Indexes and Links

Indexes

For our purposes, an Index is just a scale by which we report the value of a financial asset, or a pool of financial assets, through time.  We call these assets Reference Assets.  Many financial indexes already exist, but the Total Return of any financial asset can be computed and recorded by way of an index.

With an Index Mortgage, the mortgage lender decides the Reference Assets in respect of which it will publish Indexes and the mortgage borrower may choose to Link the mortgage debt to any or all of those Indexes.  The borrower can then add, remove or switch between Links whenever it chooses.

Links

Linking creates a mathematical association between Index performance and the mortgage interest rate.  Specifically, changes in Index Values inversely reflect in that rate.  We call the result the Indexed Rate.  By Linking, the borrower signifies its requirement that mortgage interest be computed by reference to the Indexed Rate.  Nothing else changes.  In particular, a Link is not a new or further liability incurred by the borrower.

Nor is a Link an asset.  For example, Linking gives the borrower no ownership interest in the Reference Assets.  Rather, a Link is a personal right, indivisible from the contract that created it.  That right is enforceable, and may be valuable, but it is not “property”.  A borrower could not sell a Link to a third party.

Removing Links

Links can be removed by the borrower at any time.  If certain credit-related triggers occur then the lender may also remove a Link.  If all the Links are removed then interest charges under the loan will cease to be computed by reference to the Indexed Rate and will instead be computed by reference to whatever rate (fixed or variable) would have applied had the mortgage never been Linked.  Finally, there is no early termination or break cost associated with removing a Link.

Borrower Tax Effects

It has been seen that a Link is an abstraction.  By Linking, the borrower requires the engagement of a particular algorithm, pursuant to which the applicable interest rate will be computed.  This predicates certain tax outcomes.  For example, a Link isn’t an asset capable of being disposed of to yield a capital gain.  And since Linking does not create any new or additional debt, no interest charge, and so no deduction for interest, arises through the initiation of a Link.

“One advantage of the Index Mortgage is that it does not require any “relearning” and is relatively easily explained using well understood terms …”

Citigate Dewe Rogerson, LaunchSure Report