Reminder: buying a house is a financial decision

moneymatt_2

Thought it appropriate to give that reminder given some of the things I've read and heard about the housing market lately.

Actually, I think the cliche about buying a house being a lifestyle decision rather than a financial one has been around for years. But lately - perhaps because of all the conflicting info that we read about the future of prices - it seems some people are suggesting 'opting out' of considering the financial implications on the basis that 'a house is a home, not an investment', 'it's my dream house', 'there's never a good time to buy', 'I feel like I'm putting my life on hold by renting', 'renting is dead money', etc.

This isn't a post about whether prices will rise or fall. This is a reminder that whilst buying a house is a lifestyle choice, it's also a financial decision (and the biggest one most of us will make) - the two things are inter-related. Given that most members of this site spend lots of time searching out the best deals to save a few hundred (or perhaps thousand) pounds a year, doesn't it make sense to consider the financial implications of buying something that costs a six figure sum?

Here's my take on some of the financial implications:

- financial decisions and lifestyle decisions are inter-related:

It's not sensible to ignore the financial side of buying a house on the basis that it's a home not an investment. Buying at the right (or wrong) time will have a large effect on the type of home you can buy. It's worth considering whether it might be better to delay so that your first (or next) home can be something you'd actually like, rather than the best you can get at the moment. Also, if you're overstretching yourself, your lifestyle will be affected by the fact that you'll have less surplus cash to enjoy! Bear in mind also that buying when interest rates are low and prices are high is a big risk. If prices are partly inflated because of low interest rates (ie, they seem more affordable because rates are low) then a rise in interest rates not only means that your payments will go up, it may also mean that your house value falls (as houses are now more unaffordable due to higher interest rates). Also, buying when rates are low could lull you into a false sense of security - an extra 1% could add an extra £100 month to the ave. mortgage. In that respect, it might be safer to buy when prices are low and rates high.

Buying at the wrong time might also affects the houses you buy in the future. If you buy the overpriced shoebox now, then what happens when you try to move up the ladder? If you try to move up the ladder when prices are low you may have little or no equity (or even be in negative equity) so that you don't have any money to put down for a deposit, preventing you moving up the ladder. If you buy your next places when prices are high again (so that you have some equity to put down on your next place) then that's compounding the error! You now have an even larger stake in an overpriced commodity! Buying at high prices can lock you into a trap of buying overpriced housing. For some, holding your property till the right time isn't even an option. Falling house prices affect spending power, which affects the economy, which affects employment. That can lead to the combined threat of negative equity and job losses. Unfortunately, for anyone who's house is repossesed and sold for less than what is owed, it doesn't end there. They still have to pay off the outstanding debt on a house they no longer own. Some people are still paying off negative equity from 10 years ago. Some people I speak to haver this idea of the property 'ladder' as something magical. The reason it's called a ladder is that you can climb it in terms of buying continually better houses. It works well if you buy sensibly, but as mentioned above if you're first property falls into negative equity and you're forced to sell, you'll not onyl fall off the ladder, you'll injure yourself so that it's difficult to get back on.

Paying interest is 'dead money':

Another cliche we hear is that renting is dead money. That's true in a sense, but bear in mind that mortgage payments, in the 1st few years, mostly just pay the interest on the loan, not the capital. E.g. for a £165k house on a £150k mortgage at 6% over 25 years, you'll pay £965 month. But for the first 5 years, £700-750 of that is interest. You'll still owe £135k after 5 years. If prices have fallen by say 20% in that time, you'll owe more than the value of the property having paid out £58k! That's dead money! Even if prices we're the same in 5 years, you'd still only have gained £15k of equity and spent £43k on interest. Currently it's often cheaper to pay rent than even paying just the interest on the mortgage.

There are some scary figures involved in getting this wrong and some scary outcomes which could affect people's lifestyles for years to come. Of course, prices may not continue to fall, the economy may stay strong, and buying a house might be the best thing to do - but, either way, it's reckless not to at least give some thought to the financial implications before buying.

dippy

In current conditions, rents are not really "dead money". In a lot of places, rents are comparable, if not less than interest on a mortgage. People at the bottom of the ladder, especially FTBers, have a choice to either buy in grotty and dangerous places (that they can barely afford) or rent in good areas that they would really be stretching to cover the interest let alone the repayments on a mortgage.

The support is just not there at the bottom end of the market. FTBers were priced out quite a few years back. BTL mortgaging lending is now down. Who is going to support the bottom of the chain so that people higher up can upgrade?

bridiej

Rent is dead money because at the end of the day you pay it just to have a roof over your head for a set time - at the end of that time a landlord can ask you to leave.

Whereas if you pay the same amount off a mortgage at the end of 20 (or whatever) years you will own the house, plus in the meantime you are starting to own more and more of the house.

moneymatt_2

dippy wrote:

In current conditions, rents are not really "dead money". In a lot of places, rents are comparable, if not less than interest on a mortgage. People at the bottom of the ladder, especially FTBers, have a choice to either buy in grotty and dangerous places (that they can barely afford) or rent in good areas that they would really be stretching to cover the interest let alone the repayments on a mortgage.

The support is just not there at the bottom end of the market. FTBers were priced out quite a few years back. BTL mortgaging lending is now down. Who is going to support the bottom of the chain so that people higher up can upgrade?

Exactly. About 18 months ago, I was looking to move up from my 2 bed semi, bought in 99, to a 3 bed detached. At that point, I found that I'd have to spend 3 times what I paid in 99. That 3x figure was my limit. I looked around for about 12 months, but found that as prices increased and now my limit would only get me a 3 bed semi. I decided that I wasn't prepared to pay all that extra money for such a minor improvement. I expect a lot of people will have decided not to move up thr chain for that reason.

I'm fine where I am and if I decide that I really need a 3 bed detached, I'll just rent one and either sell or rent out my place. If I rented out my place, I'd only need to find about £100-150 more to rent the bigger place. If I sold my place, with the interest saved/made, again I'd only need to find about £150 more. The figures for buying just don't add up anymore.

moneymatt_2

bridiej wrote:

Rent is dead money because at the end of the day you pay it just to have a roof over your head for a set time - at the end of that time a landlord can ask you to leave.

Whereas if you pay the same amount off a mortgage at the end of 20 (or whatever) years you will own the house, plus in the meantime you are starting to own more and more of the house.

If you make a direct comparison between paying the rent and paying the interest only on a mortgage, you'll most likely find it cheaper to rent. For example:

Buy house with £100k mortgage @ 6% = 500/month in interest (i.e. that's without paying anything off the value of the house - it's just what you give to the bank in interest charges).
OR
Rent same house at 400/ month, plus all repairs paid for by landlord.

After 20 years of doing either of these things, you won't own any of the house. The current prices are so high, that you'd have to pay more than the rent, before any of your mortgage money starts paying it off. And if prices fall in the meantime, you'll be in negative equity and therefore won't - in a sense - really own any of it anyway.

If you buy a house that is, say, £30k overvalued, over the course of a mortgage at 6% for 25years, you'll end up paying an extra £58,000. That's a whole lot more than you'll spend in waiting for a while and renting somewhere till prices come down.

I do see why people think renting is dead money, but I think they underestimate the effect of mortgage interest. They think that the mortgage they pay is buying their house. Some of it is, but a lot of it just goes in interest - that portion of your mortgage isn't buying you anything. It's going straight to your bank.

I wonder if any MSE members were stung by the last house price crash. Perhaps they could give their advice having seen it all before. Having bought at the right time (partly judgement, but mostly luck) and worked in finanical services since then, I've a much better understanding of the economics of it than I used to have and can see that FTBs buying now could be making a big mistake. If the market was like this 5 years ago (when I bought) I doubt I would have had the knowledge then to know that it was better to delay and would also have been clambering to get on the ladder.

It's entirely everyone's choice what they do and the purpose of the post was to remind people to consider the financial side of it. But I do fear that some people will regret their decision to buy now for years to come.

dippy

I'm totally with you moneymatt. People have to remember that the amount that they are paying in interest in a mortgage is also dead money. It's lining up the pockets of all the banking fatcats.

Only the repayment part goes towards increasing your equity. For those that cannot afford much of the latter to live in a decent area (not everybody wants to live the next 4-5 years in a dump in a falling market), it's the equivalent of borrowing over £100-200k to speculate that the housing market will increase in the future and you'll be able to sell when the market is favourable, not when you have to due to other circumstances.

bridiej

Maybe it's different now but when I was renting 8 years ago I was paying £310 for a one bedroomed flat - when I bought a one bedroom house my mortgage was £185 a month.

Our mortgage now is about £400 a month, if we wanted to rent a similar house we'd be looking at £500+.

When we bought our house we bought it because we liked the house and the area, not to make a quick buck once prices rose.

I guess it's a personal choice, but I know we'd rather be paying a mortgage and know that we can do what we want with the house and in six months time are not going to be asked to leave...

dippy

If your equity is a significant portion of the total value of your house, it doesn't make much financial sense to sell to rent a similar house. Not unless you think the market is falling and you can realise your equity into cold hard cash. However, when you look at the figures again for trading up, you'll see that they're not the same anymore as in moneymatt's case.

Having said that, at the upper end of the market, you don't have the dearth of amateur BTL landlords who've been buying for the last two-five years and offering one-two bedroom flats to rent aplenty.

moneymatt_2

dippy wrote:

However, when you look at the figures again for trading up, you'll see that they're not the same anymore as in moneymatt's case.

Having said that, at the upper end of the market, you don't have the dearth of amateur BTL landlords who've been buying for the last two-five years and offering one-two bedroom flats to rent aplenty.

You'd be surprised actually, dippy. Round here, there's been loads of new builds of flats and 4/5 bed houses. A lot of these are up for let presumably having been bought off plan by investors (they're too pricey for most people round here). And because big houses don't cost much more to rent than smaller ones, I could let out my current place and rent one of those for very little more. Certainly a lot less than I'd have to fork out to buy one.

Btw, here's an interesting take I read on the 'renting is dead money' argument in the current climate:

" renting off a landlord or renting off the bank via interest only mortgages"

1st one, at least you can have your capital in cash and in the bank
2nd one, at this time your capital is likely to be under threat and the bank can always take your property away if you can't pay your mortgage

dunstonh

There are some unknown issues to take into consideration.

With the big increase of buy to lets, often by people who can't really afford to run a second property unless interest rates remain low, what happens when interest rates next go high? Repossessions, price drops etc will hit harder than last time. No-one can really tell for sure what will happen but it makes a nice discussion piece.

Another consideration of mortgage vs renting is that with a mortgage your repayments will wavy line through a low and high point over the years but in retirement you will pay nothing. With renting, you will see periodic increases and will be paying for life. With most not doing enough for their retirement income, can they really afford the rent in retirement?

sam_3-2

bridiej wrote:

Maybe it's different now but when I was renting 8 years ago I was paying £310 for a one bedroomed flat - when I bought a one bedroom house my mortgage was £185 a month.
...

No maybe about it. I'd be willing to bet that in most areas of the the UK it is cheaper to rent than to buy similar properties - in some case, vastly cheaper. For example, I currently pay £750/mo for a house on which a mortgage would be more than double. Times have changed, and not for the better (unless you like renting - which I do).