end up being above market in the case of a housing bubble collapse. This could lead to it being hard to provide security of shelter long-term (at least without a lot of equity), and so a transition to the TE stream as quickly as possible is desirable.

Risks

While the collective has mortgages on its properties, it exposes itself and members to risk. These risks fall into two groups.

Collective risk

If the group fails to make its mortgage payments, it risks foreclosure (the forced sale of its mortgaged properties).

As with all home mortgages, it’s possible that the value of the mortgages could become greater than that of the mortgaged properties. This could happen because house prices go down rather than the upward trend we are all used to in Australia. Australia has a very inflated property bubble, and it’s possible it could burst causing massive deflation of property values. It’s also possible that property value goes down due to other reasons, such as being damaged or becoming uninhabitable due to earthquakes, fire or weather events. It’s possible that insurance may not always be available to mitigate all such risks in a future of worsening climate crisis.

If the collective fails to make its mortgage payments, it is not only the properties which are mortgaged which are at risk. Although other properties might be owned outright, they are still assets owned by the collective which could be pursued by a creditor.

Individual risk

It seems very unlikely that a bank will provide a mortgage loan to a collective without other forms of guarantee, especially early on. Thus, it is expected that individuals will be needed to act as guarantors on any mortgage loans, exposing them to financial liability if the collective should fail for any of the reasons described above. If there are multiple guarantors, they are generally jointly and severally liable, meaning that each person is liable for the entire amount if the others are unable to pay.

The risk undertaken in acting as a mortgage guarantor is not insignificant. At this stage, however, this model does not include any reward for individuals taking that risk.

A collective may attempt to mitigate this risk in pre-agreed ways. For example, some collectives may mitigate the personal risk taken by current guarantors by requiring their explicit consent in major decisions that financially extend the group (although this approach could introduce collective risks to the broader governance dynamics).