100% Cash - how do I plan my mortgage/finances

funkey_monkey

Hi,

I'm looking to buy my first property. I'm in the foruntate scenario whereby I can afford to buy the property outright with cash (and I still would have sufficient in reserve for rainy day scenarios like a car break down, property maintenance, etc and also to maintain a balanced lifestyle).

However, I don't feel that this would be the most sensible use of my money, as although it would leave me debt free I wonder if it would be smarter to invest the money and take out a normal mortgage in the hope/expectation that the returns on the investment would exceed the accrued interest on the mortgage.

Another alternative would be to put down a deposit and then obtain an offset mortgage for the remainder of the cost. Offsetting an equivalent amount against the mortgage would mean in effect I pay no interest but have a significant amount of near cash which can be called on if a scenario arose requiring it.

I'll only get one shot at this - any suggestions or opinions as to which is the best way to proceed?


Thanks.

ellie27

I am no expert at all, and have no clue about investments.

If it was me, I would buy my house full in cash. That would be assuming I did feel I had plenty savings left. Also I would only do it if the savings could be built up again pretty quickly from my income each month.:beer:

jb66

Id buy another house outright and rent it out, then use the rent to pay the mortgage on your own house

funkey_monkey

Thanks for the replies. I'd prefer not to buy another house as I don't feel that I want two properties to maintain and look after.

Yes, I could buy the house for cash, but if I used an offset I'm essentially doing the same but dripping my payments over the mortgage term. (I'm making the assumption here that lenders would accept 100% offset.

No other suggestions?

cns06

Can you advise on the sums involved?

funkey_monkey

Looking to buy a place for £150k to £170k. Savings of £250k. Approx £60k of this is in ISA's. £10k in shares. Remainder in crap savings accounts.

TrickyDicky101

The offset mortgage approach would sound ideal to me. There's no risk involved and little expense unless you decide you need to use some of the money that otherwise would be fully offsetting the loan.

You also retain the ability to invest your surplus cash elsewhere should you wish to take greater risks with it.

EDIT: this next bit is in the context of taking a normal mortgage and then investing the £170k cash you have elsewhere eg in Stocks&Shares:

I wouldn't want to take a mortgage if I didn't need to as that would be a built in cost that you can avoid. Sure you might be lucky and make investments that return more but you might not (and probably wouldn't).

pinkteapot

I would ask your question on the savings and investments board - there'll be good ideas over there about investments that could offer a higher return than the interest rate you're paying on the mortgage.

With mortgage interest rates currently low, it makes sense to take out a mortgage at say 2.5% as even the most basic stocks and shares ISA should return more than that per year over the long term. Back when I went to uni, some of the rich kids took out their student loan that they didn't actually need because the interest rate was so low, so they took it out to invest the money!

I wouldn't buy a second house as then you're putting all your money into property. Would be better if you can diversify your investments.

You'll want investments that you can get out of (some degree of liquidity), so that if mortgage rates go up and it no longer makes sense you can sell out and pay off the mortgage (be aware of early redemption charges, but these tend to apply in fixed rate etc periods so increasing rates wouldn't be an issue).

funkey_monkey

Thanks - yes, as it currently stands most of my investments are not making much in terms of % gains. The saving accounts are all hovering around the 1.0% - 1.25% mark. ISA's are about 1.5% and the shares are all over the place.
I believe that most of my cash in savings (approx £150k) would generate more for me by reducing the interest accumulated on a mortgage rather than their current output.

Unfortunately, I don't know enough about investing in order to make a wise choice.

racing_blue

If you google "mortgage your retirement" there are some interesting views about this.

As I understand it, the basic assumption is that equities have historically outperformed other forms of saving and investment and might be expected to continue to do so.

Once you have accepted that, it makes sense to achieve your lifetime target investment in equities as young as possible, because of the power of compounding. It is often claimed that if someone invests in shares from age 20 to 30 and then stops, they will have more at retirement than someone who invests the same annual amount from age 30 right through to age 65.

In reality, many people do the opposite - they buy a house, pay off a mortgage and it is only in their 40s and 50s that they start to accumulate significant equity investments, usually in a pension. But acquired late, these investments have less time to compound.

racing_blue

Here is text from the article:

Mortgage Your Retirement--A Commentary by Ian Ayres and Barry Nalebuff

(This essay originally appeared in the November 14, 2005, issue of Forbes.)
Conventional wisdom offered to retirement savers is to start out at age 25 mostly in stocks, then wind down to a bond-heavy portfolio at age 65.

This strategy, we think, is too tame. You should be more than 100% in equities when you are young. An exposure of 200% to start would be a better idea. That's right--if you are young, you should be buying on margin. Pay down the debt as you age and then ease off to a 50-50 stock-and-bond mix at the beginning of your retirement.

Margin buying? For retirement? It sounds terribly risky, but it in fact reduces the risk that you will end up poor. And it leaves you with much better diversification across time.

It is obvious that you're not well diversified if you invest $100 in one stock, $200 in another and $300 in a third. You'd have less risk investing $200 in each of the three stocks. Indeed, spreading risk over stock is what leads people to buy broad-based index funds.

The same idea of equal investments applies to investments across time. If you have $100 invested in year one, $200 invested in year two, and $300 invested in year three, you have too much exposure to year three and not enough to year one. This is what you get if you put $100 a year into savings and stay fully invested. You could get the same exposure to the market with less risk by owning $200 worth of stock in each of the three years. You could do this by buying on 50% margin in the first year, paying off the debt with your year two savings, then going to 33% cash or bonds in the third year.

Most investors have a lot less at risk in their retirement accounts in their early working years than in later years. In essence, they're missing an opportunity to diversify across time--they're putting too large a bet on the return on stocks in later years.

At first, it seems that this is just a fact of life. You can't have an equal amount invested in all years, because in the early years you can't invest what you don't have.

But this ignores the possibility of leverage. People invest what they don't have all the time when it comes to real estate. A 5-to-1, 10-to-1, even 20-to-1 leverage is becoming the norm. A person who buys a $600,000 house has a relatively flat exposure to the real estate market. The exposure grows only with house price appreciation and not with increased savings. The key is that your exposure to the real estate market is based on the full value of the house, not just your down payment or your current equity position.

Retirement accounts should take a lesson from home ownership. Retirement programs should allow people to take out retirement mortgages to buy more stock when they are young. Just as home mortgages become less leveraged over time, so would the retirement investment mortgages. Tax rules may inhibit, if not prohibit, margin buying in IRA and 401(k) accounts. We certainly know of no 401(k) doing this. Outside a tax-sheltered account, you can do 2-to-1 leverage in stocks, but no more.

To test how our theory would work in practice, we took historical stock-and-bond-return data collected by Robert Shiller and added margin rate information. Following Shiller's approach, we ran simulations on the returns for 91 cohorts of workers, those retiring in 1913 through 2004. We calculated the real investment return (the return above inflation) from an investment strategy that began with a 2-to-1 leveraged investment in stock at age 25 reducing to an unleveraged 50% investment in stock at age 65. We found that none of the cohorts ended up with less than a 2.5% real return on their investment (and only 2 of the 91 cohorts fell below 3%). In contrast, what would seem to be a much more conservative strategy of starting with an 85/15 stock/bond split at 25 falling to a 15/85 stock/bond split at retirement produced 29 cohorts with real returns that fell short of 3%. Because of the longer investment in equities, the average real return for the leveraged strategy across the 91 cohorts was more than double the conservative strategy.

In real estate the most important rule is location. For investments, it's diversification. Investors understand the value of diversifying across domestic stocks and many appreciate the advantage of including international stocks in their portfolio. The big missed opportunity is to do a better job diversifying over time, getting an early (and leveraged) start in stocks. We do this with houses, so why not stocks?