Reminder: buying a house is a financial decision

frugal_dougal_3

moneymatt,

That was an excellent narrative, and I hope it does encourage people to think more.

I am concerned at the number of young people I know who are selling in order to rent, but instead of investing their profit are just blowing it all on material goodies. Again, I accept it is their choice to do this but I am of the "shopping doesn't make you happy in the long term" brigade.

bunking_off

MoneyMatt,

Aha, what you write is correct. I would quibble with a couple of your figures...on a 5% mortgage rate / 25 yrs (a readily available rate), I think on average approx £600 out of the £900 will be interest rather than £650 (month 1 it's £633, by month 60 it's £560). Also, I don't know how achievable a 5% after tax (ie 6.25% pre tax) risk free deposit account is - NB you can't rely on ISAs to put a tax wrapper on at this level of investment.

Leaving this to one side, however, in "scenario analysis", the whole point is to look at all of the different scenarios that could arise and take a balanced view of the outcome.

For the one you consider (declining house values), the situation of our two options is that in 5 years the renter can afford a better house, but the buyer does not actually experience any pain unless they become a distressed seller (redundancy or whatever).

Now, let's consider a couple of other scenarios : static house prices, and rising house prices.

In the static house price scenario, the buyer has paid off £14k from his/her loan, ie has £14k equity. The renter is now purchasing a property, values haven't changed, ie they'll effectively have £27k equity. So, they'll be better off renting as all things equal they can afford a £13k more expensive house. However, I suspect that if you factor in my quibbles above, much of that advantage disappears.

Now, let's look at house prices rising....let's say they rise by a modest 10% in the time frame (that's <2% a year). The owner will now have £29k equity (these mortgage payment figures amount to an initial value of approx £150k), while the renter still has only £27k, or less (see quibbles!). Not good for the renter, but not the end of the world...they're in the situation of being able to afford the same house they could 5 years earlier.

But what if we're wrong, and house prices rise by 5% a year, ie 28% over the period? To buy the same house, the renter now has to pay some £42k more...their savings go nowhere matching that, so they're left in the situation where they cannot buy.

It strikes me that overall, a balanced view is that it *may* be better to rent. However, if prices do continue to rise, then by going down this path the renter misses the train for good and will never be able to buy. If a first time buyer's got resaonable job security hence know they won't need to be a distressed seller over the next few years, they might feel that the risk of negative equity via house price falls is worth taking if the alternative may be that they never get on the ladder.

moneymatt_2

Bunking Off,

I based the figs on a 147k loan at 5.5% over 25 years. So the interest element would be £617-673 for the first 5 years. Difficult to know what the average interest rate will be, but as I say the figs are more to an illustrate a point - ie, the potential for renting to be a better option. I'm trying not to directly say that that's definitely the case as it's only my opinion, but get people to think about the possibility. As I say, I think people need to play about with the figs themselves based on their own situation. As one poster said, there'll be regional differences - maybe for some buying is the better option.

In trying to highlight the possible benefits of delaying buying, so I am presenting one side of the argument. You're quite right that there's another side which would make buying a better option. I can't really see how prices can rise given that they don't seem to be generally affordable anymore - but no-one can say with absolutely certainty. It's a gamble people have to take either way. It's a shame that that's the case really. Most people aren't concerned with making a profit - they just want a nice home. But they have to take the financial gamble one way or the other (given that renting could also be seen as a gamble - arguably slightly less of a gamble - you can react fairly quickly if you're renting and see prices start to rise. However, if you've bought you may have mortgage tie-ins or -ve equity that prevent you from getting out). My point is that - like it or not - it's a financial decision as well as an emotional one so it needs detailed thought rather than relying on the 'it's a home, not an investment' maxim. A home it may be, but it's an asset too whose value can change dramatically for the good or bad.

moneymatt_2

Bunking off,

Just re-read your post. Whilst it balances my views, I'd 'quibble' (Bunking off TM) with the idea that FTBs could miss the train for good. Surely no market can sustain unaffordable prices for any period of time? I guess an increase in prices could be possible if there was an increase in ave. wages too, but I can't see how there could be an increase in unaffordability. As one of the posters mentioned, for many FTBs there isn't even a decision to be made.

EDIT: Also, re the savings, you could squirrel away £250 month in a cash ISA (5% +) and the remaining £150 in a Reg Saver at 7% (5.6% net).

ANOTHER EDIT!:

the situation of our two options is that in 5 years the renter can afford a better house, but the buyer does not actually experience any pain unless they become a distressed seller (redundancy or whatever).

I'd disagree slightly with this on two points. Firstly, whilst the renter could get a better house, I'm thinking more that he/she could have their mortgage over a shorter term. Hence, delaying buying isn't necessarily delaying owning outright.

Second, the buyer could experience pain if prices fall even if not forced to sell. A return to value could take years meaning that the owner is largely stuck in their property - that could be painful if the property is not suitable later on (eg, they start a family, want to move areas for a career move, etc). What's more, if you buy your first home at a high market value, it's difficult to buy your next home when the market is low because you have little or no equity or negative equity, hence you could be trapped into buying your next home when prices are high with all the associated extra costs in capital and interest.

bunking_off

Moneymatt

I think my issue on the "quibbles" is that you take a mediocre product on the mortgage side of things (it's pretty easy to achieve better than 5.5%, indeed you can - or at least could until recently? - get a 15 yr fixed for 4.95%) while using pretty exceptional rates for the savings account. Of course, you want to illustrate your point (which I don't massively disagree with) so that's your prerogative.

As a matter of interest - not for this discussion but for my own investment research - can you point me to which provider is offering the 7% rate?

moneymatt_2

bunking_off wrote:

can you point me to which provider is offering the 7% rate?

see here for reg sav: http://www.moneysavingexpert.com/cgi-bin/viewnews.cgi?newsid1108401263,93536,

here for 5%+ isas: http://www.moneysupermarket.com/ISA/BestBuysResults.asp

Xbigman

My take on this is that the original posters point is valid. It is an excellent starting point when looking at the realities of buying a property. The only problem I see is that buying somewhere is an emotional decision for a big percentage of people. When renting I had 7 addresses in two and a half years. I would have bought an outside toilet to live in rather than rent a mansion. That wasn't a financial decision, but an emotional one.

With that in mind lets look at an example. If you could rent for 500 or buy for 600 my question would be "is it worth a 20% premium on the rent to live in 'my' house". For myself the answer is yes. So for 5 years I pay extra whilst waiting for inflation to do its work on other properties rent (increase) and on my wages (increase) and on my equity (increase again). After this it is all down hill. This is what I was raised to believe, you suffered pain in the first years of a mortgage because it was worth it to own your own home. After that it got better.

The property seekers view. Go for the cheaper option.

The home seekers view. If you can buy cheaper than rent then good luck but still buy.
Regards

X

bunking_off

Thanks MoneyMatt - was looking for a better deal for the lump sum I've got in an IF ISA, but the Hali reg saver is what it says on the tin...regular savings. Suppose I could drip feed in from IF to Hali....

BTW, your theoretical renter couldn't achieve 7.6% gross compound either : if they put their £150/month into reg saver, they'd get their 7.6% for the first year, but after that it'd drop down to the Hali Web Saver rate.