“A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain.”
Whether to buy your own home or not is a tricky question for anyone wanting financial freedom.
Now that might seem to some a mad statement; in most English speaking countries, buying a house to live in is a rite-of-passage, and while these days renting doesn’t quite conjure up visions of a harried mother washing tired clothes in a tin bath while four kids sleep head-to-toe in a single bed behind her, it’s still frowned upon.
Indeed – and ironically – the British love affair with property has blossomed into Buy-To-Let (BTL), where renting is perfectly acceptable as long as it’s not you doing the renting. These nouveau landlords had better hope the rental sector doesn’t return to its bad old image of multi-occupancy squalor and sordid bedsits. (When most people want to buy their own home, just like you, it’s a daydream to believe that sufficient millions of your peers will put this aspiration aside just to rent from hundreds of thousands of similar new BTL investors and make you all rich.)
But leaving aside for now being a landlord – which can certainly make great money if you buy at the right price – what are the pros and cons of owning your own home to live in?
- You get your own house, which you can live in how you like
- You get to live in it rent free, which can be a massive saving over time and is particularly beneficial when you’ve retired
- A house is an asset that will likely appreciate over time
- You have to pay for its maintenance and upkeep (which can be as much as 10 per cent per year)
- You have to buy it
The problem with buying a house
That’s an unusual list above, isn’t it? Most commentators will bang on about how renting is dead money, and move on to compare mortgage rates and then choosing between carpets versus floorboards. But have you ever worked out just how much a house bought with a mortgage costs you?
Consider a £220,000 3-bed semi-detached home. Assuming you’ve a 10 per cent deposit, you’ll need to borrow £200,000. At the time of writing, you can get fixed rates of about 7 per cent over 25 years – historically fairly good value. Even so, the total cost of that £200,000 over 25 years is £425,000. Quite a number!
Consider also that:
- Few people in Britain fix their mortgages for 25 years, so our buyer may end up paying more (or less)
- House prices are historically at their highest ever level versus average earnings
- Unlike previous generations, today’s buyers get no tax relief on mortgages
- You don’t own the house until you’ve paid of the mortgage
- Mortgage means literally ‘death wage’
Equity, gearing, inflation and loadsamoney
If buying a house is so expensive, why has it made so many people better off?
There are various reasons; even the simple answer is a combination of the country as a whole becoming richer, people choosing to spend more on housing, a growth in the total number of households (due to divorce, later marrying, and immigration) and, crucially, inflation.
The later made today’s 60-something’s fortunes. Returning to our example above, a £200,000 mortgage would be paid off via a repayment mortgage in monthly instalments of around £1,400. But if inflation is running at 8-10 per cent – as it has on average for the past 30-odd years – then everything from wages to the price of bread rise fast, and that monthly repayment soon becomes much more manageable.
Inflation is why the older generation say that the first years of paying a mortgage are the hardest, and why your dear old parent’s or grandparent’s final payment on their mortgage was doubtless a laughable tenner. (Remember though that when they bought their house, £10 might have been a weekly wage).
We all have relatives who bought houses in the 1970s for the price of a sofa today. That’s inflation. But in real terms (that is, in today’s prices) the growth in property prices has been much more modest – and over time less than the stock market.
Inflation is the reason why it’s historically made so much sense to borrow large amounts of money from the bank – called gearing – to buy a house. (Apart from the practical reasons of few people having £200,000 on tap!) Because house prices and wages have grown so rapidly thanks to inflation, the value of previous generation’s debt has been reduced both in real terms and relative to the house buyers’ income.
Nowadays the Bank of England is committed to keeping inflation at around the 2% level. If it succeeds, the inflation debt relief of yesteryear can be consigned to the history books.
Despite this I still think buying your own house is the right move. But only if you buy at the right time, and in the right way.
Why you don’t want to rent forever
All things being equal, renting means paying off someone else’s mortgage or otherwise giving them an income – that’s why your landlord is happy to rent a home to you. (He may not have a mortgage, of course, but the principle is the same). If you buy your own home, you eventually gain an asset (the house!) that’s worth something, and you get to live in that house for free. If you expect to live another 30 or 40 years, the latter is obviously of huge benefit. Rent-free living will help with your retirement!
However in today’s low inflation world we’re still learning the rules. At the moment, people are paying huge sums for properties in the UK, between six to seven times average yearly wages (the long-term trend is about three and half times). And not only are they paying more – because of lower inflation, they’re going to find the debt takes a lot longer to clear. By my reckoning (which also considers the cost of buying versus renting), UK residential property is between 35 to 50% overvalued.
It’s incredibly hard to buy and sell at the troughs and peaks of any market, but it’s a good idea to at least buy at an averagely okay time. At the moment, I see no reason why house prices won’t come down – just like they did in the early 1990s.
Forget reasons of supply, immigration, green belt restrictions and so on. Such factors would indeed increase the value of housing but not overnight. What’s more, you’d expect to see rents rise nearly as fast if places to live were in short supply, and they haven’t. On balance, it seems likely we’re in a speculative bubble, fuelled by the record low interest rates of recent years and the arrival of Buy To Let investors scared of the stock market.
To buy or not to buy?
In general, you should buy your home rather than rent it. But this is not the time to be valuing houses for the purposes of a 25-year debt – a debt that in my opinion could seriously damage your wealth. For most young people, taking on a debt of several hundred thousand pounds will dwarf any savings or investments they have elsewhere, and immediately send their net worth negative. You only want to do that if you’re pretty sure prices will keep rising and thus make taking on the debt profitable. Save aggressively if you decide not to buy. Drink your deposit away and you’ll be no better off after any price crash than before!
If you’ve a lot of money and you still want to buy, you could hedge your bets by purchasing or even downgrading to a smaller, cheaper property. That way you’ve still ‘skin in the game’ if prices keep rising, and provided you save and invest the difference in mortgage payments between your house and the bigger one you might have bought, you’ll be growing other assets to help you upgrade in the future whether prices or not.
Perhaps the most difficult decision is faced by those who already own a property and are convinced that prices will fall. Personally, I’d stay put rather than selling up and renting. In most cases, the mental pain of any ‘paper’ fall should logically be tempered by thoughts of the paper gains from previous years – and once you’re on ‘the ladder’, reductions in the price of your own house will be matched by the price of the next house you buy falling, too. It’s notoriously hard to time the correction of apparently over-valued markets like property, even to the year, and selling and moving into a rented property is an enormous hassle. It can also be expensive – you’ll have to pony up agents and solicitors fees, removal and perhaps storage costs when you sell, and much the same plus the dreaded Stamp Duty to pay when you buy.
For Buy To Let investors with existing properties and cold feet, selling won’t be so much hassle – it’s your tenants who’ll be forced to pack up and move out. Remember Capital Gains Tax will likely be payable though, which may be substantial, even after the various taper reliefs you’re allowed. If your rental yield on your property portfolio is still positive (that is, rents are covering your mortgage costs plus maintanence and management fees) and you’re confident you can sit out any turbulance for the long term, you may well decide it’s safer and likely more profitable to stay put.
Living with – as well as in – your decision
Thoughtful readers may note that anyone renting who considers buying but decides not to on fears of price falls is also timing the market (which I’ve said is extremely difficult to do, and therefore not advised), and that if they bought tomorrow they would move into the ‘on the ladder’ category of home owner, where the advice is to stay put. There’s a contraction there.
Actually, the situation isn’t so clear cut – a new buyer would face costs that an incumbent owner doesn’t (fees, stamp duty, and very likely a higher mortgage rate at the time of writing), and these will increase the relative risk of buying into the market versus simply sticking out any correction. But I agree it’s quite impossible to judge with certainty what’s for the best when faced with a bubble market. Anyone taking on a mortgage at four or five times their annual salary is sinking a huge stake of their future net wealth into a bet that they won’t be able to buy cheaper over the next few years, not to mention leaving themselves vulnerable if economic conditions deteriorate. Equally, sitting out the market carries the real risk of prices accelerating away even further.
As with everything on Monevator.com, it must come down to your personal judgement. The only strong advice would be to be sure you are making a decision, not simply doing what everyone else does, either way.