The Index Mortgage

We coupled the forces behind the greatest migration of retail investment in history ...

Along with the rest of the developed world, retail investment in Australia is undergoing a sea change.

ETFs to come to the fore in 2023: VanEck MoneyManagement, December 2022

Of the more than 2,000 people who took part in the 2022 VanEck Australian Investor Survey, one in two said they would be either increasing their allocation to ETFs or making their first ETF investment in the next six months.

How ETFs became the tool of choice for young investors

Australian Financial Review, 1 April 2021

In the past 12 months, the number of ETF investors in Australia has almost doubled to 1 million.

ETF Boom in Australia

RMIT University, 16 April 2021

ETFs have also grown dramatically as a result of active stock market participation. Recently, the value of ETFs in Australia has exceeded $100 billion.

Why everyone is investing in ETFs

Australian Financial Review, 24 October 2023

Exchange-traded funds are an investment megatrend ... the biggest investment trend of the decade.

Vanguard data shows Australians have $153 billion invested in ETFs, up from $8.9 billion in 2013.

Investors eye opportunities in 2024 Van Eck, December 2023

ETFs are by far the most popular investment vehicle ... We see the ETF market in Australia reaching $180 billion by the end of 2024.

... to Australia’s biggest retail credit market ...

Australia: value of mortgages by type Statista, 2022

As of December 2022 owner-occupiers' debt outstanding exceeded AUD $1.4 trillion dollars

Global ETF FUM from 2018

... and re-defined retail financial services.

The Index Mortgage: LaunchSure Report

Citigate Dewe Rogerson

In the new market it will become the norm to keep your investments ‘in’ your mortgage, it would be stupid not to.

After tax beta is the new alpha.

The Index Mortgage. A better way to accumulate and manage personal wealth.

With an Index Mortgage ...

 the borrower has the option to use equity in his or her home as a means to obtain a passive exposure to growth assets ...

 with no cash investment and without incurring additional debt ...

such that the result is equivalent to receiving asset performance (less an “internal” funding cost) free of tax.

Thinking of investing in an ETF?

ETF’s do deliver low cost exposure to growth assets. But now there is a better way.

With an Index Mortgage you can get exposure to growth assets and experience the benefit as a reduction in your home loan interest charges. And since home loan interest is not tax deductible, that’s an after tax saving.

Better yet, indexing your loan requires no cash investment. No investment. No paperwork. No management fees. No platform charges. No accounting to do. No tax return to prepare.

To learn more, see our website at www.index.mortgage.

Reference Materials

Explainer Videos

We recommend the following whiteboard animation videos. Each is less than 3 minutes long. Introducing the Index Mortgage. Click here.

• Linking explained. Click here to play.

• Types of indexes. Click here to play.

• Borrower qualification. Click here to play.

• Calculators

We have developed a calculator to assist you in assessing the Index Mortgage against alternative wealth creation strategies. See page 24.

ATO Ruling

The Index Mortgage is the subject of a binding ruling issued by the Australian Taxation Office. Click here to download Australian Taxation Product Ruling PR 2023/10.

Tax Ruling Disclaimer Required by Australian Law PR 2023/10 is a ruling on the application of taxation law and is only binding on the ATO if the Scheme is implemented in the specific manner outlined in the product ruling. The Commissioner of Taxation (Commissioner) does not sanction, endorse or guarantee this product. Further, the Commissioner gives no assurance that the product is commercially viable, that charges are reasonable, appropriate or represent industry norms, or that projected returns will be achieved or are reasonably based. Potential participants must form their own view about the commercial and financial viability of the product. The Commissioner recommends you consult an independent financial (or other) adviser for such information.

What could go wrong?

Tax planning. Discretionary trusts. Debt recycling. Income splitting. There’s a lot of moving parts. Maybe it works. But why take that risk?

With an Index Mortgage you can get exposure to growth assets and experience the benefit as a reduction in your home loan interest. And since home loan interest charges aren’t tax deductible, that’s an after tax saving. But don’t take our word for it. The Index Mortgage comes with the protection of an ATO Tax Ruling.

Better yet, indexing your loan requires no cash investment. No investment. No paperwork. No management fees. No platform charges. No accounting to do. No tax return to prepare. To learn more, talk to your financial adviser or go to www.index.mortgage.

Executive Overview

Defined Terms

Terms in this document that first present Like This are defined at page 32.

The Index Mortgage

An Index Mortgage loan may be drawn to buy or renovate real property that does not produce income - typically a principal place of residence. Personal expenses such as cars. eduction or holidays can also be funded through an Index Mortgage. Interest charges in respect of such debts are not tax deductible.

The aim of the Index Mortgage is to reduce these non-deductible interest charges by translating the “out performance” of a pool of Reference Assets into a discount to the mortgage interest rate.

Three points merit immediate comment. First, we call this association of the loan interest rate to asset performance a Link. Secondly, each pool of Reference Assets stands for a distinct index, mandate or strategy. Finally, “out performance” compares the relative performance of two indexes.

Indexes

The first of these indexes is the Reference Index. It reports the market value of the Reference Assets through time. Changes in that value reflect the Total Return of those assets. The second index is a Benchmark Index. It reports interest compounded at a Benchmark Rate, being the Reserve Bank’s overnight cash rate plus a margin.

From the borrower’s perspective, the Benchmark Rate is a hurdle rate that must be outperformed. In this sense, Links are “internally funded” and the Benchmark Rate is a proxy cost of funds.

Standard Loan Rate Applies When Loan Not Linked

When the loan is not Linked, interest is charged at the Standard Loan Rate

Linking and the Indexed Loan Rate

By Linking, the borrower signifies that he or she want exposure to the performance of the Reference Assets, manifested through the Indexed Loan Rate. So, a Link is simply an election to have a different interest rate apply in respect of the loan over the period of the Link. This makes a Link a personal right, indivisible from the loan contract that created it.

That right is enforceable against Mortgage Lender, and so may be valuable, but it is not "property". For example, one could not sell a Link to a third party. In particular, Linking does not give the borrower any interest in the Reference Assets. A Link is not an investment. Nor is a Link a liability. It bears repetition that Linking simply changes the effective rate of interest payable in respect of an existing liability.

Not being an asset or a liability, a Link is not a thing that requires “funding” by the borrower. Nor does a Link require any “contribution” of assets. A Link is not an offset mortgage and the Reference Assets are not like the

cash deposit that an offset borrower must “contribute”.

The Indexed Loan Rate

The Indexed Loan Rate is a backward looking rate that cannot be finally struck until the Link is ended. Until then interest is provisionally charged at the Standard Loan Rate. We reconcile the interest provisionally charged at the Standard Loan Rate with the interest actually due at the Indexed Loan Rate through an Interest Adjustment.

Interest Adjustments

At the end of each Link, Index Manager computes an Interest Adjustment, being the accumulated difference between interest computed at the Indexed Loan Rate and the interest charged at the Standard Loan Rate, over the period of that Link.

An Interest Adjustment that is signed positive is credited to the loan balance. This represents a refund of interest overpaid relative to the borrower’s contractual entitlement. An Interest Adjustment signed negative is debited against the loan balance. This means the borrower has underpaid interest relative to his or her contractual obligation.

Summary and Net Result

Linking gives exposure to the economic • performance of the Reference Assets, net of an

We can’t help you with the first.

Pay down the mortgage or get exposure to growth assets?

But we can show you how to get exposure to growth assets and experience the benefit as a reduction in your home loan interest. And since home loan interest charges are not tax deductible, that’s an after tax saving.

Better yet, indexing your loan requires no cash investment. No investment. No paperwork. No management fees. No platform charges. No accounting to do. No tax return to prepare.

Tough choice. You know growth assets will probably outperform mortgage rates over the medium to long term. But reducing your home loan makes sense too. Especially seeing as home loan interest is not tax deductible.

To learn more, talk to your financial planner or mortgage broker. Or go to our website at www.index.mortgage.

Now you don’t have to choose. With an Index Mortgage you can pay down your mortgage and get exposure to growth assets, through the mortgage interest rate. The better the assets perform, the lower the effective rate of interest. That means you experience the benefit as a reduction in non-deductible interest charges. And since home loan interest is not tax deductible, that’s an after tax saving.

To learn more, talk to your wealth adviser or see our website at www.index.mortgage.

“internal” cost of funds.

Because Links are internally funded, no cash or

• asset contribution is required from the borrower. A Link is not an investment that one “buys”.

Nor is a Link a new or additional liability. In

• particular, the borrower does not draw upon the mortgage to initiate a Link.

Rather, Linking manifests as a different rate of

• interest payable under the mortgage loan. This means the benefit of Linking presents as a relative saving of home loan interest charges.

Since home loan interest isn’t tax deductible,

• the benefit of Linking presents as a reduction to an after tax expense.1

FAQ

See page 12 for answers to frequently asked questions.

Summary of Economics

If your client wants exposure to growth assets and pays some tax at the highest marginal rate, then an Index mortgage is very probably the optimal solution. For detailed analysis, see pages 21 to 31.

Anything they can do we can do better.

ETF’s are a low cost way to get exposure to growth assets. But there is a better way.

With an Index Mortgage you can get exposure to growth assets and experience the benefit as a reduction in your home loan interest charges. And since home loan interest is not tax deductible, that’s an after tax saving.

Better yet, indexing your loan requires no cash investment. No investment. No paperwork. No management fees. No platform charges. No accounting to do. No tax return to prepare.

To learn more, talk to your financial adviser or go to www.index.mortgage.

1 Of course, the converse is also true. An increase in the mortgage interest rate on account of an underperforming Link will not make any part of the interest charge tax deductible.

Indexed Loan Components

$1,150,000

Result from actual historical data for a $500,000 Link to the ASX 200 Gross Total Return Index initiated on 4 September 2010.

$1,050,000

$950,000

$850,000

At 4 September 2019 the Reference Index was 1,049,887.93 and the Benchmark Index was 770,002.07, Had the Link ended that day, the resulting Indexed Loan Rate would have meant the borrower was entitled to an interest refund of $279,885.86.

$750,000

$650,000

$550,000

At 4 September 2012 the Reference Index was 520,047.93 and the Benchmark Index was 571,521.05. Had the Link ended that day, the resulting Indexed Loan Rate would have meant the borrower was obliged to pay an additional $51,473.12 in interest.

$450,000

$350,000

$250,000

Licensing and Substantiation

Index Mortgage is a Credit Product

In a detailed legal opinion available here, King Wood Mallesons affirm that an Index Mortgage:

(a) is not a “financial product” under the Corporations Law; and

(b) is a provision of “credit” for the purposes of the NCCPA.

Consequences

For present purposes the consequences are twofold. First, an agent does not require an AFSL to promote the Index Mortgage. Secondly, an agent will require an ACL if he or she is to provide “credit services” in respect of an Index Mortgage.

The term “credit services” is defined in the NCCPA as giving “credit assistance” or “acting as an intermediary”. Relevantly, someone:

(a) gives “credit assistance” if that person suggests or recommends a particular credit product or a particular credit provider; and

(b) “acts as an intermediary” if that person acts to obtain a provision of credit to a consumer.

Assumption

Obviously, no issue arises if you are licensed to give financial product advice and hold a licence to provide “credit services”. However, if you are only licensed to give financial product advice, the following is important to note.

A. Client Information Package

The document titled “Introducing the Index Mortgage: Information for Clients” (the Client Deck) is broadly equivalent to this document.

You can safely provide the Client Deck to third parties as that document is purely informational and does not contain any recommendation, suggestion or introduction. In particular, providing the Client Deck will not be the provision a credit service.

B. Explainer Videos

We recommend that you invite your client to watch the following whiteboard animation videos. Each is less than 3 minutes long. Introducing the Index Mortgage. Click here to play.

• Linking explained. Click here to play.

• Recommending that your client watch these explanatory videos is not the provision of a credit service.

C. General Advice on Linking

You can give advice on the risks and benefits of taking exposure to assets like the Reference Assets. You can also give your opinion as to whether a Reference Index is likely to outperform the Benchmark Index over different time horizons.

What you can’t do is recommend that the client take out an Index

Mortgage in particular.

D. Comparing Credit Alternatives

There simply is no single credit product that is meaningfully comparable to an Index Mortgage. However, if the client wants to engage an agent in an effort to compare the Index Mortgage with alternative credit products then you should refer the client to a licensed mortgage broker.

That said, we have built a calculator that compares an Index Mortgage to a scenario (being a combination of transactions) with a risk and reward profile before tax that is roughly equivalent to an Index Mortgage. See the description at page 24 et seq. You are welcome to use that calculator.

Since that alternative is not a credit product, you can assist your client by making that comparison without providing a credit service.

E. Client to Apply Personally

If the client expresses a desire to take out an Index Mortgage, and to act for himself or herself in the doing of that, you can either:

(a) refer the client to Mortgage Lender or refer Mortgage Lender to the client pursuant to our Referrer Program; or

(b) direct the client to the Index Mortgage website to enable him or her to personally make an application for credit.

F. Client to Apply Through an Agent

If the client wishes to take out an Index Mortgage and to engage an agent to assist in that, then you must refer the client to a licensed mortgage broker.

Substantiation

Australia’s responsible lending laws require that a credit contract be “not unsuitable” for the borrower. To assure compliance with that law we require one of the following before we approve an application:-

A current certificate issued by a qualified accountant affirming that

the client meets the so-called “sophisticated investor” criteria under s.708(8)(c)(i) and (ii) Corporations Law.1

•

A certificate from a qualified financial adviser stating that he or she:

(a) has provided personal or general advice (as defined in ss.766B(3) and (4) Corporations Law) to the client; and

(b) believes the client understands the risk and benefits of Linking generally.2

A certificate from a qualified financial adviser stating that the client

• has previously invested in financial assets similar in type to the Reference Assets.

• risk and benefits of Linking, as agreed on an ad hoc basis.

Evidence that the client can reasonably be taken to understand the

1 As to who is a “qualified accountant” see ASIC Corporations (Qualified Accountant) Instrument 2016/786.

2 A qualified financial adviser is an adviser currently named in the register of financial advisers maintained by ASIC and whose AFS licence indicates that the adviser can give advice upon securities.

General Concepts

What is an Index Mortgage?

What is the Indexed Loan Rate?

What is a Reference Index?

What is the Benchmark Index?

What is a Benchmark Rate?

An Index Mortgage is a home loan with a unique feature, namely the borrower has the option to embed an exposure to growth assets (like equities) within the mortgage loan. This is called Linking to a Reference Index. Linking manifests as a reduction to, or increase in, the rate of interest under the borrower’s home loan. The resulting interest rate is called the Indexed Loan Rate.

The Indexed Loan Rate is a backward looking interest rate that takes into account the opening and closing values of the Reference Index and the Benchmark Index.

A Reference Index is a time series of values that reflect the Total Return of an underlying pool of Reference Assets.

The Benchmark Index reflects the effect of compounding at Benchmark Rate(s).

Technically, a Benchmark Rate is parameter within the algorithm whereby we compute the Indexed Loan Rate. More meaningfully, from the borrower’s perspective, a Benchmark Rate can be thought of as a proxy cost of funds. By this description, Links are “internally funded”, at Benchmark Rates.

Each Benchmark Rate is a constant margin to a market benchmark rate. The actual margin depends upon the underlying Reference Assets. For our ASX 200 Link, the margin will be 225 bps. For a more volatile asset (such as a digital currency) the margin will be greater.

Capital efficiencies resulting from the way Mortgage Lender hedges its index exposure means it can offer Benchmark Rates that are very probably lower than the rate at which the borrower could fund himself or

Does a Link require an investment of money by the borrower?

Does a Link require the borrower to contribute assets?

If a Link is not an investment or an asset transaction, then what is it?

Is a Link a new borrowing?

The Mechanics of Linking

Does the borrower have to Link?

How does a borrower put a Link on? herself.

No. A Link is not an investment. Consistent with Links being internally funded, we do not look to the borrower as a source of capital to enable a Link.

No. A Link is not an asset transaction. This too comes back to Links being internally funded. And this is also where the analogy to an offset mortgage breaks down. With an offset mortgage the borrower must contribute an asset (namely cash at bank, held with the mortgage lender). There is no analogue to this with an Index Mortgage. In particular, the borrower does not deposit or pledge Reference Assets in order to effect a Link.

By Linking, the borrower is electing for interest on the mortgage loan to be charged at the Indexed Loan Rate over the period of the Link. This makes a Link a personal right, indivisible from the loan contract that created it. That right is enforceable, and may be valuable, but it is not “property”. For example, one could not sell a Link to a third party. This anticipates certain tax outcomes. In particular, a Link isn’t an asset capable of being disposed of to yield a capital gain.

No. A borrower that Links $100,000 of an existing $1 million home loan owes $1 million immediately before and immediately after the Link is initiated. It bears repetition, by Linking, the borrower is simply electing for interest on an existing mortgage loan to be charged at the Indexed Loan Rate

No. Linking is entirely optional.

So long as the credit criteria are met, the borrower initiates a Link simply by nominating the level of exposure required and the Reference Index that the borrower wants to Link to. If the requested exposure falls within the parameters of Mortgage Lender’s credit algorithm, the Link will be automatically

Are borrowers “locked in” to Links?

Must the borrower Link its whole loan?

approved. Otherwise the request will be referred to a human credit analyst.

No. On any business day the borrower might instruct for a Link to be added or removed.. There is no break cost for removing Link exposure.

No. The effect of Linking (the Indexed Loan Rate) is applied against the whole loan balance. So, the whole loan is indexed, but a borrower cannot Link its entire loan.

Suppose, a borrower has a loan of $1 million. He or she might elect to Link, say, 10% of that sum. The effect of that $100,000 Link will be “spread across” the entire loan balance via the Indexed Loan Rate, but the opening exposure to the Reference Index will only be $100,000. We expect borrowers will Link between 10% and 50% of their loan balance, but we will write Links for as little as $50,000.

What type of assets can a mortgage be Linked to?

Can the borrower Link to more than one Reference Index?

Does Linking change the loan repayments?

A borrower may Link to any Reference Index within the constellation of Reference Indexes nominated by us . In theory, any financial asset traded in a liquid market can be the subject of a Reference Index.

Yes, noting that each Link is initiated and managed discretely.

How can the borrower transact in Links or check Link performance?

No. Rather than continually adjust the scheduled repayments to reflect changes in the Indexed Loan Rate, the daily difference between interest at the Indexed Loan Rate and interest at the Standard Loan Rate is “rolled up” into a future value we call the Interest Adjustment. This Interest Adjustment is credited or debited to the loan balance when the Link is ended. This means that during the course of a Link, the scheduled repayments only change to the extent that they would otherwise have done (i.e. because the Standard Loan Rate changes).

Links can be added or removed through a web portal. Links are marked to market daily, with the result published every evening through that same portal. This means the borrower can always check the emerging effect of Linking for himself or herself.

What happens if the result of Linking is unfavourable to the borrower?

In such cases the Interest Adjustment is added to the loan balance. Two possibilities then arise. First, the borrower has the option of paying the loan down to the scheduled balance, by paying the Interest Adjustment into the loan account. Secondly, the borrower may amortise the increased loan balance at the Standard Loan Rate over the remainder of the term. This will require recalculation of the remaining the loan repayments. Our credit algorithms take this possibility into account.

The Risks and Benefits of Linking

Is the benefit or cost of Linking brought to account for tax?

Why use a Link to gain exposure to growth assets?

No. Linking means that interest charges over the period of the Link will be lesser or greater than the interest that would otherwise have been charged. Because interest charges under a home loan are not tax deductible to begin with, any saving of, or increase in, such interest has no tax effect. It follows that the borrower effectively “receives” the benefit of Linking free of tax, in the form of reduced, nondeductible interest charges. Of course, the converse is also true. If Linking proves unfavourable then the resulting cost is not tax deductible.

Linking is a superior mechanism by which to hold an exposure to growth assets, for three reasons. First, a Link requires no cash investment. Secondly, the proxy funding cost associated to a Link (the Benchmark Rate) is very probably lower than any alternative accessible by the borrower. Thirdly, Linking is tax neutral. In fact, Linking does not require any interaction with the tax system.

Ignoring the advantages identified in the previous answer, does exposure to Reference Assets by Linking entail the same risks and benefits as a direct investment into those assets?

Yes. Linking neither increases nor attenuates the underlying economic exposure. For example, directly owning a share in BHP will obviously yield the Total Return of a share in BHP. But a borrower that Links to BHP will also experience that total return, albeit net of the proxy funding cost1 and through the Indexed Loan Rate. That said, because a Linking borrower does not have any interest in the Reference Assets, he or she cannot enjoy the non-economic benefits of ownership, such as the right to vote at a meeting of shareholders.

1 Of course, the Linking borrower does not have to fund the acquisition of anything, whereas the direct shareholder must finance its purchase of the share or lose the opportunity to apply the share purchase price to some other end.

Simple Worked Example

A borrower with a $1 million loan wants $100,000 of index exposure. The borrower logs into the web portal and selects the key Link variables, namely: Reference Index.

• Initial Link Sum = $100,000.

• For simplicity, we suppose a loan on these terms:Interest-only for two years at 6.35% per annum

• (the Standard Loan Rate), with interest charged annually in arrears.

We also assume the following: The Link is closed after 1 year.

• The Reference Index opens at 100,000.

• The Benchmark Index opens at 100,000.

• A 6.35% per annum Benchmark Rate, with

• interest charged annually in arrears.

To exemplify a favourable Interest Adjustment, we assume a Total Return for the Reference Assets of 10%. To demonstrate an unfavourable Interest Adjustment, we assume a Total Return of -2%.1

Money can be exchanged for goods and services.

That makes money pretty useful.

If you pay some tax at the highest marginal rate and you invest in growth assets, then you are leaving money on the table. To learn why, talk to your financial adviser about the Index Mortgage. Or go to our website at www.index.mortgage.

The Index Mortgage. No dollar left behind.

1 Given that the ASX 200 consistently generates an annualised dividend yield of 4% to 5%, a Total Return of -2% implies that the price index returned -6% to -7%.

Case 1: Favourable Interest Adjustment

On the first anniversary date:-

• $63,500 interest payment is made.

The loan balance remains at $1 million after a

The Reference Index closes at 110,000.

• The Benchmark Index closes at 106,350.

• The Indexed Loan Rate is 5.985% per annum.

• The Interest Adjustment is $3,650 ({6.35% -

• 5.985%} x $1 million) and so $3,650 is credited to the loan balance.

•

Post adjustment, the loan balance is $996,350.

Case 2: Unfavourable Interest Adjustment

On the first anniversary date:-

• $63,500 interest payment is made.

The loan balance remains at $1 million after a

The Reference Index closes at 98,000.

• The Benchmark Index closes at 106,350..

• The Indexed Loan Rate is 7.185% per annum.

• The Interest Adjustment is -$8,350 ({6.35% -

• 7.185%} x $1 million) and so $8,350 is debited to the loan balance.

• $1,008,350.

Post adjustment, the loan balance is

Nothing is certain except death and taxes.

We can’t help you with the first.

But we can show you how to get exposure to growth assets and experience the benefit as a reduction in your home loan interest. And since home loan interest charges are not tax deductible, that’s an after tax saving.

Better yet, indexing your loan requires no cash investment. No investment. No paperwork. No management fees. No platform charges. No accounting to do. No tax return to prepare.

To learn more, talk to your financial adviser. Or go to our website at www.index.mortgage.

More Complex Worked Example

Assume a mortgage loan with these parameters: Credit foncier with monthly in arrears payments.

• $1 million loan amount.

• Standard Loan Rate = 6.35% per annum (convertible monthly)

• Term = 300 months

• Solving for the credit foncier payment, we get $6,548.78 . This value is used in 4 below.

1 EXCEL: = PMT (NOMINAL(6.35%,12)/12, 300, -1000000, 0, 0)

After the twelfth payment, the balance of the loan is $982,652.89 . This value is used in 4 below.

2 EXCEL: = 1000000 + CUMPRINC (NOMINAL(6.35%,12)/12, 300, 1000000, 1, 12, 0)

Upon making the twelfth payment, the borrower Links the loan to obtain $100,000 of exposure to a Reference Index. The borrower logs into their web portal and selects: Reference Index.

• Initial Link Sum = $100,000

• Over the next 24 months the value of the Reference Index increases by 20% (=9.54% per annum), at which point the Link is removed. We assume a constant Benchmark Rate over this period of 6.35% per annum (convertible monthly). Hence: Open Value Reference Index = 100,000

• Close Value Reference Index = 120,000

• Open Value Benchmark Index = 100,000

• Close Value Benchmark Index = 113103.23

• 3 EXCEL: = FV (NOMINAL(6.35%,12)/12, 24, 0, -100000)

8

At t=0: mortgage loan is drawn.

8

At t=12: Link is initiated.

8

At all times the borrower’s asset is the residence the subject of the mortgage and the borrower’s liability is the mortgage loan. Borrower balance sheet

At t=36: Link is removed.

Solving for the Indexed Loan Rate over the 24 month period of the Link we derive 5.6819% per annum (convertible monthly) as compared to the Standard Mortgage Rate of 6% per annum (convertible monthly).

This gives a total interest saving of $6,896.77 relative to what would have been the case had the loan not been indexed.

4 EXCEL: = PRODUCT(24, 6548.78) – (982652.89 – FV( NOMINAL(6.35%,12)/12, 24, 6548.78,982652.89, 0)) – (PRODUCT(24, 6548.78) – (982652.89 – FV( NOMINAL(5.6819%,12)/12, 24, 6548.78, -982199.61, 0))

We can check that the Indexed Loan Rate is correct, because the total interest saving over the term of the Link must equal the difference between the closing balances of the Reference and Benchmark Indexes.

5 EXCEL: = ROUND(120,000 – 113103.23,0) = ROUND(PRODUCT(24, 6548.78) – (982652.89 –FV( NOMINAL(6.35%,12)/12, 24, 6548.78, -982652.89, 0)) – (PRODUCT(24, 6548.78) – (982652.89 – FV( NOMINAL(5.6819%,12)/12, 24, 6548.78, -982199.61, 0)),0)

Note that the scheduled loan repayments ($6,548.78) did not change on account of Linking. Linking does not change repayments

Introduction to Analysis

Calculator

We have developed a highly configurable Calculator that lets you explore the Index Mortgage and two other financial Strategies, benchmarked against a Baseline standard mortgage. That analysis entails some nuances that merit comment.

Standard Loan Rate and Indexed Loan Rate

To begin, we restate two concepts.

First, the Standard Loan Rate is the rate of interest payable under an Index Mortgage loan that is not Linked. Secondly, the Indexed Loan Rate presents as a discount or premium to the Standard Loan Rate, depending upon Link performance.

Standard Loan Rate Includes Link Option Premium

The Index Mortgage is not a “vanilla” loan and it cannot be priced as such.

Compared to vanilla mortgages, the Standard Loan Rate under the Index Mortgage typically prices at a 0.25% per annum premium. This Link Option Premium represents the cost of providing the loan indexation option within the Index Mortgage.

You don’t need to build a watch to tell the time.

People are curious. How can we deliver index exposure without cash investment? The full answer is complicated. But you don’t need to build the watch.

The short answer is that we can access financial instruments that aren’t available to the average person. Combining these in just the right way significantly reduces our per unit cost of index exposure. So, we buy exposure to hedge our position, enabling us to deliver the benefit as a reduction in the mortgage interest rate.

Like every lender, we look to recoup our costs, including our hedging costs. That’s why we charge a small ‘product premium’ inside of our standard loan rate. Truth is, if you never intend to index your loan, you should take up a different mortgage and save yourself that premium.

But if the idea of index exposure reducing your home loan interest appeals, then an Index Mortgage might be for you. And since home loan interest charges aren’t tax deductible, that’s an after tax saving. So, no investment required and no tax return to prepare.

To learn more, talk to your financial adviser or see our website at www.index.mortgage.

Amortisation of Baseline

Here we must recognise the Link Option Premium.

Obviously, that premium is not payable under the Baseline case. To reflect this ,we apply the loan repayments required to amortise the Index Mortgage at the Standard Loan Rate (i.e. including the Link Option Premium) to both the Index Mortgage loan and the Baseline loan.

This means the Baseline mortgage will amortise faster than it otherwise would do.

Methodology

We compare Strategies by applying each Strategy until one of the Strategies results in, or enables the repayment of, the home loan.

At that point1 the net wealth of the borrower under each Strategy is compared. Obviously, the Strategy that generates the greatest net wealth should be preferred.

Paying more than your fair share of tax?

1 That is, we compute the realised advantage of the “winning” Strategy. This understates that benefit compared to approaches that include future interest savings (to the extent that such future savings identify to a realised saving).

We can’t make that right. But we can very probably reduce your biggest after tax cost. With an Index Mortgage you can get exposure to growth assets and experience the benefit as a reduction in your home loan interest. And since interest on your home loan isn’t tax deductible, that’s an after tax saving.

Better yet, indexing your loan requires no cash investment. No investment. No paperwork. No accounting to do. No tax to pay. To learn more, talk with your financial adviser or see our website at www.index.mortgage.

Scenarios Described

Index Mortgage Versus Baseline

We begin the analysis with the simplest case, which is to compare the Index Mortgage with “doing nothing”, where “doing nothing” is the Baseline.

Strategy B: Baseline + Investment Loan + Investment

Of course “do nothing” is no answer to the client that wants exposure to growth assets. That client is going to do “something”. The question is: what is the best “something” to do.

Strategy B is the leaping off point for this analysis, because Strategy B seeks to replicate an Index Mortgage by combining:

(a) a standard home loan;

(b) a traditional investment loan; and

(c) a direct investment into the same assets as underlie the Reference Index.

Because the investment loan must be serviced, Strategy B requires more cash than does Baseline or Index Mortgage (neither of which recurrently consume cash beyond the payments required to amortise the home loan).

We assume that the additional cash required by Strategy B is met by the borrower, but from a source external to the transaction. Concomitantly, to the extent that Strategy B cashflows exceed the requirements of other

strategies, these Excess Cashflows must be applied to the benefit of those other Strategies (i.e. we must equalise the pre-tax cashflows across all strategies).

Strategy A: Baseline + Prepayments

With that understanding, Strategy A is simply the Baseline with Excess Cashflows applied as early redemptions of principal.

Strategy C: Index Mortgage

Strategy C creates a Link to the same assets (and in the same amount) as the Strategy B direct investment. As with Strategy A, Excess Cashflow is applied to reducing the mortgage loan. Obviously, this increases borrower’s equity in the property, thereby improving the lender’s security position.

Reinvestment Factor

In recognition of this, Strategy C allows the borrower to Link some or all the Excess Cashflows. The cell Inputs! “ReinvestmentFactor” sets the proportion of each Excess Cashflow prepayment that is assumed to be the subject of an additional Link.

Since we seek to reflect the borrower’s attitude to risk in both Strategy C and Strategy B, we also apply the ReinvestmentFactor to Strategy B.

Strategy B is subject to the tax system, and so generates cash equivalent

tax benefits.1 In Strategy B ReinvestmentFactor determines the extent to which such benefits are reinvested into additional financial assets. To the extent not so reinvested, cash equivalent tax benefits are applied to reduce the home and investment loans ratably.

Have

your cake and eat it too.

So, you have some free cash. Now what? Pay down the mortgage? Invest in growth assets?

With an Index Mortgage you can pay down your mortgage and get exposure to growth assets. Better yet, you experience the benefit of indexing your loan as a reduction in interest charges. And since home loan interest is not tax deductible, that’s an after tax saving.

Now that’s sweet.

1 For example, for a taxpayer with an effective rate of tax rate of 45%, a $100 tax deduction on account of a tax deductible expense has a cash equivalent value of $45.

To learn more, talk to your financial adviser or go to www.index.mortgage.

Working with the Calculator

Inputs

Cells in the Inputs! sheet that look like this: are input cells that establish the parameters of the scenario to be tested.

Most inputs are self-evident and the Input! ReinvestmentFactor has been explained above. Notably, you can select which market the Reference Assets pertain to including the ASX 200 and Nasdaq.

Results

Results are presented in different ways in the SummaryResults!, ResultsByYear! and HeatMap! sheets.

ResultsByYear!

ResultsByYear! reports the termination of each Strategy by anniversary date, culminating in the final result per the methodology detailed above.

Assuming an early termination at year x is different to assuming each Strategy was always going to be implemented for x years, because the Strategy B interest deductions are based on an assumed investment loan term equal to the home loan term (as opposed to a term of x years).

Consequently, for non-interest only scenarios, ResultsByYear! overstates the benefit of Strategy B relative to the result that would apply were we to

assume each strategy was only ever intended to be implemented over x years.

HeatMap!

HeatMap! reports a table of comparative results arrayed by CapitalGrowth (y-axis) and DividendYield (x-axis) for the current scenario.

Each cell in the array reports the relative advantage of the Index Mortgage for the user defined parameters and a pre-selected range of x and y values.

Because of the time necessary to compute the table, HeatMap! requires a full recalculation (Formulas: Calculate Now or F9 shortcut key).

Specific Scenarios Considered

The Zone of Interest

Each of the Tables in the following pages is overlaid by a blue box that we call the Zone of Interest. This box encapsulates a range of possible combinations and results broadly consistent with the Total Return of the subject Reference Index over the last 5 years (measured at 14 May 2024).

Tables 1A and 1B: Index Mortgage Versus Baseline

At pages 27 and 28 we demonstrate the relative advantage of the Index Mortgage compared to the Baseline mortgage. Table 1A assumes the Index Mortgage is Linked to the ASX 200. Table 1B assumes a Link to the Nasdaq.

Within the Table 1A Zone of Interest the after tax benefit ranges from 40% to 70% of the initial mortgage debt. Within the Table 1B Zone of Interest the after tax benefit ranges from 86% to 92% of the initial mortgage debt.

The significance of such results can hardly be overstated. Put another way, a $500,000 Link that repeats the Total Return of the Nasdaq over the past 5 years would result in an Index Mortgage paying out more than 20 years ahead of the Baseline mortgage.

Tables 2A and 2B: Index Mortgage Versus Leveraged Investment

Of course a borrower that took out an investment loan per Strategy B to obtain an exposure to the Nasdaq would also have benefited greatly compared to doing nothing.

To account for this, Tables 2A and 2B at pages 29 and 30 compare the Index Mortgage against Strategy B. The comparison is like for like, with both the Index mortgage (Strategy C) and the leveraged investment (Strategy B) having the same underlying exposure.

Undeniably, Strategy B is an efficient mechanism to create wealth. But Strategy B can only outperform an Index Mortgage in a small range of low yield scenarios, none of which touch upon the Zone of Interest. Moreover, Strategy B involves considerably more management (accounting, compliance and tax returns) than does the Index Mortgage.

In short, for most reasonable parameter sets, the Index Mortgage is superior to Strategy B and is always less burdensome to administer.

Table 3: Rate Sensitivity

Finally, it is instructive to consider the relative sensitivity of Strategy B and Strategy C to changes in interest rates. We do so (Table 3 at page 31) by reference to the ASX 200, assuming capital growth a constant dividend yield of 4% per annum.

From this we see that Strategy B can only outperform the Index Mortgage in the small corner of the Zone of Interest that corresponds to a high interest rate/low equity yield environment.

Table 1A: Index Mortgage (Strategy C) Versus Standard Mortgage (Baseline): ASX 200

Dividend Yield

Table 1B: Index Mortgage (Strategy C) Versus Standard Mortgage (Baseline): Nasdaq

Dividend Yield

Table 2A: Index Mortgage (Strategy C) Versus Baseline + Leveraged Investment (Strategy B): ASX 200

Table 2B: Index Mortgage (Strategy C) Versus Baseline + Leveraged Investment (Strategy B): Nasdaq

Table 3: Table 2A Scenario with Constant Dividend Yield of 4%: Sensitivity to Cash Rate RBA Cash Rate

Baseline

Dictionary

Benchmark Index

Benchmark Rate

Calculator

Client Deck

Corporations Law

Excess Cashflows

Indexed Loan Rate

Australian Credit Licence.

Australian Financial Services Licence.

A standard principal and interest home loan against which the efficiency of three wealth building strategies is assessed. See “Calculator”.

A time series of values reporting the progressive accumulation of a sum compounded at a contiguous series of Benchmark Rates.

A rate set by us, expressed as a margin to the overnight cash rate.

An Excel model that assesses three wealth building strategies against a Baseline. See page 24 et seq.

The document titled “Introducing the Index Mortgage: Information for Clients”.

Corporations Act 2001 (Cth) and any regulations made pursuant thereto.

Strategy B requires more recurrent cash than other strategies (in order to service the investment loan). This means, measured relative to Strategy B, that Strategies A and C have excess recurrent cashflow. These Excess Cashflows are used to pay down the mortgage loan in each of Strategy A and Strategy C.

A backward-looking interest rate that incorporates the economic effect of Linking. The Indexed Loan Rate reports as a discount or premium to the Standard Loan Rate.

Index Manager

Indicative Adjustment

Initial Link Sum

Interest Adjustment

Link

Option Premium

Reference Assets

Reference Index

Referrer Program Standard Loan Rate

A member of the IMCO group of companies.

An estimate of the Interest Adjustment that would result if the underlying Link was terminated.

An amount nominated by the borrower and accepted by the Mortgage Lender pursuant to which we scale the effect of loan indexation.

The “rolled up” interest saving or cost attributable to Linking, being the accumulated difference in interest charges computed at Standard Loan Rates versus interest charges computed at Indexed Loan Rates. The Interest Adjustment is deducted from, or added to, the mortgage balance when the Link is taken off.

An election by the borrower to have interest charges under the mortgage loan inversely reflect movements in the Reference Index measured against the Benchmark Index.

The positive spread between a “vanilla” mortgage loan rate and the Standard Loan Rate under an Index Mortgage loan.

National Consumer Credit Protection Act (2009).

A pool of financial assets that conform to a mandate specified in a Fact Sheet. Reference Assets may comprise shares in a corporation, interests in an exchange traded fund or pooled investment scheme, traded commodities and futures, options or other derivatives.

A time series of Reference Index values that report the Total Return of the underlying Reference Assets.

A program that enables the referral of potential borrowers to Mortgage Lender and vice versa pursuant to rr.25(2A) and 5) of the National Consumer Credit Protection Regulations 2010.

The interest rate that applies when an Index Mortgage loan is not Linked.

Strategy

Strategy A

Strategy B

Strategy C

Taxes

Total Return

Zone of Interest.

Any of Strategy A, Strategy B or Strategy C.

The Baseline, with Excess Cashflows used to effect early redemptions of principal.

The Baseline coupled to a leveraged investment. Strategy B is the closest one can come to reproducing the risk and reward profile of the Index Mortgage with conventional credit facilities and a direct investment into growth assets. The inclusion of an investment loan within Strategy B that requires servicing means Strategy B is a greater consumer of recurrent cashflow than the other strategies.

The Index Mortgage, configured to replicate the Strategy B exposure to growth assets.

Income and capital gains taxes.

The percentage change in value of a pool of Reference Assets computed over a period:

(a) having regard to the market value of those Reference Assets at the beginning and end of that period;

(b) without taking into account dividend franking credit gross ups or associated tax offsets;

(c) assuming dividends or distributions received in respect of Reference Assets over that period are reinvested into additional Reference Assets of the same type at prevailing market prices;

(d) after accounting for brokerage and other transactional costs;

(e) without deduction on account of Taxes; and

(f) assuming temporarily uninvested cash earns no return.

An overlay on the Heat Map Tables in pages 21 to 31 that encapsulates a range of combinations of capital growth and dividend yield consistent with the Total Return of the subject Reference Index over the last 5 years (measured at 14 May 2024).