“Should I buy a house in London? Rent is dead money, I better get a mortgage. But London house prices are so expensive! it’s a bubble! Waaah!!”
I hear these arguments very often from people who either want to purchase their first home or upgrade to a better one.
For the most of us, buying a house will be the biggest financial transaction in our lives. Therefore, there’s lots at stake, a huge margin for errors and great opportunities too.
Why buying now is the best thing to do?
Pleasure of living in your own house
Living in a house you own provides this awesome feeling of owning your place. You can drop walls, buy quality furniture and customize it exactly the way you want it. It’s the dream environment, your nest that provides comfort and calmness in life.
If you enjoy some DIY and want to be more hands-on with your living space, buying a house is great!
A mortgage may seem to be lasting forever. However, after typically 25 years you own the goddamn place. This means you’ll be living for free for the rest of your life.
Home can be a good investment
From the investment point of view, “renting is dead money”. You can either buy a house and get a mortgage or instead pay someone else’s mortgage.
House prices have an upward trend in the history of Britain, and more prominently in London. If you had owned an average £245,351 property in Apr 2009 and sold it for£481,648 in 2016, you would have doubled your money! An 8.5% return on investment (ROI) year-on-year. Not bad at all.
It’s actually much higher than that if you have a mortgage. Reason being is that you benefit from the whole appreciation despite having put only £25,000 (10%) deposit in the first place. The technical term for this is leverage. Something very powerful that makes property investment one of the best asset classes out there.
Plus you are enforced to invest since your asset is reinvesting its own profits automatically. Owning a house makes sure you won’t reap any stock profits and buy a new car. Instead, you will leave the compound effect to do its magic.
Tax-free selling asset
Last but not least, here in the UK, you don’t pay any taxes when selling your own house. It’s called “Private Residence Relief”.
So if the plan is to sell your home after 5-10 years and move to a more affordable place on earth, zero tax is quite convenient, isn’t it?!
Despite having to pay the unavoidable stamp duty tax, the UK government wants to help the first time buyers, as well as homeowners, buy their own home. Here are the useful schemes:
- Help-to-buy ISA: Offers £3,000 bonus every year if you set aside £12,000 when building a deposit. Basically, they boost your savings to help you gather a decent deposit.
- Shared Ownership: If you cannot afford a mortgage on 100% of a home, you can buy a share of it (25% – 75%), and pay rent to the government on the remaining part. Then later you can contribute more and buy more of your home.
- Help-to-buy Equity Loan: The Government lends you 20% (or 40% in London) towards buying a new built home. You are not charged any loan fees for the first 5-years on this 20% loan. This makes buying much more affordable since you only need to deposit 5%. And because a picture is a thousand words:
Why prices go up?
There are a number of factors driving property prices up in London
Huge demand & low supply
The whole problem (or advantage depending on how you look at it) in London is that (almost) nothing gets built. As long as the population growth outstrips the new supply of homes, London house prices will go up.
Here in the UK, we need to be building 250,000 houses every year. Yes! 250,000!
For about a decade we are not even half way there. Why? Because of planning permissions issues, bureaucracy, lack of available land, and not enough skilled people and materials needed.
The ultra-low-interest-rate makes mortgages very attractive. As of Jan ’17, the Bank of England interest rate is set to 0.25%. This means that a bank giving you a mortgage at 2% actually charges you very little if we account for ~1.6% inflation.
That’s free money!
Weak pound attracting foreign investment
Brexit is happening. Uncertainty is part of the story and nobody knows what’s on the horizon.
For this reason, the pound as a currency has dropped quite a bit. From the 1.40 pre-referendum levels against the euro, it’s around the 1.15 mark now.
This is something that makes the rest of the world want to invest their money in London since everything sells at a 20% discount! London property market is considered as a safer investment than cash. Which brings us to the first argument: higher demand -> higher prices.
London is a global financial centre. The UK economy is one of the most dominant in the world and this is reflected in the house prices. In addition to that, the property law system is one of the oldest and most stable in decades (solicitors are still terribly slow though!).
So, buying a house is great.
Of course, there will be blips along the way but I doubt rents will become cheaper than mortgages for some time. Therefore, if it is to buy a property to live in versus renting someone else’s (and paying their mortgage) it’s an easy answer – how much rent do you pay at the moment per year?
It’s basically “how much rent” vs “how much interest + service charge + ground rent + insurance + maintenance”. We don’t include the repayment part of the mortgage in the calculation – more about it in a moment.
Plus even if there is a house price crash, the price of your property only becomes important if you want to cash in. Only then you need to sell. Something which is more applicable to second homes than a home where you live.
Why buy now is NOT the best thing to do?
1. Rent is dead money, but so is interest
First things first. “Rent is dead money” but so is “interest”. When you pay for a mortgage you don’t get back the interest you are charged, but only the repayment part. A mortgage consists of the repayment and the equity.
Repayment: The amount of money that goes towards owning more of your home.
That’s funny since buying a home means you should own it, but you really don’t until you pay back the real owner – the bank.
When you buy a house with a 10% deposit, every repayment goes straight into your house equity. This means that the next year you will own 12% of it, the year after 14% etc until you own the whole house. Essentially this is your own money and you’ll get it back if you sell your home.
Interest: A fee paid to the bank for lending you the money. Depending on the case, this can be as high as your rent!
This money is as dead as the rent, since you’ll never get it back. Interest is what makes a profit for the lender (bank), and the reason they lend to us in the first place.
2. Stressful Debt
Let’s not forget the psychological aspect of it. Owning a house may feel great, but knowing there is a huge debt behind is always stressful.
An average London property right now costs around £475,000 which means if we put a 10% deposit down, we’re looking at a £672,992* debt mountain!
The £1870 monthly payments are not considered low given the £30,000 average wage of a Londoner. Let’s not forget that if you fail to pay the monthly amount, the bank will take both your house and your initial deposit for life.
The £1870 monthly payment in today’s world (2.29% interest) will cost £2500 when interest rates reach their standard 5% rate, or £3010 at 7%. Can you afford the payment when interest rates rise?
Owning a house is not only fairy tales and warm moments. Of course, these are part of the story but day-to-day there can be issues.
Are you the type of person that can take care of unexpected toilet problems, boiler issues that happen every now and then? I know I’m not 🙂 Or are you happy to pay contractors to get the job done.
The carpets will need to be replaced even if they’ve only suffered “fair wear and tear”. Someone will need to pay for it and there is no landlord to take care of it. Also, maintenance costs not only money but time as well – either to research and fix it by yourself or to hire someone and pay for it.
4. Risk of falling prices
Trees don’t grow to the sky
This german proverb is used in the stock market to show that the larger a company becomes the harder it is to keep growing at the same rate.
It also reminds me that London house prices cannot keep increasing forever. They are supported by the wages which do not follow the prices at the moment.
Prices go up but they can go down as well. We had house price corrections in the past.
According to the Guardian, London house prices now stand at a 14x average earnings (!) That’s record high.
The graph does not look so nice at present. The last thing I want is to buy a £500,000 house and see it go down to £440,000 in the next few years. That would mean I could have bought it at a discount had I waited until the sky-high prices drop to more approachable levels.
Brexit makes matters worse in the short-term. Not because Britain will be worse off out of the EU – it may be a good thing – but because of the uncertainty. Restriction in immigration also means less demand. Markets don’t like uncertainty and it will take at least a couple of years to realize the impact – either positive or negative. Until then, London house prices will probably not increase at previous rates or may even fall. Is this a risk worth taking?
Renting offers a powerful advantage – flexibility. You can move in and out depending on the circumstances. In big cities, like London, this is even more important.
When renting, you can move closer to work which saves both time and money. What if you get a mortgage and you’re presented with a great career opportunity in a different city or abroad? You could always convert it to a buy-to-let and rent it out but things start becoming more complicated than giving your landlord a 1-month notice.
As you have probably noticed, buying a house is not the easiest decision of your life. There are multiple factors and financial questions to ask. If you’re looking for a quick answer, unfortunately, there isn’t one!
If renting costs the same as owning, there is really no question about it. Getting a mortgage would make more sense in the long term. But in all other cases, things get more complicated.
Because of the very high prices, a mortgage in London is usually more expensive than rent. Why not save the extra money and invest it for a profit? Although, if prices go up then you may lose in the long term.
At the end of the day, it’s only money. Depending on how you look at it, it’s only money that will be lost or won.
And let’s not forget about the quality of life you will have when you own a nice place compared to the compromises you will be making when renting.
Given the current London house prices, I haven’t bought a home yet. I have instead, invested the extra money I’ve saved while renting. This provides me with a nice passive income each month and the opportunity to share my tips in another blog post!
But the final call is yours: Will you buy or rent?
*Assuming an average 4% interest rate and 25 years mortgage term
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