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Prince Harry and Meghan Markle recently made news when they purchased a $14.65 million dollar home in the exclusive community of Santa Barbara, California. Like many high-end homes in California, their new estate is on a private road behind gates and boasts of a world that most Americans can only dream of including a guest cottage, tennis courts and a stunning pool. Further, by being tucked away in Santa Barbara, it offers an exclusivity that can only come with these premiere properties.
While a new life in Santa Barbara might seem luxurious, in many ways, Harry and Meghan’s recent move offers insight into some of the more challenging personal finance questions that many of us wrestle with, including mortgages and insurance. Because of their status, they are also making financial choices that are exclusive to the wealthy, from the specific types of mortgage products to how to purchase a home while keeping it private.
Low Mortgage Rates, High Mortgage Balances
For the wealthy, the choice of mortgage product is unique. It has been reported that Meghan and Harry have obtained a $9 million mortgage for their new Santa Barbara estate, but it’s most likely not your standard 30-year fixed product.
Typically, in cases like this, the mortgage product of choice is the Interest Only Adjustable Rate Mortgage or ARM. With an ARM, the bank loans you the funds, but you pay only the interest on the mortgage for a defined period of time. At the end of the term, the rate adjusts, and the mortgage amortizes with both interest and principal.
In the present market, ARM rates are incredibly low, pricing at 2.5-3.25% for a 7- or 10-year term. As a result, it’s fair to assume that Harry and Meghan are paying somewhere between $225,000 to $292,500 for use of the funds. While a staggering amount for most Americans, in the world of the wealthy, this is very cheap access to funds.
Another tool built into the Interest Only ARMs that the wealthy often use is the recast provision. This allows that if the mortgage holder makes a principal paydown of the loan, the loan ‘recasts’ itself to adjust the monthly interest payment to be based off the new mortgage balance.
Privacy Needs
The wealthy often want their real estate purchases to remain private, which is likely the case with Harry and Meghan. The two main ways to maintain privacy when purchasing a home is by using a privacy trust or an LLC.
Like most trusts, a privacy trust has a grantor who sets up the trust to benefit a beneficiary, and a trustee who manages the trust’s assets. In a privacy trust, the grantor can also be the beneficiary, which is likely the case for Harry and Meghan. But they cannot be the trustee.
This is where privacy comes in. Harry and Meghan have likely used one of their financial professionals to serve as trustee. This is not uncommon, and often the trustee’s address is on public documents in to avoid using the address of the wealthy trust grantor.
Another privacy technique is the use of an LLC to hold the asset. The LLC can take on any name that is available in the state in which it is set up. However, all LLCs need a managing member and this information is part of the public record. Rather than the wealthy individual serving in this capacity, an independent third party can be named managing member, thus maintaining the privacy of the wealthy owner of the asset.
Insurance Coverage
Finally, along with the purchase of their luxury estate, Harry and Meghan must be sure they have the appropriate insurance coverage. That may be challenging given that California, and specifically Santa Barbara, has been subject to fires and mudslides over recent years, which makes it difficult to obtain insurance coverage.
The wealthy often use certain high-end carriers who focus on the more expensive properties and assets. Such firms include AIG, Chubb and Pure, which can provide a higher-end experience for the wealthy.
One question that Harry and Meghan likely wrestled with is whether to obtain earthquake coverage, which can be prohibitively expensive given the high likelihood of earthquakes in California. It can also come with a high deductible of 15% or more.
While we do not know if they obtained such coverage, the general rule of thumb is that the coverage makes sense if you have significant equity in the house you are trying to protect. In Harry and Meghan’s case, two-thirds of their purchase price was financed. As a result, they may have simply decided not to obtain this coverage, but rather to self-insure, an viable option for those with great wealth.
A Common Path
Of course, we don’t know for certain that these are the choices Harry and Meghan made in purchasing their new home, but for the wealthy, they are very common solutions for financing, privacy and insurance needs. What remains to be seen is whether the former “royals” can generate the income necessary to support these types of assets.
