Entertainment: Are NFTs on your HOME the future of mortgages?

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NFTs, or non-fungible tokens, are being used as a method of ownership for everything from music albums to digital artworks to posts on Twitter.

An NFT is essentially a certificate of ownership for an asset that – unlike money – is unique and cannot be replaced like-for-like.

As well as a piece of music or an online avatar image, this could arguably also apply to a home – and it is with that in mind that US mortgage lender LoanSnap has minted the very first NFT mortgages.

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It is one of the first times that NFTs have been taken out of the digital world and applied to physical assets.

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It is at a very early stage – only eight mortgages have been minted so far – but if the concept took off, it would mean that anyone who could buy cryptocurrency could own a share in someone's mortgage.

'There has been lots of criticism of cryptocurrencies like Bitcoin, as people are asking, what are the use cases and practical applications of it?' says Martha Reyes, head of research at cryptocurrency trading platform Bequant.

'But NFTs have taken off more than coins in the public imagination. There is this concept of the democratisation of finance, and of art – and there are clearly other areas we haven't yet considered.

'It is allowing access to things that have huge barriers to entry.'

While currently in its infancy in the US, NFT mortgages aren't available in Britain - and it is likely the majority would feel uneasy about borrowing this way given the volatility of cryptocurrency and the potential fraud risks.

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This is Money takes a look at how it could work and the potential pitfalls.

How does it work?

In the case of a song or an artwork, an NFT gives the owner the right to resell, distribute or license it as they see fit.

For a home, the investor is buying a lien, or a share of a lien, on a proportion of the property.

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This is the legal right a lender has to repossess a home if the mortgage holder fails to pay their debt.

So far, LoanSnap has wrapped eight mortgage liens into NFTs collectively worth $2.7million, which it refers to as 'eggs'.

What is LoanSnap?

LoanSnap is a US mortgage lender, which says it focuses on 'looking beyond just the lowest interest rates'.

Instead, it says it looks at each customer's individual finances and finding the best loan for them.

It specialises in offering 'smart loans', which refinance other debts such as credit cards and student loans into customers' mortgages, with the aim of lowering the total interest they pay.

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The company says it also aims to reduce the stress caused by money and give people a clear view of their financial situation.

The eight existing 'eggs' are secured on homes in California, Washington, Iowa and Alabama, US.

The NFTs also contain securely stored information about the property and the borrower on a blockchain, which investors can access.

At the moment it is essentially a remortgage product for people who already own some of their home, allowing them to take out equity.

The borrower chooses how long they want to pay back the loan for, and the interest rate is set by an 'automated market maker', which we explain below.

On the technical side of things, the whole process is run using LoanSnap's 'Bacon Protocol': a set of lending rules built using smart contracts on the Ethereum blockchain.

The project is colloquially known as 'Bacon Coin', inspired by the phrase 'bringing home the bacon'.

Where do crypto investors come into it?

LoanSnap has provided the funding for the first eight mortgages in order to test the concept.

But in future, the lending funds will come from crypto investors who buy a stablecoin called bHome, getting them a fractional share in one of the NFTs.

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A stablecoin is the industry term for a cryptocurrency pegged to another asset.

Multiple crypto buyers will fund a single mortgage loan, meaning the barrier to entry is much lower than, for example, being a buy-to-let landlord.

'People can access it on both sides of the equation – as a homeowner or investor – if they have a little amount of money to spare,' says Reyes.

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As the homeowner makes mortgage payments to the lender, or the value of the property grows, the value of the bHome token grows in equal measure.

This generates a return similar to what a bank would earn on lending a mortgage. A single bHome coin is currently worth $1.02.

The smart contracts are able to pool funds, mint the bHome coin and fund loans that match certain criteria.

The Bacon Coin website reads: 'Mortgages have been a cornerstone of our financial systems. Banks, insurance companies, and governments buy trillions of dollars of mortgages each year to make money in a safe way.

'The Bacon Protocol introduces a brand new type of decentralized mortgage loan. It makes mortgages cheaper, faster, and more flexible for homeowners.

'It brings the same power and value that mortgages give banks, financial institutions and governments to anyone who can buy cryptocurrency.'

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LoanSnap has said it wants as much of the process to happen online as possible – but as a house is a real-world asset, there are some things that need to be checked on in person.

This comes down to a team of regulated and licensed originators, which the company describes as the 'only necessary connection to the real world.'

They carry out checks on the home and the borrower, ensure that the property is maintained as laid out in a Deed of Trust, create the lien, and receive a commission in bHome for their work.

NFT mortgages are clearly in their infancy and remain untested.

" This may all sound a bit far-fetched, but so was shopping on the internet twenty or so years ago"
Angus Stewart, mortgage broker

But some experts said they could see the benefits of the system for both homeowners and investors, and could envision a future where borrowing a home loan from crypto investors was common.

'This may all sound a bit far-fetched, but so was shopping on the internet twenty or so years ago,' says Angus Stewart, chief executive of online buy-to-let mortgage broker Property Master.

'What we are seeing being created is a new financial marketplace in cyberspace.'

The Bacon Coin project has attracted some influential backers, including Richard Branson's Virgin; Mantis, the venture fund owned by electronic music duo The Chainsmokers; and former American football star Joe Montana's L2 ventures.

It is also backed by Baseline Ventures, True Ventures and Thomvest Ventures.

More secure and quicker transactions

There might be an investment case for NFT mortgages, but what is in it for the homeowners?

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LoanSnap claims that the process being done via smart contracts will mean fewer administrative headaches when sorting out a mortgage – as well as lower costs.

'When taking out a mortgage there are so many intermediaries and the costs and taxes are tremendous. If you can make that process more efficient, that would be welcome' says Reyes.

NFT mortgages in general could offer more security because the transaction is done on blockchain – a way of digitally storing information which is guaranteed to be secure.

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'Blockchain technology can be used to provide transactional certainty when bringing together buyers and sellers,' says Stewart.

'Both parties could have access to all the data they need to make a decision there and then, and the completion of the deal could be much quicker and easier with a much more automated and convenient process.'

To move, a homeowner would pay back the loan to the lender using proceeds from the sale of their home, in much the same way as a traditional mortgage.

However, some fear that the novel nature of NFTs, and the fact that there are several parties involved in one transaction, could actually lead to more of an administrative headache for borrowers in the short term.

'A new scheme and innovative ideas is welcome,' says Nicholas Mendes, mortgage technical manager at broker John Charcol.

'But as we have seen with the 'Unmortgage' scheme, which matched a borrower with money from a pool of 'funding partners', the limitations and hoops you need to jump through to complete are a challenge.'

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There are also concerns around who owns and has access to the data. 'It could be very scary, and there has got to be the right level of controls about who owns and accesses that data,' says Stewart.

'Regulation will be running to catch up with what the new technology can bring.'

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In LoanSnap's case, the Bacon Protocol only stores data that is already publicly available. Its smart contracts passed an audit by blockchain auditor BlockHunters, and received its highest rating.

Who is lending your mortgage?

One of the possible advantages of NFTs is that they could open up borrowers to a much wider pool of lenders than are currently available.

If the concept grew, they could have access to not only banks but also other investors such as pension funds, as well as retail investors from around the globe.

'It's good for the borrower because it opens up liquidity: they can borrow from anyone around the world,' says Reyes. 'At the moment, you can't really do that in the mortgage market.'

It also opens a can of worms in which the homeowner doesn't really know who is funding their mortgage. However, experts say that this might not be a top concern for borrowers.

'As long as the funds are available, I don't know how concerned they are about who their lender is,' says Stewart. 'And there are ways to prove availability of funds using the blockchain.

'The issue might be how easy the mortgages are to deal with in terms of servicing – but that is increasingly outsourced, even on mainstream mortgages.'

Could the cryptosphere be easier to borrow from than banks?

While it is unclear how the NFT mortgage market will grow and develop, crypto investors are not obliged to follow the same lending conventions as banks when it comes to things like loan-to-value ratios or customer credit scores.

Currently, the LoanSnap's platform is playing it safe. It only accepts loans which meet the Fannie Mae and Freddie Mac Conforming Loan guidelines – a standard set of rules about things like maximum loan-to-value ratios and the credit scores of borrowers. However, it has said that this could change later on.

While going too far down the road of highly-leveraged lending is clearly unwise, NFT mortgage platforms may be willing to take on a slightly higher risk profile because no single institution or individual lender is liable for a whole mortgage.

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This means they could potentially offer help to those who find it harder to get a mainstream home loan.

This includes first-time buyers with small deposits, the self-employed, or those who struggle to meet banks' loan-to-income ratios.

Mendes says: 'Currently a borrower is limited to the criteria of the lender and so it may not be possible to get on the property ladder.

'But with the continuous development of technology, reliance and importantly acceptance, we could see the purchase process develop in the future.'

In future, he says that NFT-based lenders could opt to offer a loan to these borrowers based on an assessment of their unique circumstances, but to set their interest rate at a level that justified that risk.

Remortgaging 'at the click of a button'

Not following the same conventions as banks means that an NFT mortgage could potentially be much more flexible than a regular one, too.

'It has flexibility, so you could change the interest rate as the market changes,' says Reyes. 'And there are no early repayment penalties.'

In LoanSnap's system, the homeowner is only obligated to make monthly interest payments, they are free to pay back parts of the loan whenever they like and there are no early repayment charges.

The company also claims it makes remortgaging easier, saying: 'The loans can be refinanced at the press of a button.

'When rates go down, the borrower can see that their monthly payment can be lower and choose to pay off the existing loan with a new one at the lower prevailing rate.'

What are the rates and how are they set?

The LoanSnap system relies on an 'automated market maker' to decide rates. When there is lots of money waiting to be lent, rates will fall to entice in borrowers – but when there is little, rates will rise to entice in lenders.

It says the size of the loan is also taken into account when deciding the rate.

It says: 'The Bacon AMM creates a simple supply-demand curve to incentivize borrowers and liquidity providers to participate in the system when needed.'

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The interest rate they are offering is lower than the average interest rate.

According to an article in Coin Telegraph, the interest rate for an NFT mortgage ranges from 1.5 per cent to 3.1 per cent, while the average interest rate on a 30-year fixed-rate mortgage earlier this month was 2.98 per cent according to Freddie Mac.

The rates available on LoanSnap's mortgages are fixed for now. But Stewart says that, if the NFT mortgage concept developed over time, he could see different lenders in the market competing with each other to attract borrowers by offering lower rates.

He even sees a future where individual lenders could 'bid' for a slice of a borrowers' mortgage.

'We may see a situation where customers looking for a mortgage will find a much broader range of lenders bidding for their business,' says Stewart.

" '[Investors] are not the ones making the decisions about what to invest in, and the algorithm is deciding the interest rates"
Martha Reyes, head of research at crypto trading platform Bequant

'In the case of a portfolio landlord, I could see lenders bidding for their whole portfolio in one transaction for example.

'The borrower has much more control, and the lender becomes much more of a commodity.

'Think of it as a sort of reverse auction. The outcome will mean more consumer choice, lower operational costs and pricing which is more closely aligned to the risk profile of the borrower.'

There are some concerns about a computer picking investments and setting rates, however – especially when it comes to ensuring that housing market mistakes of the past are not repeated.

'The big issue is do they meet the Hera test,' says Reyes, referring to the Housing and Economic Recovery Act which sought to improve accountability in the mortgage industry following the US subprime mortgage crisis in 2008.

'[Investors] are not the ones making the decisions about what to invest in, and the algorithm is deciding the interest rates.'

Will it take off?

With the first loans only just minted, it will probably be years before most homeowners have even heard of an NFT mortgage.

But some say the idea could gain ground with younger homeowners, who are distrustful of big finance and are already investing in crypto.

'Banks are becoming much stricter with younger people,' says Reyes. 'They are being priced out of the market or even going elsewhere.

'Some of them might go off and buy crypto [to fund their home purchase] instead. Young people don't trust the banks, anyway.'

However, US investors learned hard lessons from the subprime mortgage crisis, so any shake-up in the market will need to be approached with caution.

'We have seen how new concepts for investors to dip into the secured market bring high rewards,' says Mendes. 'But the risks of 2008 financial crises will be one we do not want to repeat.'

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