Am I storing up trouble for the future?

martinsurrey

bouicca21 wrote: »

Won't be allowed to go up to 10%? Some of us are old enough to remember 15% under Thatcher ...

OP under such circumstances you simply manage. It gets tough but somehow it is always doable, especially for someone like you who is obviously really good at managing money. And the housing boom has already set in in several areas, so getting on the ladder while you can is a good bet.

But in the 80’s at 15% interest rate, you could still afford a standard semi on one wage, try that now, raw rates are nothing if you don’t include relative house prices!

m0t is right (IMO), if rates rise that high again, soon, the nation will all go under, everybank will fail, and the OP's mortgage will be the least of her worries, more pressing would be finding a pointy stick long enough to stop people stealing her food.

I wouldsay a 5 year fix is enough (I have recently got one myself). In 5 years, you have to hope you’ll have increased your salary, house prices will have risen (maybe not in real terms, but in £££) so your LTV will have dropped even more and you can get an even better deal than fixing at a worse rate now for 10 years.

Tancred

Doctorbee wrote: »

Well, I know that none has a fool-proof crystal ball but I worried that I might be overstretching myself.

I am a single girl with an exemplary credit history who has saved very hard for a long time for a deposit and has 50% to put down on a little place that I have found. My mortgage broker has found me a 5 year fixed rate mortgage at 3% interest that would allow me to pay about 30% of my take home salary which is all good.

However, I've heard so much in the press about the imminent housing boom predicted for 2014 when Help to Buy kicks in properly and that (despite what BoE says) interest rates will have to shoot up after 2016 - endless warnings for FTBs (like me) taking on too much and overstretching themselves. I am worried that if interest rates do go up to say 10% or above after 5 year fix ends that I would really struggle/wouldn't be able to manage repayments (over 60% of take home pay). What would be my options if this happens? How easy would it be to extend my mortgage term or switch to interest only? Should I opt for a ten year fixed to stop myself having 5 years of sleepless nights worrying about this?

Everyone says that I am worrying about this all way too much and I am getting FTB cold feet at thought of responsibility. I am wise to jump in before a boom starts?

Thanks v much for any thoughts or advice.

30% of take home pay on a mortgage is a bit too high, but sadly not unusual for a single buyer. I wouldn't worry too much about interest rates because they won't rise dramatically in a single leap, it will be a little at a time. Also I don't see any prospect of 10% rates anytime soon - I think 5% is much more realistic. By then you will be able to remortgage and find a better deal, especially as you'll have some equity built up.

princeofpounds

Hi there.

Part 1 - why you are right to worry about things like this.

Most people don't think further than the first mortgage payment unfortunately!

This question is far more important now than it used to be in the past. When middle-aged and older people were buying, it was frequently - this is a generalisation - at interest rates in a 5-10% range.

(Interest rates were at these prices because inflation was running at similar levels - interest rates need to compensate an investor for inflation, amongst other things. This is a simplification but is generally true).

It was somewhat difficult to buy a house as borrowing the money was relatively expensive. However, houses were much cheaper then - this is not a coincidence. The thing that affects house prices far more than anything else on timescales of less than a decade is the cost and availability of mortgage financing. The fact that buyers were typically much younger and with single incomes shows you that it was probably far easier overall than today.

There is one exceptionally important way it was easier than today that is actually just as important as simple pricing - the duration of the 'stress period' was far shorter. This is not a technical term, I am simply referring to the first few years of the mortgage where the outstanding principal of the mortgage (i.e. the amount borrowed and yet to be repaid, not the interest) is still large.

In a scenario where interest rates and inflation are around 8%, the real-terms value of that principle is inflated away quite rapidly. At the end of a 5 year fixed term the real value of the principal will be reduced by a factor of (1-0.08)^5. which is 34%. Pay those (admittedly high) interest payments for just 5 years and you could reasonably expect the burden of debt to drop by more than a third. In 10 years you could expect to own more than half the equity in your house simply for paying interest.

You could therefore also expect that if interest rates surged by a third at the end of the 5 year fixed term you wouldn't be paying any more in real terms than you were at the beginning.

Today, the figure could be expected to be closer to 3%. The principal adjusted by (1-0.03)^5 corresponds to a real-terms decrease of just 14%. Pay your interest for five years and you could only expect the burden to decrease minimally.

So the upshot is that in these financial conditions we should all care so much much more about the danger of what interest rates will be in 5-10 years time. We carry the interest rate risk for far longer.

And whilst I think we can be pretty confident that interest rates will remain low for a couple of years we have NO real idea what will happen beyond that.

But finally on this part - be aware that there is always an element of risk in decisions like this - a house is an investment and a mortgage is a financial product, and so outcomes can be more positive or more negative than you initially expect. The thing to do is to be aware of the risk and plan for it, not freeze into inactivity.

ging84

I think mortgage rate going up to 10% within 5 years is unrealistic, and if you live with that sort of outlook, you simply wouldn't ever risk taking out a mortgage unless it was fixed for life.
I think really what you need to think about is a 5 year fixed the best option in the current circumstances, if the prediction of interest rate shooting up after 2016 do you want a mortgage that will end 2 years after that where your mortgage would suddenly be very expensive.
Where as if you were to take out a fixed term that ended before the end of 2016, you would then have the flexibility to take out a new fixed term before mortgage rates have gone up to a rate that would be unaffordable for you.

Tancred

Moonraker71 wrote: »

I'm in exactly the same position as you OP. I currently have a mortgage of £80k with 13 years left to run; when I eventually exchange and complete in a couple of weeks it will be £160k with 25 years to run. No doubt many people will think I'm absolutely nuts. Single person, sole income and I'm also self-employed –!even more reason to freak out.

I'm a fairly cautious person but in the end it came down to this: I'm in my forties, I've lived in a one bedroom flat for 11 years, have had no outside space for 24 years. I don't want to live like this any more. Quality of life and feeling like I have a peaceful home with a bit more room to swing a cat is more important to me at this stage of my life. And the only way I can move to a slightly bigger property (tiny house) with a garden is to borrow more. I live in the most expensive city in the UK outside London. It's hard enough for couples and families here, let alone for a single person.

As I have 40% equity and I'm extending the term of the mortgage, my repayments will be only marginally higher than they are now (less than 25% of my income) which gives me leeway to overpay when freelance work is good and the comfort of a low monthly payment when times are tight. But I'm hoping to massively overpay and get the mortgage down as much as I can.

Am I worried? Yes and no. No because – I've made this decision so I have to take responsibility for it. So I refuse to get stressed about something I've done of my own free will. I didn't have to do it. But yes, doubts do creep in about future repayments. But the future is the future. I'll deal with it then.

I don't think you are nuts - I wouldn't want to live in a one bed flat at my age (46). I'm married but living as we do in the 'royal' county, prices are sky high for anything remotely habitable. Moving from a terraced to a detached means we'll be paying a mortgage until age 65/62 but I think it's worth it.

princeofpounds

Part 2 - How to think about this risk

We must accept that beyond a short term horizon interest rate predictions are pretty futile with any accuracy. This is especially the case in a world where unprecedented monetary policy (QE etc.) is being conducted.

Certainly we can do no better than the markets. Unfortunately the interest rate markets are being entirely manipulated by the central banks right now (that is what central banks do increasingly now - control the price of money over different time horizons and risk levels). But there isn't much better out there.

So whilst you don't have to go for a 10 year fixed, it is definitely worth looking at their pricing. They represent the market's best estimate of the cost of a mortgage over that time period. They are currently higher than short-term mortgages because the expectation is that borrowing prices will go up over time.

Treat it as a base case scenario, not a worst case scenario, for that is what it is. But don't assume you have to feel comfortable with imagining such payment levels either.

I am worried that if interest rates do go up to say 10% or above after 5 year fix ends that I would really struggle/wouldn't be able to manage repayments (over 60% of take home pay

This is a really helpful stress test that represents the next approach I was going to suggest - using historic interest rate ranges for worst case scenario analysis. We can't predict where interest rates will be far out, but we can suggest where they may be.

Apart from a brief couple of months, 10% is about the highest they have been in the in the last few decades. So it's a useful stress test, probably more aggressive than needed.

Let me just say that many first time renters in popular cities like London do pay up to 60% of take home pay in rent. So I would consider this a survivable amount if you are relatively young, do not have dependents, and are not paid total peanuts. Remember that if you have any ambition for career progression you should be in a better place for earnings in 5 years time. Remember also that this is a pretty realistic worst case scenario on a 60 year basis, not a rose-tinted spectacles one that only looks back 20 years or so.

Basically, with your huge deposit you are in a very strong position, especially if you can anticipate earning more as your career progresses.

princeofpounds

Part 3 - some thoughts on comments in the thread

Interest rates won't rise to 10%, they will be kept low because it would bankrupt too many people if they went up significantly - any political party that allowed this to happen would be committing suicide.

This is probably true. Unfortunately if rates were kept lower than the global markets demanded then what would happen instead is that the pound would rapidly depreciate. This would make imports increasingly expensive. Inflation would accelerate.

The goverment of the day would then be stuck between a rock and a hard place. Raise rates and bankrupt people, or keep rates low and starve them of food, energy and consumer goods (depending on our trade balances at the time).

That's more or less what happened in the early 90s when rates DID shoot up, even though it totally nailed mortgage borrowers at the time.

At the moment we are going for a soft version of the latter option.

Somebody ends up paying the price for subsidising borrowers in the long term!

Plus if it did look like rates were going up during your 5 year fix you could sell the property at profit because of the boom.

Generally financial market moves are coincident, they don't give you time to react in that way.

Also while you are on the fixed rate try and overpay as much as you can/are allowed to on your mortgage as that will put you in a better position when you come to remortgage

This is what people are 'supposed' to do during periods of low rates to help reduce the 'stress period' of their mortgages. Of course it usually doesn't happen! As I pointed out most people think only of the first payment. If it's cheap, don't think about paying more principal off, think about borrowing more

30% of take home pay on a mortgage is a bit too high, but sadly not unusual for a single buyer.

I think you are living in another world (or maybe just the North ;-) )

Young people starting their careers routinely pay 40->50% of income on housing now, whether rent or buying. The old 1/3rd rule of thumb doesn't really work any more.

Tancred

princeofpounds wrote: »

I think you are living in another world (or maybe just the North ;-) )

No. I live in the 'royal' county - the most expensive place outside Greater London.

princeofpounds wrote: »

Young people starting their careers routinely pay 40->50% of income on housing now, whether rent or buying. The old 1/3rd rule of thumb doesn't really work any more.

I'll be paying 19% of take home pay on all housing costs (mortgage, council tax, estate management charge and house building and contents insurance) once I complete my current purchase on a 3 bed detached house.

But then again I'm not young - I'm 46!

Paying 50% of your post-tax income on the mortgage alone is asking for severe trouble. Avoid. How could you possibly afford to drive or take a holiday? Even a meal out or going to the cinema become a struggle!

Lizling

Tancred wrote: »

Paying 50% of your post-tax income on the mortgage alone is asking for severe trouble. Avoid. How could you possibly afford to drive or take a holiday? Even a meal out or going to the cinema become a struggle!

Not necessarily. It depends on your individual circumstances.

BitterAndTwisted

I'd only truly worry about being able to afford the mortgage should interest-rates soar if I was buying a one bedroomed property. If the S was to hit the fan a lodger could always be found, and that would mean an absolute minimum of £300 a month extra income with no tax to pay on it.