The moral hazard of being kind to the indebted

julieq

The issue isn't differential return. It's the fact that you're putting money into an illiquid asset which someone else can force you to sell on THEIR terms under certain circumstances, and without risking their own capital. That squeezes any capital contraction COMPLETELY into your share of the equity, which gives an unpleasant gearing effect. Say you have 50% equity on a £100K house, and you hit trouble and you're forced to sell. You take a 10% hit on the sell price and sell for £90K, pay back the £50K. You've just lost 20% of your capital, and the lender has lost nothing.

It's even worse if you own a smaller percentage, because ALL of the risk is to your capital under these circumstances, up to and including losing it all and still owing money. It is particularly foolhardy to overpay if you think price drops are inevitable, which is Macaque's position. Refer back please to his original post, which was what I was answering.

Take as a contrast the situation where you have £50K offsetting savings on a £100K house. You can survive for years, and if you want you can put the house on the market on YOUR TERMS. This removes a great deal of the risk. Personally I'd take a notional "loss" on mortgage repayments versus returns for that security, given there's plenty of utility in living in the house and the alternatives are much more expensive.

But it's pretty much certainly the case that with a bit of nous you can use offsetting savings to invest and beat mortgage rates - that's been true historically for years - with a well balanced set of investments.

There are some situations - very heavy penalties for high LTV possibly, or staying below threshold values for benefits - where you can argue that there may be benefits in overpaying - remember here please that I'm assuming the alternative is offsetting in some way, not spending the money on plasma TVs. But even then it's not clear for the reasons I've explained. In the general case overpayments are an emotional response to a perception of debt as a monkey on your back.

This isn't a particulary controversial analysis incidentally, but as I've said it's contrary to the uberbear doctrine and usually precipitates a furious flurry of insult and ad hominems. Actually if you're a bull overpayment makes more sense (the gearing reverses when prices rise) but it's still into an illiquid asset which you can't get at in times of most need - any life changing event, unemployment or separation being the obvious ones.

pqrdef

hallmark wrote: »

Utter cobblers, it's perfectly sensible. You'll tend to find that people who do the above spend their lives not in debt & requiring bailouts.

But if it makes sense to pay down mortgage debt when it's cheap, doesn't it make even more sense when it's not cheap?

Five years ago, we had higher mortgage rates, bigger differentials between mortgage and savings rates, and real wages rising and expected to continue to rise. Seems like that would have been a good time to be paying down mortgage debt. So why do we have a craze for it now that we didn't have then?

Wookster

julieq wrote: »

The issue isn't differential return. It's the fact that you're putting money into an illiquid asset which someone else can force you to sell on THEIR terms under certain circumstances, and without risking their own capital. That squeezes any capital contraction COMPLETELY into your share of the equity, which gives an unpleasant gearing effect. Say you have 50% equity on a £100K house, and you hit trouble and you're forced to sell. You take a 10% hit on the sell price and sell for £90K, pay back the £50K. You've just lost 20% of your capital, and the lender has lost nothing.

It's even worse if you own a smaller percentage, because ALL of the risk is to your capital under these circumstances, up to and including losing it all and still owing money. It is particularly foolhardy to overpay if you think price drops are inevitable, which is Macaque's position. Refer back please to his original post, which was what I was answering.

Take as a contrast the situation where you have £50K offsetting savings on a £100K house. You can survive for years, and if you want you can put the house on the market on YOUR TERMS. This removes a great deal of the risk. Personally I'd take a notional "loss" on mortgage repayments versus returns for that security, given there's plenty of utility in living in the house and the alternatives are much more expensive.

But it's pretty much certainly the case that with a bit of nous you can use offsetting savings to invest and beat mortgage rates - that's been true historically for years - with a well balanced set of investments.

There are some situations - very heavy penalties for high LTV possibly, or staying below threshold values for benefits - where you can argue that there may be benefits in overpaying - remember here please that I'm assuming the alternative is offsetting in some way, not spending the money on plasma TVs. But even then it's not clear for the reasons I've explained. In the general case overpayments are an emotional response to a perception of debt as a monkey on your back.

This isn't a particulary controversial analysis incidentally, but as I've said it's contrary to the uberbear doctrine and usually precipitates a furious flurry of insult and ad hominems. Actually if you're a bull overpayment makes more sense (the gearing reverses when prices rise) but it's still into an illiquid asset which you can't get at in times of most need - any life changing event, unemployment or separation being the obvious ones.

But But But I thought houses were such a safe bet?

You want people to own houses but not pay them off?

No wander you have no qualm with creating moral hazard.

julieq

Wookster wrote: »

But But But I thought houses were such a safe bet?

You want people to own houses but not pay them off?

No wander you have no qualm with creating moral hazard.

God Wookster, you're a stuck record. I dealt with the "safe bet" issue a couple of days ago. And I am answering a SPECIFIC point Macaque made which is that people should be OVERPAYING mortgages, which is a sub optimum strategy.

For reasons I have just spelled out in great detail.

So what's the response? Usual Wookster ad hominem and misrepresentation. Well done.

No-one is saying mortgages shouldn't ever be paid off. Although actually there's a perfectly valid school of thought which says an interest only mortgage held indefinitely isn't a bad way of paying accomodation costs. I could certainly argue that by extension of the same arguments I'm making here, but I AM NOT DOING THAT.

Thrugelmir

julieq wrote: »

But it's pretty much certainly the case that with a bit of nous you can use offsetting savings to invest and beat mortgage rates - that's been true historically for years - with a well balanced set of investments.

Which investments have constantly outperformed mortgage rates?

treliac

I can't see the attraction of continuing to pay mortgage interest any longer than necessary. I've certainly got better use for that money.

Okay, I can see the argument related to losing a job and having some spare cash in hand, but how many of us operate on that assumption and yeah, why not rely on benefits if the worst happens, which you won't get if you have the funds... you'll just drain them away instead.

I don't think state payment of mortgage interest is time limited if you have children either.

julieq

No single investment consistently performs. That's why you need balance and you need to change things around. I'd have thought you knew that.

A balanced set of investments with an overall target of around 5% return is perfectly achievable, but it requires some work. But you've also skipped most of the argument in which I pointed out that EVEN WITHOUT offsetting investments you're in a better position by not sinking cash into overpayments. Even if you lose on the differential between savings and mortgage rates, the loss is worth having for the additional capital security.

If you're going to argue, address the main point rather than nitpicking around a side issue.

julieq

Treliac: go back to what Macaque was saying, and read my argument. You (and he) are free to do what you want, but that doesn't make it the most rational course of action, and it's ridiculous to claim that it is. You're also free to rely on benefits, but I'd rather not have to because that would eventually cause serious problems and probably a forced sale anyway.

I have no idea where the idea of moral hazard comes in except in the fantasy that base rates are set to benefit homeowners and punish the prudent.

treliac

julieq wrote: »

Treliac: go back to what Macaque was saying, and read my argument. You (and he) are free to do what you want, but that doesn't make it the most rational course of action, and it's ridiculous to claim that it is. You're also free to rely on benefits, but I'd rather not have to because that would eventually cause serious problems and probably a forced sale anyway.

I have no idea where the idea of moral hazard comes in except in the fantasy that base rates are set to benefit homeowners and punish the prudent.

You seem to get very angry that people prefer a different approach to yourself. I find it perfectly rational to conclude a monthly charge of £500 in interest as soon as I can.

silvercar

How exactly are the STR-ers parasites?

There are a group of people who will financially never be in a position to buy, there are also those who need mobility and are therefore more suited to renting at their current stage in life.

Then along come the STRs, who increase the demand for rental properties. Not just forcing rental prices up, but jumping ahead of a lot of the committed renters, either because they are more credit worthy or because they can afford to pay rent up front.

Add to that they are gambling on future house prices and I don't see how any one can praise them as a group.

risk taking monopolisers.