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Today I want to talk about Mortgages.
Mortgages are something that haven’t concerned me until recently, when I started talking informally to a Financial Advisor who happens to be a family friend. I knew that mortgage rates varied depending on LTV (loan to value – i.e. the size of your deposit) and there were many different kinds – Trackers, Fixed Rate, Variable Rates etc.
The one thing that I knew very well was that unless you had a deposit of around 15%, you could end up paying a ridiculously high interest rate – 7% or higher! There are numerous financial establishments in the UK, priding themselves on offering ‘fantastic’ 90/95% mortgages to first time buyers. Various slogans accompany adverts such as ‘stop paying someone else’s mortgage – get your own house today’. But is it worth it?
Lets look at an example. I will use the example of my own situation for transparency and will not bother converting this post to dollars (sorry international readers, but the currency doesn’t matter on this one). One other thing to mention before I start – I view ‘mortgage interest payments’ to be equivalent to ‘rent’ given that it is an expenditure with no return.
Mrs Scot and I are currently paying £825 in rent a month. Council tax sets us back an additional £150 a month totaling £975 pm. These payments leave us with no equity whatsoever. We currently live in a one bedroom maisonette and our house is cramped to say the least.
Upon discussing our first home, we decided our requirements were
- 2 bedrooms
- Decent Sized Living Room
- Decent Sized Kitchen
- Dining Room
We started looking at the housing market and potential places to live by using PropertyWide. We concluded that we would need about £180,000 to buy our first home.
Let’s put these figures into perspective with one of the first time buyer 95% mortgages.
7% interest on £171,000 (we would have to save £9000 for a deposit) per year equates to almost £12000 interest per year – or £1000 per month. Thinking of interest as ‘rent’ – This is crazy! We would be paying £175 more a month before making any capital repayments! We dismissed the idea pretty quickly.
This was until my F.A. suggested something clever. Why not take equity out of one of my parents houses for a deposit and repay them separately, hence unlocking a lower interest rate from your own mortgage – Simple! Why didn’t I think of that before? It’s not an idea that you hear banks suggesting everyday – then again why would they?
By taking 15% of the house value (£27k) from one of my parents houses, we have been able to unlock a 4.19% Mortgage for the remaining 85% of the value. Effectively we have a 100% LTV mortgage at a combined rate of about 4.15%. This leaves us paying £7470 interest per year – or £623 per month. Not only is this over £200 less ‘rent’ than we pay now, the house is bigger, comfier and it is our own! And the council tax in the area is £50 a month cheaper – Total Saving £250 p/m. How incredible is this!! The situation will only get better over time given that as we make capital repayments, the interest portion of repayments will continue to decrease.
I have had a few friends and ‘friends of friends’ ask my opinion on if they should rent or get a mortgage. My advice is simple and as follows:
- Work out how much interest you would pay each month on a mortgage for your idea home
- Work out how much interest you would pay each month on an equivalent home to where you are currently renting
- Compare these figures to how much rent you currently pay
Depending on what these figures are, you can make an informed decision. For example, if you cannot afford the monthly payments on your dream home, consider first buying an equivalent property to your current rental.
Let’s look at the following example:
- Your current rent is £700 p/m
- Your dream home costs £250,000 and you cannot afford mortgage repayments of £1340 p/m
- An equivalent home costs £150,000 with mortgage repayments of £804 p/m
Moving into your dream home is currently out of the question. You cannot afford it. Really you have two options – continue to rent, or buy a smaller place before your dream home. The equivalent ‘rent’ on buying the equivalent home works out at about £520 – You can make interest and equity repayments on a home for the same price that you are currently renting! Crazy.
Please note that even if you already have a mortgage, with historically low interest rates refinancing is always a good option. Take advantage of a mortgage refinance calculator available online to find the best deal.
Of course not everybody can get a mortgage – but there is a myth that a lot of people think they should wait until they have a massive deposit. This is not always the case – Work it out for your situation 🙂
Over here they charge extra insurance fees if you put less than 20% down. I know some people do get other financing to reach that level though.
I think most people’s problem is that they do want their first home purchase to be their dream home. So they over-commit to a mortgage that they cannot really afford. It is much better if you first get something smaller. You could later resell that smaller home or use it as a rental property.
Jeremy @ Modest Money recently posted..My Decision To Live In An Expensive City
It’s sad that home ownership is such an expensive undertaking in some countries, e.g. Scotland. It’s pathetic that it’s so expensive in Canada and just proves that we’re in a massive bubble — we have nothing but land over here. People don’t seem to understand that reality, and they’ll pay anything to get a dog kennel in-the-sky in a bloated market like Vancouver or Toronto.
Joe recently posted..Blog Party #4 – The TurboTax Contest Finale
So true – I love that expression ‘a dog kennel in-the-sky’ – Will definitely be borrowing that one 😀
lol feel free — I got it from a commenter on “http://www.canadabubble.com” which is, by the way, an amazing site. Extremely funny stuff if you want to laugh about the Cdn predicament. A condo apartment here should not cost the same (or more) than a “flat” in England. Canada has nothing but land – we have something like 10 million square kilometers and only 30 million people. Our price:rent ratios and price:income ratios are at exorbitant highs. Kooky.
Joe recently posted..Remember the Positives
Some good content on that site – will add it to my ever expanding reading list 😀
Your land:people ratio is mental! Everyone should have massive estates 😛