Buy outright or mortgage? (Opportunity cost of money)

Rupertf

Hi there, hope someone can help me please.

About 7 months ago I came into £350,000 by way of inheritance. I’m 32, married with 1 child and have my own home with only a small mortgage. As I’ve been dealing with grief I haven’t really given much thought to how to use the money, but before Christmas I’ve now (as you do) made a New Year’s resolution to do something with it.

I went to the local branch of my high-street bank (where I have the money sitting in a current account) today for a financial advice session. I’d already decided that I’d like to buy another home, something to rent out and ultimately give to the kid(s) when the time comes. I’d already viewed a property last week which I’m interested in.

Anyway, the advisor I spoke with made a compelling argument for getting a mortgage rather than buying outright, which initially had seemed counterintuitive to me, as I have the capital. Now I must admit I’m not that financially-savvy, but it seemed to me like he made a good point about what he called the “opportunity cost of money.” He explained that by buying outright I’d really only be saving myself (or ‘making’) the interest I would have paid on a mortgage, which he said is about 3.5%. He then went on to explain that by getting a mortgage and keeping 90% of the capital with me, I could invest it and grow it by more than the 3.5% I’d be saving (‘making’) by buying outright.

I confess he had me pretty much fully-subscribed to this, but then he began trying to sell me a mortgage (or at least size me up for a mortgage in principal). At this point I started getting cold feet, thinking he’d just told me what I needed to hear in order to jump into buying something from him. I gave him a firm “no thanks” and decided to come here for help.

Where do I go next please?

tom9980

He is based on past history correct, especially if you put it in a pension and get extra contributions from the government and maybe employer on top. But you are right he was trying to convince you to take a mortgage with his bank so he could gain commission or hit a sales target.

Personally I would advise you to look at your pension provision first, then consider buying a nicer place to live in. I wouldn't at this time advise anyone becoming a landlord given the changes the letting industry are about to undergo in the next few years.

I would look on the savings and investments sub forum for further advice than here.

SpiderLegs

Rupertf wrote: »

Where do I go next please?

Presumably you have understood the requirements for being a landlord and worked out a business plan for this venture?

Your OP reads little like you got up one morning and just decided to start a BTL business. I do hope that’s not the case.

JayRitchie

As said above look at pension provision. What percentage tax do you pay? You are normally better off making use of pensions - so you might pay cash for a house and use the income to pay extra into a pension scheme,

daveyjp

The one thing you lose by buying a property is potential liquidity should you need money quickly, Selling property is expensive and takes time, remortgaging also takes time.

Investing to achieve in excess of 3.5% at the moment will involve an element of risk as no one is offering a guaranteed 3.5% return. You can lose as easily as you can gain.

I'd go and see an independent financial adviser, rather than a mortgage salesman before touching the money and look at your financial matters in the round.

ThePants999

Sorry for your loss

The advisor told the truth - at least, he gave you one way to look at it - but it depends on your attitude to risk.

Option A, you buy a house for £350,000. Option B, you buy the house for a £100,000 deposit and a £250,000 mortgage at 3.5%, and invest the other £250,000. Because you HAVE that option B, you're effectively getting the rental income (net of costs) from the first £100,000, so with option A, you're spending the other £250,000 on simply not having to pay the mortgage interest on £250,000. That basically gives you a guaranteed 3.5%. With option B, you'll typically get something like 5-7% on your £250,000. BUT - you might get a good chunk more than that, or you might get less. You might even LOSE money.

Imagine two possible futures. In one future, you chose to invest, and the investment went DOWN 1% a year, losing you money, when you could have earned 3.5%. In the other future, you chose to buy outright and earn 3.5%, but markets were good and you could have earned 10% by investing. In the first scenario, you're down 1% in absolute terms and 4.5% in relative terms. In the second scenario, you're up 3.5% in absolute terms but down 6.5% in relative terms. Which feels worse? Your answer will help you understand how risk averse you are. There are plenty of people who would hate to lose a penny and want the guaranteed 3.5% even though they're losing out on average, and there are plenty of people who want the best expected return even though things might go wrong. There's no right answer.

However, IMO you should consider option C - invest the lot. Unlike investing, getting into the lettings business isn't free money, it's a bunch of work, and has risks of its own. You have to pay an additional 3% stamp duty when you buy the house. You're running a business, and you're subject to a whole lot of law you need to become familiar with. You're responsible for all the maintenance on this house. Your tenants might trash the place. Your tenants might not keep up with the rent. You might have a long period with no tenants (and no rent) while still incurring costs. Some people are fine with all of that, but some people don't really think about it and sleepwalk into the lettings business thinking it's a lot easier than it is.

Also, a house is a poor thing to give your child. I guarantee it won't be the one they would choose for themselves, but they'll feel pressured to keep it anyway. And even if they do sell it, they'll lose all the benefits of being a first time buyer. Oh, and don't forget the capital gains tax. Much better to give them the money to buy a house of their own choosing!

Moneyminded

You admit that you aren't financially savvy so before making a decision what to do with the money research your options and take the time to consider the best course of action for you and your family. If you are still grieving take some time to really think about it. As others have mentioned speak to an independent financial adviser who will be able to talk you through all of your options rather than trying to sell you a specific product.

A little time spent now to really think through your options could ensure peace of mind in the future. Don't do anything with the money until you feel comfortable you fully understand all your options and you have made an informed decision on what is best for your future.

AdrianC

Rupertf wrote: »

I went to the local branch of my high-street bank (where I have the money sitting in a current account) today for a financial advice session.

Alarm bell 1.
They aren't anything approaching independent with their financial advice. They are tied salesmen. They can only look at your situation and tell you which of their range of products their computer says you'd be best buying.

I’d already decided that I’d like to buy another home, something to rent out

Alarm bell 2.
You are starting a business. Do you understand this?

It is not your home. It is merely an asset of your business. It will be your tenants' home.

Do you know anything about the tax changes over the last couple of years, designed specifically to make people think about getting out of this industry, not into it?

and ultimately give to the kid(s) when the time comes.

Alarm bell 3.
Apart from the minor detail that you may well have another 70 years before you kick the bucket... Even if you do still run your residential letting business when you die, do you want to inflict it on your potentially by-then retirement-age kids? More to the point, will they want to run your business?

You can, of course, liquidate any investment and buy your kids a home as and when required, should you so wish.

I’d already viewed a property last week which I’m interested in.

Alarm bell 4.
Is this property even remotely suitable for your lettings business? Would you be better looking at several cheaper ones? Or... other investments entirely? Diversification!

Anyway, the advisor I spoke with made a compelling argument for getting a mortgage rather than buying outright

Of course he did. And I'm sure the commission on a £300k BtL mortgage is negligible and absolutely no incentive...

Now I must admit I’m not that financially-savvy, but it seemed to me like he made a good point about what he called the “opportunity cost of money.” He explained that by buying outright I’d really only be saving myself (or ‘making’) the interest I would have paid on a mortgage, which he said is about 3.5%.

Let's not forget the income tax...

I could invest it and grow it by more than the 3.5% I’d be saving (‘making’) by buying outright.

And did he promise to find you a low-risk investment product (more commission!) which would reliably return 3.5% after tax...?

Where do I go next please?

Here - https://forums.moneysavingexpert.com/forumdisplay.php?f=17

sst1234

That’s a large amount and your knowledge of money basics is so sparse that you should do nothing without consulting a financial advisor. That’s not trying to be cruel, just helpful. You shouldn’t just get up one morning and proceed with spending £350k if you haven’t taken any interest in the economy and financial markets for the last few years.

The_Earl_of_Streatham

You shouldn’t just get up one morning and proceed with spending £350k if you haven’t taken any interest in the economy and financial markets for the last few years.

Best give it to an independent financial adviser who for a fee will be happy to invest it for you until it's all gone.

ciderboy2009

Where is this £350k currently? Hopefully you've got it spread out around different banks with no more than £85k in any one bank - particularly as it looks like you've had the money for more than 6 months so are outside of the extended 'life events' protection.

https://www.moneysavingexpert.com/savings/safe-savings/