The Ghost of Negative Equity will stalk the land again – a cautionary mortgage tale from 25 years ago

What was the dumbest thing an Ermine has ever done in personal finance?

I bought a house in 1989. With an endowment mortgage, a 20% deposit and a 10% interest-free loan from a credit card, which I paid back. The how isn’t the mistake, though it had errors. It’s the when. 1989, and early in my working life.

You can’t go wrong with property. everybody needs somewhere to live. Safe as houses

Bollocks, says the Ermine, with feeling

This is a story from a distant front line for first-time buyers in the first half of their working lives. No prediction about house prices is made or implied, because the market can stay irrational for longer than you can stay solvent.  Most of us will only get three quarter-centuries in our lifetimes, and the first 25 years is wasted on learning how to drive the world, from the mewling and puking stage to young adult, ‘cos humans are slow learners with grand ambitions.

Of all the financial asset classes out there, residential property is exceptionally evil, because we buy the asset class in the first half of our working lives, with borrowed money. For the simple reason that we want the byproduct – it gives us somewhere to live.

If you’re over 35 and think Buy To Let when you hear “house” don’t bother reading this. You are much better capitalised than a FTB, you have more experience, you can make your own risk assessment, and quite frankly if it all goes titsup you have only yourself to blame.

The Ermine is the Ancient Mariner

In Coleridge’s The Rime of the Ancient Mariner the Wedding Guest hears, but does not understand. I was once that Wedding-Guest, in 1989 – people did suggest to me that it might be an unwise time to buy, what with all the frenzy of MIRAS¹. But that’s the trouble with housing, you WANT IT, WANT IT, WANT IT so bad. RENT IS THROWING MONEY AWAY, MUST MUST MUST get on the HOUSING LADDER. So you lose your mind. If this tale is a warning for you, you will not heed it, such is the way. But like the Ancient Mariner, I’ll tell it anyway.

what the housing ladder seems to look like

I’ve told it before in February when my original 25 year mortgage would have been due, but this one has added analysis to show just how badly it could have gone wrong. Imagine, for a moment, some starry-eyed young pup in the pub talking to his mates

“I’m going to borrow a shitload of money – five times my gross salary, if you please, and I am going to stick it on the stock market, in a FTSE100 tracker.”

Hopefully they’d wrestle him to the ground, or at least ask “are you crazy, man?”

Same pub, same bunch of mates, and he goes “I’m going to borrow five times my salary, and I’m going to buy a house”

And everybody around the table goes “hey that’s fantastic, congratulations you’re getting on the housing ladder, woot” and high fives him.

Jenn Ashworth

The Grauniad’s personable Jenn Ashworth tells us that by 31 she’s had 14 addresses. And she’s sick of it. Sorry, dahlink, it’s not that unusual. For an ermine that was

1. parents (SE london)
2. Southside (Sth Kensington halls of residence, now demolished)
3. Earl’s Court shared room three storeys up, gas appliances defective – you lit the oven throwing lighted matches into it
4. Knightsbridge bedsit sublet from someone who did a runner with three month’s rent. The ermine learns that people steal money
5. Different and crummier part of Earl’s Court
6. short stay with parents – 1 hour commute to work, then when I moved to the BBC a 3 hour commute to work. enough to get me out ASAP into
7. Acton Town house shared with four other guys, deposit stolen by landlord, shower powered off lighting circuit so I had to isolate before getting killed/burnt down.
8. Southampton student accommodation (I took time out to do an MSc)
9. Alperton shared with 2
10. Ealing 2 bedsit infested with black slugs. One month’s rent stolen by landlord
11. Ipswich digs 1
12. Ipswich digs 2
13. first Ipswich house this article is about. This is only the second time I had my own toilet and bathroom 😉

I was in my late 20s then. Having lots of addresses goes with the patch of being young 😉

How did buying a house all go wrong for me?

Thatcher and Nigel Lawson

Let’s cast our mind back to what the world looked like in 1989. Nigel Lawson hadn’t discovered climate change or that money was to be had in denying it but he had discovered money, he was Chancellor. There had been a boom going on ever since the end of Thatcher’s first recession (1980-82), the young Ermine had switched jobs a few times as you do in your twenties and discovered that while London was a fantastic place to be young in I was never going to be able to buy a house unless I got a better job than design engineer for the BBC.

So I left to come to Suffolk and work for The Firm, at the time a premier research facility for a FTSE100 company. Fantastic place to work, the pay was better and houses were cheaper less expensive than in London.

Young ermine to world – what is this Boom and Bust you speak of? I have no experience of that, so it doesn’t happen…

You know how kids are absolutely convinced you can’t see them if they can’t see you? Well, that sort of thought error doesn’t always stop at 11. I graduated in 1982 into Thatcher’s first recession. All I had seen over my working life was an improving economy. I started in the pits of six months of unemployment as the economy slowly crawled from the wreckage, then getting the first real job, all around the gradual upswing was the backdrop of what I expected of the economy. So I rock up in 1989, and house prices are rising, the economy is booming, everybody is feeling chipper.

25 years of high living has taken its toll on our Nige. Presumably the Domestic Goddess got her looks from her mother 🙂

That Lawson bloke says he’s going to stop couples getting mortgage interest relief at source. At the time the Ermine was not wise in the ways of the world, so I didn’t join up the fact that this would give everyone Torschlußpanik thus increasing demand² for a short time, leading to a ramp in price.

That sounds incredibly dumb, now. In fairness to my new colleagues, several of them did even highlight that possibly there might be distorting effects due to this policy which might be something to think about. However, in one’s late 20s you’re so flushed with the grand victory of having spent your first 25 years successfully getting a handle on how the world works. And you haven’t had the stuffing knocked out of you by discovering that your map of how the world works has holes, and by itself doesn’t track changes in the world. So you are smarter that everyone else and invincible. The good news for me was I made that class of mistake at the wheel of personal finance, rather than at the wheel of a car…

So I bought that house. With an endowment mortgage, if you please. Single man, no dependants, so the life insurance aspect of the endowment was worth sod all to me, and The Firm’s pension offered death lump sum anyway. A dead young Ermine would have been worth a lot of money to someone.

My parents, bless ’em, had done their bit for my financial enlightenment – although it seems that these days parents don’t bother to share the hows and whys of personal finance mine did.  I knew how mortgages worked and what the difference between and endowment mortgage and a repayment mortgage was. Hell, I even knew what the NAV of an investment trust was and how it could be at a premium or a discount, though I wasn’t to use that knowledge for 20 years. And had been educated in no uncertain terms that an endowment mortgage was a dipstick sort of move. But hey, the LAUTRO saleswoman had pretty green eyes and how can you turn down the promise of a 3x lift on the expected endowment outcome³? It sounded good to me! That’s the trouble, you can know something but not understand it. You can teach knowledge, but you can’t teach wisdom, because wisdom is integrated knowledge. I had always seen things getting better throughout my working life, so I knew that house prices were always going to be rising relative to wages, and I feared getting left out.

Now some of that knowledge was correct, but not for the reasons I understood. House prices were rising relative to wages because of the increasing entry of women into the workforce since the 1980s. Prior to that, a household typically used the man’s wages to pay the mortgage from, but all of a sudden households had more resources available to them, with two incomes coming into the household. What they did with that is throw it down the toilet of inflating house prices, so houses got dearer relative to wages, and everybody moans how hard it is to have children and afford a house these days, because more of the combined household capacity to do work is focused on paid work outside the home. Don’t shoot the messenger – Elizabeth Warren’s book first highlighted to me exactly why I struggled so hard to raise the cash to buy a house. I was a single man, at a decent job, with a 20% deposit and in interest-free loan of 10%. I was fighting couples with two incomes, and that’s not a fair fight, hence the difficulty.

So I purchased the house, settled in, had all the usual shocking costs you have when you buy your first house because you have no furniture (I bought mine secondhand), you have no tools, you have precious little physical capital. I was paying 6.5% on the low start (ARM) loan⁴, and paid back my interest free credit card loan in one year, as required. What I didn’t pick up was that there was a shitstorm. Incoming. Take a look at this

the total costs and savings associated with buying a house. 2012 rebased £ on the LHS, % on the RHS. It also explains why the greybeards have all the money…

It covers a period of a little over twenty years, and shows the inflation-adjusted⁵ to 2012 prices equity, payments and imputed rent of an ermine’s first house

Now every bugger tells you you can’t lose on houses. Take a look at the equity blue line, which shows the difference between the house price tracking the index for that year and what the purchase cost was. For ten long years that line is negative. You can’t lose on houses. Until you do, and then you lose big-time.

In negative equity you cannot move, must not lose your job, and must keep paying the mortgage

Because if you don’t, you get evicted from ‘your’ home, and to add insult to injury, they flog it at a knockdown price, and unlike in the States, they still come after you for the difference. It happened to my neighbours and a few other places in the street. The mortgage company comes along, sticks a notice on your window that this property will be foreclosed on such and such a date, and you’re out on your ear. Oh yeah, and you still have a mahoosive debt that follows you around like a lost dog.

What do all those coloured bars mean?

Although everybody talks about houses as if they were a financial investment and part of your free cash flow, only BTL landlords buy houses as a straight financial investment. The rest of us buy them to avoid paying rent, and give us a place to put all our stuff, watch TV, make love, raise children, all that sort of thing. You can do all that in a rented place too, but since you ‘own’ a house you don’t have to pay rent on the house. Instead you get to pay rent on the money you bought it with. So instead of throwing it away paying it to a landlord you throw it away paying it to a bank.

The red bars represent all the cumulative money I saved through not paying rent to some shyster landlord, estimated at about 4% of the Nationwide adjusted house price and then scaled to 2012 prices by inflation. It is possible these should be adjusted to interest rates, in which case I understate the cumulative benefit of the rent I didn’t pay.

The blue bars represent the cumulative excess that I paid over and above the cumulative amount I would have paid in rent to a landlord⁶, because I am paying it in rent to a bank. This is also adjusted to 2012 pounds, like the rent. I am buying a great big wodge of Stuff, so obviously it’s gonna cost me more than if I just rented the usage of it for 25 years. You can see that even after 24 years I’ve actually still paid out more than I would have done if I just rented. This conundrum is basically why you rent when you are poor. It’s cheaper, and that was particularly the case at a time of very high interest rates, of which more later.

The lime green bars are the equity in the house, the same as the blue line, but tossed on the debit or credit side of the ledger as appropriate.  The value of the rent is the value delivered by the asset, and looking at the blue lines which are the excess paid over the value gotten as rent I would estimate break-even in about 25 years. However, since this is an asset that increases in value and is bought with borrowed money I actually broke even in 2001, when the increasing value of the house added to the accumulated rent I hadn’t paid beat out all the money I had paid to the mortgage company. Note in 2001 I don’t own the house as of yet, it’s just that I could theoretically sell up and breathe a sigh of relief that I hadn’t paid more than if I had rented.

Why was that such a big mistake?

I stayed put for 10 years. Now imagine all the shit that can go on in a life.

• You can lose your job. There was a hell of a recession on in the early 1990s. Look at what would have happened in 1993 – I would have been foreclosed, would have lost £20,000 in 2012 money, would be bankrupt and without a roof over my head. No fun at all.
• If you buy the house in your early 30s the pitter-patter of tiny feet tends to happen in the next decade. Tragically unromantic, but the years after the first child are high risk years for relationship breakdown. If your house is in negative equity you’re going to take a big hit at a rough time
• You have to move for work. Now you get to rent your house out and rent another. There are parasitic costs and voids associated with renting a house out

I was single when I bought that house so I avoided 2 but the other two scared me. For a long time. This graph simplifies things so I assume I have a 100% mortgage. I was dumb, but not that dumb. I had a deposit and an interest-free loan from MBNA, to the tune of 30%, but even so I was in negative equity till about 1995. Negative equity kills you fast and kills you good, because of the leveraged way we buy houses.

Was it just an ermine that got this wrong? No, apparently a million other dumbasses had such an awful sense of timing as I did – but this newspaper article is from 1992, so still in radio silence on the Internet, because the WWW started in 1994.

With roughly ten million mortgage holders, that means that more than one in ten people with mortgages are trapped by debt. They are unable to sell till prices go up. They can’t sell and are stuck. [UBS Phillips & Drew]research analyses house price falls and the number of first time buyers, the group most likely to be in trouble because at least 50% of them took out mortgages of more than 95% of the value of their home.

Rachel Kelly,  “A million first-time buyers caught in mortgage debt trap.” Times 24 Apr. 1992: 4. The Times Digital Archive

I had a 30% deposit (ie a 70% LTV). That wouldn’t have helped me in the suckout, though it did shorten the period of negative equity relative to that shown on the chart, by shifting the line up a bit.

So how does that affect Mr Wannabe 2014 house buyer? Houses always go up. Everybody says my house is my pension.

To be honest, I don’t know why everybody says my house is my pension, though RIT has a good take on that subject. It would scare me shitless if I had housing as a large part of a pension, because you need several houses in different areas to get sector diversity, the baby boomers are going to die off in the next 20 years so their houses will be sold and it’s hardly like I’ve seen property as a great wealth store. Everybody else has it as a religion and who am I to criticise other Britons’ religion as long as they leave me be. Fill your boots guys.

If they’d bought a house worth of the FTSE100 on the same leveraged basis and paid their rent with the dividends they would probably be saying the FTSE100 is my pension. It’s buying a long term appreciating asset with leverage and not trading the bugger come what may and not getting marked to market in suckouts that makes houses a good investment – if you stay the course and don’t take those hits in the early days. Look at that chart and note that buying on a high meant I was exposed to the risk of having to sell up and having the house marked to market at a loss for a third of my working life. Safe as houses, guv, safe as houses.

The cyclical rises and falls of the house prices are slower than those of the stock market. Just because it’s a quarter of a century from the last turn of the cycle doesn’t mean it’s all different now, like the mills of God this one grinds exceedingly fine and exceedingly slow… 25 years ago jobs were more stable for the average employee, waiting to pass through the meshing gears of the mill until they turned you out the other side was a realistic option. But look at that 10 year suckout. It’s one of those questions you gotta ask yourself, really…

 

So what is different this time? It’s not about price, it’s about affordability!

Monevator observes that the house price to earnings ratio is creeping up. Some of the ideas about increasing ratio of two-earner households resonate with Elizabeth Warren’s book about the US situation. So obviously the whole price to earnings metric is hard to make fit these days. The new in word around town is affordability. Don’t worry about the amount of money you are borrowing, that’s just a number, it doesn’t mean anything. Can you afford to pay the mortgage okay?

Now if someone waltzed into a shop selling LED TVs with a credit card and said that, it would be viewed as a personal finance faux pas. Do that for a purchase three orders of magnitude bigger and suddenly we all go hey, that’s cool, don’t look at the price, can you make the repayments?

There is a case that the 3 x single, 2.5 x double income multiples that were the maximum lenders would advance in the past are too conservative now. 25 years ago we were coming off long runs of double-digit interest rates from ’78 onwards. That sort of thing limits the amount of mortgage you can pay off in a 30 or 40 year working life; 1991 was the last time interest rates were in double figures, so for 20 years they have been lower. But the average is closer to 5% than the 0.5% they are now.

I kind of feel the need for Clint again. Take a look at the yellow line, interest rates. Now just like the young ermine didn’t catch on with this whole boom-bust kerfuffle, because he hadn’t seen it, there are no doubt people who are thinking

what are these double-digit interest rates you speak of? I know nothing of such fiscal brutality

Look at the chart. Most of the time it spent at the long-run value of British interest rates of 5 or 6 %. That has a direct bearing on your affordability. The young ermine, though foolish in many ways, had the sense to ask of the mortgage company what would repayments be if interest rates doubles. It’s actually quite easy with an interest-only mortgage which is running alongside an endowment. If the interest rates double, you pay twice as much per month 😉 I figured I could managed that, just. I didn’t expect to be doing that, the very next year. I froze in that place. I didn’t go out much. Then the high interest rates started to depress house prices, and it began to dawn on me that I had made the most stupendous personal finance mistake of my whole life.

It dwarfs the second biggest PF cockup I made, which was a rash two years of major momentum-chasing and trading muppetry in the dotcom boom and bust. I only used ISAs and wasn’t rich enough to fill the first one. I probably destroyed about £7000 worshipping at the altar of Buying High and Selling Low, with a side order of Excessive Churn. I blew about £10,000 in 2012 pounds, but I got something of value in return. Education – it made me ready to learn how to go about things better. There was no bias or scamming in the training course that Mr Market dished out, and more to the point I threw away the money as I earned it. I didn’t borrow it from a mortgage company, and once it was gone it was gone, but I didn’t owe it to anyone.

The stock market has been a lot kinder to me than the housing market, and in a much shorter time, too. True, it delivers a jolly good kicking every so often, there aren’t the slow languorous cycles of the housing market. Perhaps the background radiation of this epic fail remains in my personal finances, because unlike the case for most Britons in my age and ex-income group, my house is not the dominant part of my net-worth, excluding pensions, if I were irrational enough to compute it as part of my financial assets 😉

Interest rates are at historic lows, that’s a good thing, surely?

On interest rates we’re a little off the right-hand side, but interest rates haven’t budged since then. They’re at historic lows. They can’t go any lower, because otherwise the Bank of England would be paying us to borrow money from it. So when you are making the switch from price to earnings (3 x single or 2.5 * double ISTR) you are making a nasty little pact with Mephistopheles.

you shouldn’t be striking deals with this bad boy. He tends to turn up and the most inopportune times to call in his dues

You are making a bet that things really are different this time, and that for reasons you can’t explain, unlike over the last 25 years interest rates are going to remain at historic lows of a tenth of their long run average for at least the first 3/4 of your mortgage (19 years of a 25-year mortgage). You can afford for ’em to let rip a bit after that, because inflation will have reduced the value of your debt by about half then anyway, plus in an ideal world you’d have paid off some of the capital too.

You’re also making some other assumptions. That your pay will keep up with inflation, which given the power shift from labour to capital may be unwise. That nothing untoward will befall your employment, or if so, then you will be able to find another job at similar or better pay without moving. Unless you live in London, that may also be unwise. If you do live in London you can’t afford to buy a house if you are a prole, or even one of the 99%. Then there’s the risk of the more personal crap that can get in the way of things – divorce, children dropping the second salary for a while and upping your costs. But hey, it’s affordable…for now

You can see what an interest rate hike did for me. Obviously the heave-ho from 7.5 to 14% raised the payment, but it also made the aggregate payments much higher for a while. Look how fast the cumulative overpayments relative to renting ramped up (the blue bars). They only start to yield to the cumulative imputed rent in 2000 over half-way through my working life, and it is probably only about now that the total amount paid in mortgage costs is less than the total amount I would have paid if I had rented. Of course, I now have a fully paid-up house that has a future income stream associated with it – the rent I don’t have to pay.

The risk of being hit by negative equity is highest at the beginning, when you are young, for the simple reason that you haven’t paid off any of the house yet. The amount of total money sucked out relative to renting is highest in one’s 40s. It’s not a personal finance trajectory that is for the poor, and not one that fits well with the costs of having children in one’s 30s.

I can’t yet work out whether this cost peak is an artifact of having eaten that fall in house prices and the high interest rates early on. The fall in house prices is not reflected in the running cumulative costs, however, except as an effect on imputed rent⁷

what do interest rates do to house prices?

George Soros – this bad boy did for the Ermine in ’92 by ejecting the UK from the ERM. Lamont skyrocketed interest rates to try and stay in

They make them fall in real terms or at least reduce the rate of increase relative to inflation. Particularly in the Brave New World of gauging how much you will pay according to affordability, rather than a price/earning ratio. Affordability is inversely proportional to interest rates, so as interest rates go up, prices have to fall to stay affordable. You can see that in the negative equity that I suffered at the start, though this may be correlation with the long drawn out 1990s recession. The interest rate spike was cause by Britain being ejected from the ERM – interest rates were raised to try and stop the pound falling, but the Bank of England lost the fight. That is the trouble with economic variables – they are hard to separate and qualify individually.

Why do governments push home-ownership so hard?

Not all governments do. Not even all British governments did until 1980. When I was at school it was perfectly normal for middle managers to live in a council house. Then Thatcher got in, and it’s been a world of hurt from 1980 onwards. When I look at this I can’t help feeling that it is a rum way to run an economy and seems to do a lot of hurt to a lot of people trying to catch up with the shibboleth that you must own your own home. The huge exposure to risk when you are young, the massive suckout of money in one’s 40s to buy the house compared to the rental option. Is this really worth all the pain? At the moment it is because the rental option is really horrible – there is no useful security of tenure in the UK and the army of amateur landlords seem to be patchers and bodgers when it comes to maintenance. It seems the solution to complaints about the state of the place is to get a less discriminating tenant – it is a landlord’s market.

If the government were interested in the maximum quality of life for the most people, it would stop fiddling about in the housing market and fix the alternative, renting. Most of the house-building in the post-war period was done by councils building council housing

post-war housebuilding (BBC)

and this carried on at a notable rate until it was shut down by Thatcher’s Right To Buy – there was no point in building houses with ratepayers money to flog them off cheap to somebody who was in the right place at the right time. Private enterprise clearly hasn’t picked up the slack, because presumably there is a profit incentive to maximise house prices for new-builds by controlling supply 😉 Or some other reason, but it’s clearly not happening.

Renting in the private sector is miserable. If you favour the tenants too much you get misery for the landlords and then misery for the tenants who don’t have a place, though joy for those who do. If you favour the landlords, as is the general case now, you get misery for the tenants, and drive people towards owner-occupation who perhaps aren’t ready for the financial hit. Owner occupation is much more expensive for the first ten or fifteen years. Calculators like this make me laugh because they are simplistic, assuming a constant interest rate, and constant house price inflation and they also take the equity in the house on the plus side. The only time you get to see the increasing equity in your house is if you downsize. The next time is when your kids sell the house after they’ve come back from the crematorium. Even after 25 years I’m not sure I’m up on the deal yet as far as money spent on buying relative to what I’d have spent on renting is. I do have an expensive asset and I’m done paying rent and mortgage for the foreseeable future, so I’m better off overall. But it was an expensive ride and I took outrageous shedloads of risk. After all, nobody sat me down when quoting for a mortgage and went

Now Mr Ermine, how do you feel about the possibility of losing 33% of the value of this house should you be SOL and lose your job in the first ten years?

Saying yes to that sort of risk that puts you into Highly Adventurous nutcase levels with shares, and yet people become gibbering wrecks if it’s intimated to them that the stock market can do that to you 🙂 Safe as houses, they say, safe as houses… What the hell did the stock market do to get all the bad rap? A financial adviser won’t let you sit down and open your mouth without you taking an attitude to risk test, and yet you can blithely sign up for a mortgage and the only warning you get is

Your home may be repossessed if you do not keep up repayments on your mortgage.

No shit, Sherlock. No mention of the risk, eh?

You are about to take the sort of risk that put a million buyers at risk in within living memory – the Bank of England interest rate is at historic lows and could increase tenfold without drifting out of the long run average. Have you thought about what that would do to your repayments, and have you had a word with Clint about it?

Nary a word that this might happen

Housing is, however, not just about money. The excess cost of buying is probably worth it to get rid of AST tenancies, horrible landlords, one month eviction periods, shitty house maintenance and all the other hurt that often comes with amateur BTL landlords. Fixing the rental market probably means building decent social housing, enough to compete down rental prices and set standards, and relieve the pressure on the owner-occupier market. Owner-occupation is much less suitable for a world of shorter-duration or less secure jobs. I don’t know if Thatcher was right in her time but that world is long gone now.

Of timescale-blindness

We are scale-blind to extremely short timescales. That much is clear when you try and swat a fly, or watch a sparrow land on a blackthorn bush without impaling itself, as it makes micro-adjustments to its flight path to avoid the might spines. Listen to this whitethroat at normal speed – it sounds pretty scratchy and nasty to me

Now listen to what that presumably sounds like to a real whitethroat, which can hear finer temporal detail than us. All I have done is slowed it by 8 times

That’s still coarse on the sort of timescale that high-frequency trading works. You can’t stay on top of that. The effect happens at long time scales too, we just don’t see things that change over decades as much as we see them if they change day to day, which means that we become increasingly blind to groundswells in finance that have a longer period than a working life. Hence this article, it is a distant report from a receding event horizon. It happened, and it’ll happen again. What makes this worse is that the WWW started in 1994, so for the Internet generation this history is not accessible. I used my local Library’s newspaper search facility to research some of this, and it is uncanny how the themes from 1988/9 seem to be repeating themselves now, and how certain pathologies associated with mortgages seems to be evergreen. Such as stupid berks taking money out of their home equity in the good times to pump up their lifestyle only to come over all surprised when it all goes titsup in crashes. Life has rainy days in it. Save up for them.

Should I not buy then?

Markets can remain irrational longer than you can remain solvent

John Maynard Keynes

Search me guv. London, for a start, is a different place. I’m not in that league. I left London 25 years ago because I was too poor to live there. You’re competing against foreign money treating London real estate as a reserve currency, and there’s a lot more of the rest of the world’s 1% than there are Londoners. It’s not a fair fight. I could earn enough as a single man to fight the DINKY couples but the 1% are way out there, sometimes you gotta know when to hold ’em and know when to fold ’em. For most people London falls into the latter category.

Elsewhere, you buy a specific house in a specific part of the UK, subject to local conditions. I personally wouldn’t buy right now, but then I haven’t lived with AST tenacies and scummy BTL landlords ⁸ for a long time. I can see how that makes people prepared to pay over the odds. Maybe it really is different this time.

I learned something writing this and analysing the costs – in particular that when you buy a house with a mortgage you commit to ongoing higher outgoings for over twenty years – that’s real money you have to earn and pay out. It’s true that the break-even point was 10 years in my case, but my spending was still higher than it would have been renting to 20 years. The break-even point is brought forward by the nominal value of the house, which is only realised when you die or partially on downsizing.

I didn’t have any idea when I started down the mortgage track that this was the case. I earned enough and was lucky enough to dodge the negative equity bullet to get away with it, but it could easily have gone a different way, and then the ermine would not have been retired. Safe as houses – think of those million people in negative equity in the early 1990s. I was started down this track of thinking by Paul Claireaux’s blog post on House Prices Now – he has some other charts of interest there, and a far better grounding in the financial technicalities, where I’ve just lived it. His summary?

What I conclude – is that  (in broad terms) UK house prices have gone into outer space!

There is a general message that when buying investments one should take valuation into account. That is doubly the case if you are going to buy it leveraged – and a house is one of the few assets Joe Public buys on margin. Negative Equity is what happens when you get that wrong, and being foreclosed, going bankrupt and having the debt chase you is what happens when you get that wrong and lose the ability to pay the mortgage. Only you can say if getting away from those crappy landlords is worth the risk.

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1. MIRAS is a historical piece of Government fiddling in the housing market being changed where they didn’t tax you on the interest paid on a mortgage. Interest rates and tax rates were much higher in the 1980s than they are now ↩
2. short-term Government interference leading to a pulse in demand just before an election. Any connection with Help to Buy is of course specious scuttlebutt and should be ignored. Of course. ↩
3. in those days money halved in value every ten years. So that 3 x lift was pretty much breakeven after 25 years with free investment risk chucked in, but optimism and being a smartass is one of the privilege of the youthful, eh. Boy was I taken for a ride ;) ↩
4. I used the low start loan so I’d have a chance to pay back that interest free credit card. It was the correct use fo an ARM loan – the young ermine got the details right, it was the big picture that I made a hash of. ↩
5. To track the house value I used the Nationwide house price index for old properties, East Anglia section. The house was a two-up two-down built in 1840, the Nationwide are pretty accurate because scaling the price I bought at forward to 2012 gives pretty much the value Zoopla gives for a similar joint in a similar area. To track inflation I used the January of the year figures from this Guardian spreadsheet. For the Bank rate I took figures from the Bank of England and did the manual calculation to get the yearly interest rates, and assumed a mortgage was 1% more. I estimated rental prices as 4% of the yearly house price, which would fit for now. I moved around the middle of the period, so the second half of this is a simulation. ↩
6. I had to subtract what was already indicated otherwise the overall picture would be wrong. When the blue bars disappear, it will have finally been cheaper in terms of money paid out to have bought, not rented. ↩
7. Update 22 April – a house just like mine has gone up for rent across the way, so I looked up how much it would cost to rent. The imputed rent assumption is pretty damn close, it’s nice to get a real-life confirmation of the cost-modelling. ↩
8. I’m sure there are some decent landlords. It’s just that I never ran into them and from what I hear most tenants don’t either. OTOH I’ve heard from some landlords about some seriously chavvy tenants. Shame that so much money changes hands and both parties seem to be pissed off with the deal ↩

When we are lender of last resort, we take your soul

Paul Tucker, outgoing deputy Bank of England governor, summed up an essential truth about debt[ref]It’s a shame I can’t second-source the original quote. If Philip Aldrick made it up, he’s wasted at the Telegraph[/ref]

“When we are a lender of last resort to a bank … we take the institution’s soul. And we say we will give you back your soul when you’re healthy and I get my money back,”

It’s not just banks. It’s any borrower – they swap a little bit of their financial soul for the use of the money now. It’s why I paid off my mortgage, despite knowing the most rational way to maximise my financial position would be to pay it all down bar £1000 and invest the residual amount. Wherever I hear someone who is financially aware and getting ready to pay that mortgage down, I’ll often try and highlight that alternative for consideration. The analytical case for keeping it is best made here, so I won’t bother trying to state it, but it is compelling, particularly for anyone under 45 IMO.

For me, my soul was worth the opportunity cost. The dead hand of the lender of last resort is symbolically powerful. The lender plays the part of Mephistopheles to your Faust – they have access to resources you don’t have, and will lend them to you. On one condition – they take a charge over part of your soul 😉 Where Faust screwed up was accepting a charge on his immortal soul, but if you borrow more money than you can realistically pay back from your future income streams, you’re surrendering yourself to a life of debt-slavery.

Personal finance is not all about the numbers. It is about your values. Mine were honed over the past few years, as the scales fell from my eyes and I realised at work I was doing something I was ok with most days but in a way that really pissed me off, and I was doing it because I was fearful of the claim of that lender of last resort. It was time to give Mephistopheles the order of the boot.

Buying a house is all about hope and belief in the future when you’re young. You ignore the swish of the arrowed tail departing with a piece of your financial soul… The demon is forgotten for decades, but he’s still there, and He’ll Be Back when there are grey hairs on these two (photo: xaviernau/iStock)

 

Because I’ve had it for well over a decade, my mortgage wasn’t that much towards the end. It was a nice tracker, and capped to boot, but it had to go, though I did take the time to mull over whether ownership of my soul was worth the opportunity cost. Had I ramped it back up to 100%[ref]I don’t think this would have been permissible, I could reclaim overpayments but it wasn’t an offset[/ref] and bought the FTSE all-share in April 2009 I’d have been about £20,000 better off if I sold up now. I can live with that.

2007 mortgage statement. BM didn’t get fat off my back that year 🙂

So my soul is worth about 20k, It’s a good deal, that’s the price of peace of mind. I am a lot more risk-tolerant with money that I have made, but less so with money I have borrowed.  That’s because in the 1990s I saw what happens when you buy assets on leverage and they go down. You get to pay months worth of overpayments into a black hole called negative equity. Although an offset mortgage is designed to offset money you have borrowed against money on deposit, in the end it is still a mortgage – the company has a primary charge on your property.

Mortgages are a young person’s game IMO

Although a mortgage is nominally charged against the value of a house, what actually pays it off is the future value of your income stream. The future value of a burned out Ermine’s income stream is lower than of the 30-year old in the 1990s[ref]It’s probably not zero as I suppose a pension is a future income stream, and in some ways more secure than income from employment, you don’t get made redundant from a pension.[/ref]. It’s why for most people [ref] I’m talking about wage-slaves working for The Man here, not people whose risk-tolerance is higher than normal, and or people who have unconventional assets like a business or BTL[/ref]  you should have paid off your mortgage by the time you’re 60, because the value of your future income stream starts to tail off for the simple reason you have fewer earning years left. If I were investing in buying shares of people[ref]I know, it’s called slavery, this is a hypothetical thought experiment ;)[/ref] give me an able 30 year old who is honing their craft over a talented 50-year old any time, because the income may be lower but the value of the human capital transforming into a future income stream is higher – because there’s more future!

It’s why I have little sympathy for over 50s who are still running interest only and grouse that they will have to sell their homes to discharge the mortgage. Let’s take a look at how they got here –

Underperforming endowments have left many people aged over 50 with interest-only mortgages facing an average shortfall of £49,000, according to [a special interest group pushing their equity release ‘solution’].

Er – no. Let’s try this again, shall we?

An ostrich-like mentality of ignoring warnings of endowment shortfalls in numerous letters sent to them from the mid-1990s onwards, ie a wilful refusal to act for over twenty years has meant these people failed to address their financial situation despite numerous warnings over decades.

That’s better. I was one of these people who got those letters in the 1990s. I fired off stinking letters to the endowment company. I opened a PEP (ISA in today’s speak). I pressed my claim and got reset to where I would have been with a repayment mortgage. Guess what I did with the settlement money?

I paid it right away to the mortgage company as a capital repayment, because that’s what it was – compensation to set me back to where my mortgage should have been.

Many people considered these a windfall and spent in on a nice new car or that holiday they’d always wanted. It was part of their mortgage, so effectively they were saying ‘let’s have a blowout, and hell, let’s add it to the mortgage’.

When endowment firms tell you ‘we lied, and you won’t be able to pay your mortgage off’ then the first thing to do is DO SOMETHING, FFS… Hell, that average shortfall of £49,000 would probably only have been an extra annual payment of £1000 (because paying down the capital reduces the interest). The Daily Fail tells us that wisdom comes with age, particularly in temporal discounting which is important in personal finance[ref]Yeah, I know it’s the Daily Mail. It’s peculiarly tough, because young people actually have more future so the cost of getting temporal discounting wrong is higher for them. But it does follow my life experience.[/ref] While at least with temporal discounting this probably does apply to me, it seems unevenly spread in the older population 😉

The trouble with the demon Mephistopheles is that he plays a long game. It’s easy to forget the long shadow of the repo-man over the typical mortgage term of a quarter of a century. The starry-eyed young Ermine that casually signed way five years of annual income with a flourish of his pen is a different creature from the gimlet-eyed mustelid that signed the cheque discharging the final amount that transferred ownership. But Mephistopheles doesn’t forget, you gotta sign that cheque at some time, or deal with the consequences of the Devil owning your financial soul. I saw that shadow in the 1990s, and learned. My personal finance policy is simple

Owe nobody any money for more than half a year

I don’t take it all the way to Shakespeare’s advice to Laertes

Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.

This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.

I do lend money, both as a Zopa-ist, and as a stock-market investor 😉 The key is never lending money to any entity or grouping that you can’t afford to lose. I do think the Bard has a point when it comes to consumer debt, though, when he says

And borrowing dulls the edge of husbandry.

presumably meaning you don’t take as much care of something you bought on credit as if you saved up your hard-earned beforehand.

Kate Moss. And no, she wasn’t talking about personal finance in ‘The Waif that roared“

It is this casualisation of the value of Stuff that makes the consumer economy go round, fuelled by debt. Mindful of the value of my soul, however, I don’t have to take part in it, because, to paraphrase Kate Moss

No rush of consumer baubles tastes as good as financial independence feels…

It’s the low level of needless consumer spending that I found didn’t give me lasting value, and this is particularly injurious to financial independence because it’s unthinking and it adds up. I came to the conclusion that in many ways with decadence it’s better to ‘go large or go home’. If something’s really of value to me, I will, after suitable deliberation, go for it,  if I can imagine looking back and thinking ‘that was a good purchase, given what I knew at the time’ – or even that it was a qualified risk and I accepted the range of possible outcomes. It’s the unthinking drip, drip, drip a little bit here, a little bit there that I have no truck with. I am mindful of the fact that the lender of last resort takes my soul; I would not be financially independent if I owed anyone any money for any length of time.

Nutty thing to do from a personal finance point of view, paying off your mortgage. But I wouldn’t have it any other way, because I know the value of my financial Soul, not just the price of it 😉

Don’t fight the tape, Dave, the NewBuy Mortgage Guarantee will cause untold pain

The trouble sometimes with Government, is that it often gets itself into areas it shouldn’t touch. Such as meddling with the market, offering to guarantee home loans of half a million pounds to buy new houses. What on earth could go wrong?

So let’s take a step back and see what’s going on here. A putative homebuyer is looking to buy a house that they can’t afford. So Dave waves his magic wand to make lenders accept the risk by guaranteeing the money with taxpayers’ money. Now I would then suggest to the homebuyer they look for good value for money. With houses, like with many other durables, the best value is in the second-hand market. But no. Conflating the desire to help people buy stuff they can’t afford with some dirigiste industrial policy to support housebuilders, Dave makes them buy unnecessarily expensive houses – ie new-build.

Face the facts, Dave. You can’t make enough on the average income in the UK to buy a house in a lifetime. A middle class man on the average wage used to be able to buy a house on his own, my Dad did it on a blue collar wage. Then it took two people to do it when Thatcher sold off the council houses, meaning people who were too poor to buy a house themselves were robbed of the opportunity to have social housing, though a lucky bunch of 1980s tenants got their houses at knock-down prices to buy their votes.

I managed to buy a house on a single white-collar wage, but I lived somewhat below my means to do it. Nowadays if I were starting over I wouldn’t be able to afford even the interest on my current house on what my starting wage was in real terms.

And now another Tory government is going to dive into this frenetic marketplace with its hob-nailed boots and dance all over the face of the price mechanism in a capitalist society. Dave, the reason your middle class voters can’t buy a house these days is because we don’t make anything of significant value in Britain any more, and our standard of living is going to fall accordingly. You’re going to provide mortgage guarantees for houses priced at up to £500,000!!! I couldn’t even dream of buying a house for that much now, at the peak of my earning power and with a fully paid up house to defray some of the capital! What right do you have to buy your votes with the dreams of some daft young couple that is going to put themselves in hock for far more than they can afford in the long run?

Imagine a couple both with good jobs earning the average household post-tax income of £25,000 ish. Even if they paid no interest it would take them 20 years of their entire household income to pay that off. That’s assuming in those 20 years they eat nothing, have no kids, never go on holiday. It’s barmy. It is just so wrong, on so many fronts.

Dave, the price of houses is telling your middle class voters they cant afford a house. There is an old stock market adage from the 1930’s, ‘don’t fight the tape’. It means listen what the price signal is telling you. And for God’s sake, don’t fight that signal, because it will crush you.

Oh and to those putative homeowners – don’t do it to yourselves. Buying new-build is expensive, you’ll get more house for your money buying second-hand. I didn’t have enough money for the deposit on my house in the late 1980s. So I borrowed an interest-free from my MBNA credit card, and used a low-start mortgage to focus repayments to the credit card in the first year. It worked for me, I got my mortgage cheaper because I had a lower LTV and didn’t pay a bean for the loan. In those days you didn’t have the sneaky 3% handling charge on 0% cash advances. There are other ways of raising the deposit than having the government railroad you into buying an overpriced new-build house when you can least afford it.

 

Middle Class Finances – Death by A Thousand Cuts

Another one in the complainypants section, but this one’s a more subtle object lesson in how not to lead a middle-class life. Perhaps the Ermine’s heart is softening as he gets older, or there’s a little bit of the there but for the grace of God since I screwed up with the toxic UK housing market too, though I don’t have 4 children 😉

Let’s hear it for the Daily Mail’s Shona Sibary, who sold her house and considers herself now in the rent trap.

Shona and family, before they got into the rent trap

Now I was able to see her fundamental problem, just from looking at the picture. In Britain today, a middle class family with both parents working will find it hard to raise four children. We normally associate big families with the undeserving poor because of the headlines, but thankfully they are not the only section of society that has large families, otherwise we would long ago have succumbed to the premise of the movie Idiocracy. The unsung other sector of society that often has larger than normal families seem to be those with a bob or two. Like David and Samantha Cameron, who ain’t short of a bean, or even IDS and Nick Clegg. Other wealthy families include Victoria & David Beckham (4) and Boris Johnson (4)

I first noticed this with older colleagues at work. The Firm was a prestigious operation in the 1970s and 1980s, and pay was probably upper middle class (in the eighth or ninth decile of the IFS income scales). There is a surprising prevalence of three-child families there, which I had found particularly surprising when I joined nearly a quarter of a century ago.

It’s not surprising that nowadays it is the poor and the wealthy that can go beyond the one and two-child norm. The former get us all to pay for it, and the latter are presumably rich enough to pay for it themselves. Anyway, ’nuff about families. How did Shona screw up?

Shona’s financial red cards

By failing to watch her back. Shona had a couple of big red cards,  I suspect that family was living way beyond its means for a long time.

Red flag #1 – they were remortgaging, not building equity in their home.

Look at how an old-skool repayment mortgage builds up equity in the house, by repaying some of the capital.

how a traditional mortgage builds equity

I pinched this from the excellent Mortgages Exposed website, which unfortunately uses infernal frames so I can’t link to the source itself, it’s under Capital Repayment in part 1. Now there are other ways of doing it. My original endowment mortgage was interest only, so in parallel with the mortgage there was an investment that should have been slowly rising to match the original loan. Either way, you should be building up equity, even if it takes the form of a separate asset.

Now the modern way to look at a mortgage is to take out an interest only loan, sit on your butt and whistle a dancing tune while the value of your house goes up. Voila, free money, you get equity without having to lift a finger. The catch is, of course, that the value of the house has to go up 🙂

Shona asserts that

After two decades of slogging to buy a house, maintain it and give our children security for the future

No, you did nothing of the sort. You’ve had that mortgage for seven years. If you look at the graph above, you should have a quarter of the equity in the house, assuming house prices hadn’t gone up at all from the start.

If you look at the equivalent graph for my mortgage career

an ermine’s inflation-adjusted income and mortgage stupidity

You see that by 1996 I had at least reduced the total, by about a fifth in real terms (this graph is inflation adjusted to a nominal salary of 10k in 1984). That underestimates my repayment as it doesn’t show the value of my endowment.

So what did you do Shona? You remortgaged. Taking that equity out, and spending it. Doing that once is a bad sign – nothing wrong with remortgaging per se, but spending the proceeds is bad. Doing it another two times is more than careless, it’s positively greedy.It’s a big red sign in your finances that says “Wrong Way, Do Not Enter, Turn Back NOW”.

Your house is a place to live, it is not an ATM. Over the 25 year span of a mortgage, you will probably see at least two housing booms and busts. I bought in a boom, ate a 10-year bust, and discharged my mortgage in the next boom, that has now turned to a bust (my mortgage would have finished in February 2014 had I not discharged it early)

It is the foreknowledge of that next bust that should make you say “I will not take the money I gain from remortgaging and use it for anything other than buying an investment which will go towards buying this house”. For most people that investment is reducing the total amount of the next mortgage, which is tantamount to saying “never withdraw equity from your house, unless you are trading down”. There are some people who can do better than that. They are few and far between. Otherwise that bust is just round the corner, waiting to bite you.

Red Flag # 2 – your house is not your biggest cost!

This is awesome. If you really are middle class, and buying your house, then that house is nearly always your biggest cost. If it isn’t, you are either not middle class, you are rich/wealthy. Or you are in deep, deep, trouble. Nowadays it’s pretty marginal for the ‘middle class’ to be able to afford the typical ‘middle class’ three or four bed detached family home in the ‘burbs. If your house isn’t your biggest cost and you’re not rich, you’re skint.

Let’s take a look at what Shona spent the money on.

In our defence, we weren’t spending the money on expensive designer clothes, luxurious holidays or flash cars.

So glad to hear it. So what exactly was it that you overspent on then?

Much of it was going on school fees and upkeep of the house.

If you’re withdrawing equity from your house to keep the damn thing standing then you have got too much house for your income. However, that’s not really your problem. It’s the school fees. According to the ISC the average termly fee at a day school is £3655, about 11 grand p.a. A cursory look at your family photo puts three of those kids in school, ie £33k p.a. Assuming for sibling rivalry you aim to do that for all of them, you are looking at paying 4 * 11000 * (18-11) = £308,000 if you just pay school fees for secondary school 11 to 18 and £572,000 if you pay from 5 to 18.

That’s more than your house was worth at the peak. The house is not your biggest problem. It’s a combination of having too many children and looking down on the sort of education that dragged up scumbags like me. So for all the mawkish whingeing about losing your home, Shona, you have failed to clock the real problem with your finances. ‘Tis the fruit of your loins and the style in which you’d like to keep them. With their own rooms, if you please, nothing else will do for Shona’s little ones 😉 Since humans come in two genders and it is apparently not acceptable for brothers and sisters to share a room these days you actually only need three bedrooms if the family is boracic lint, fixed that for ya.

Get real, Shona. You were on a middle class income but living a life not commensurate with your means. It’s hard enough for the middle class these days to buy one house in 25 years. To aim to do that and spend even more than that on the nice things in life on that middle class income is taking the piss. It cannae be done, and you’ve just found that out the hard way. To my eyes you’ve cut the wrong thing, but I respect it’s your call.

Shona shows me I need a financial Distant Early Warning Line

I learned something from Shona. Her family fell foul of slow changes that gradually overwhelmed them. Many things get imperceptibly worse day by day, as global imbalances right themselves but they’re resisted by the structures we have already built. The creeping rise of Digital Taylorism making the professional and technical job a stressful and unrewarding experience is an insidious change, little by little. I didn’t realise that until it became too much and my defences were overwelmed, hence the crash course over the last three years in becoming finacially independent as a counterattack.

In the 1950s the US instigated a distant early warning line to scan the northern skies at the 69th parallel north of the Arctic Circle. It was standing sentinel for the signs of incoming Russian nuclear bombers, and was located in the harsh North to give enough early warning to mount a counter-attack.

I need something analogous to stand watch for slow insidious creeping costs and sound the early warning. I plan to instigate an annual review of financial commitments as a percentage of resources. If I see a non-negotiable cost starting to rise proportionally I will consider that the alarm is sounding and it is time to attend to it. It is always easier to launch a counter-attack before it is upon you overwhelming your defences, and this annual review of commitments will be my distant early warning line against stealthy creeping costs.

Shona’s family could have used something like that. Okay, the alarm would probably have sounded as soon as it was set up, but certainly on the second child’s school fees. It would have been an easier call to make at that stage – do we want a big house, or do we believe in the value of public school education* makes it worth getting the girls to share a room?

While I am working I’ve generally lived sufficiently below my means that I didn’t need that sort of thing. Though I aim to have over 50% income in hand once I stop working, I’ve still got several decades, decades in which I believe living standards in the West will decline in a big way. Though I may be resistant to wages being eroded, I won’t be immune from inflation and its evil twin, rising prices and taxation. A financial DEWline will help me marshal resources ahead of time, and shift them to minimise taxation. Particularly with significant holdings in shares, it’s good to have as much advance warning if changes are needed, to average out the horrendous temporal volatility.

*NB for non UK readers, bizarrely schools that you pay fees for, those that Americans rationally call private schools are called ‘public schools’ in the UK, because we’re strange like that.

Why the Demise of the Interest-Only Mortgage isn’t a bad thing

So you walk into a shop, and spot that nice new flat-screen TV you want. £500 to you, sir, or you can buy it interest-only for £2 a month. Wouldn’t you smell a rat somewhere? The rat is, of course, the small print that says you’ll have to pay £500 at the end of the interest-only loan.

Now I know that some people, particularly in the United States, buy their cars like this. It is called leasing, and the name gives it away, you never get to own the car. It’s a long term rent. It looks absolutely and stupendously daft to me, but if the image of driving a nearly new car is that important to you, well, ‘you pays your money and you takes your choice‘.

So what the heck makes buying a house on an interest-only mortgage any different? You still never get to own the house. What it the point of that? The interest only mortgage was a clever wheeze to ramp up house prices and for banks to make more money. The beautiful part of this game is that the buyers go all gooey-eyed and think the mortgage company is doing them a favour by lending them more than they can afford. Hey, that Mr Interest Only Bank can lend me £200,000 whereas Mean Old Prudent Bank will only lend me £150,000. Isn’t Mr Interest Only Bank such a nice guy?

Two words. Northern Rock. It didn’t work out well, even for the lenders.

A history lesson

1960 – the Repayment mortgage

When my Dad borrowed his first £500 mortgage, way back in the early 1960s, it was simple. He told them his income, they looked up in a table what they could lend him, and armed with that knowledge he could look for a house. He borrowed the £500, and then paid them the interest plus a proportion of the price of the house, the latter proportion increasing with time.

Repayment mortgages were all that were available, based on the simple premise that you pay your instalments for 25 years and when the last one is paid the house is yours.

1990 – the Endowment Mortgage

Fast forward thirty years, and I get to go to the Abbey National, and bamboozled by the choice of endowment and repayment I foolishly go for an endowment mortgage. This is still on the principle that I pay interest only to the mortgage company, but simultaneously to a life-insurance policy which supposedly grows with time till after 25 years it is worth at least the price of the house. So although I was only servicing the interest on the mortgage, I was in parallel accumulating an asset that matched the cash price of the house, which when paid to the mortgage firm would discharge the debt. And the house would be mine. The mortgage company took a charge over the endowment, so I couldn’t sneakily stop paying it without them knowing.

2005 – The Interest Only Mortgage (Don’t Bother with the Capital, it’ll work out somehow)

Like an endowment, but endowments got a bad name, for not paying enough to match the price of the house. So just do away with the need for an endowment! How does that work? Well, you get to the end of your 25 year term, and you still owe for the house! Okay, so inflation hasd probably halved the real value of the debt, which is all to the good, but you still don’t owe your damn house at the end. It is a leasing arrangement. Why not just rent instead?

The assumption is that rampant house price inflation means that your house is worth so much at the end that the increase covers the total. But you still can’t sell off the chimney or your third bedroom to discharge the debt, and you are likely to be coming up for retirement. I wouldn’t want to have to stick my hand in my back pocket to come up with what I paid for my house over a decade years ago, though as it is I could just about do it.

increasing complexity, decreasing security and honesty

There’s a lot of bleating about interest only mortgages, because about a third of firt-time buyers bought their houses on an interest only basis.

Shockingly, I heard a father talking on Money Box about how it was so rotten that his son couldn’t find an interest only mortgage to buy his first house. David from Sussex said (13:45 on the iPlayer)

a bit surprised and disappointed to hear they’re only looking to offer capital repayment mortgages, and with my son’s circumstances, which I’m sure is the same for a lot of other first time buyers, the intention is not to stay in the property for that long

So how does that work, then, David? Are you saying your son doesn’t need the house after a while, can sell up, pay back the capital from the proceeds and stick a tent on the pavement? Or do you want him to be able to overpay for this house, so he doesnt’ spend the excess on booze and fast cars? Why exactly is it that you want him to borrow more money for a house he can’t afford the buy, only to lease? Do you realise, David, that your son is in an auction for houses, and if mortgage companies don’t let people borrow so much money then the auction price will fall?

It’s too late to save the people that did overpay for houses by going interest-only to the max, but we can at least not propagate the mistake. If you are going to buy a house, then buy the damn thing, don’t lease it for 25 years and then wonder why it isn’t yours…

Overall, look at the changing mortgage proposition over the years. My Dad was offered an honest and straightforward service. Pay this much for the next 25 years, and you will own your house.

I was offered a less honest service but at least one that in theory would end up with me owning the house. It didn’t work out that way because the complexity of a with-profits endowment hid untestable assumptions and I was stupid enough to buy a product that didn’t match my circumstances. In all fairness to my parents, they told me a repayment would be better for me, they told me why, and educated me well enough to be able to see why, but I was a damn fool and had eyes only for the potential gain, without the wisdom to look for the potential loss. That’s what being 28 did for me, I knew everything and nothing, so greed trumped wisdom.

Unlike my parents, David is failing his son in giving him only half the story. If he actually told his son, “look, you are taking a very serious risk here by going interest only, but you are in a profession where your pay will increase dramatically and as long as you start saving for the capital from then on you may consider this a calculated risk” then that would make all the difference.His son would still be taking a risk and would probably be just as cocky as I was, but at least David would have discharged his duty as a parent 😉

He sort of alludes to the early years being hard, but wage profiles may be flatter nowadays and young people start out with more debt, so the assumption that money will be easier after five years probably doesn’t hold. David needs either to underwrite his son’s migration from interest-only to capital repayment with the Bank of Mum and Dad, or not encourage his son to overpay. Because it’s simple to summarise the issue

if you can only afford to pay an interest-only mortgage on your house, then you can’t afford to buy that house.

Although I think the demise of the interest-only mortgage has been exaggerated, its death would be no bad thing at all.

Just leave the housing market alone, Dave

So the taxpayer is going to back 95% mortgages for first time buyers to buy new build homes. Now where have we seen this before? Governments fiddling in the housing market. Such a bright idea, it goes horribly wrong each and every time. You’re grubbing about with what is probably most people’s single most valuable financial asset, purchased on a highly leveraged basis. Small errors can get magnified stupendously.

What on earth could go wrong? Well, for a start the impecunious are usually better off looking to the second-hand market to get better value. It’s why I have never bought a new car. I could afford it, but I have no desire to take the sucker punch for that brand new kudos. Same for houses. I’ve never bought a new one, because the value is so poor. Let other people take the brand-new premium first. So why the heck is the Government screwing the first time buyers by making this mortgage guarantee conditional on them buying a new house? Yes, it’s good for the housebuilders, but why get the most cash-strapped to take the hit too?

There seems to be a belief that it’s every Briton’s human right to be able to buy a house in ther 20s. It isn’t. Some people are too poor to buy a house. That’s tough, but there are alternatives and have been throughout history. It’s called renting, and also sharing with others.

Let’s take a look at the decision-making process in how people buy houses. People look at what they can afford to spend at the time they are buying. If they are really clever they look ahead a little bit and allow for the extra cost of children, should that be a consideration. They then imagine that will carry on for the foreseeable future, and spend right up to that limit.

Make financing easier? Buyers will drive the capital cost of the houses up, as they can finance higher capital sums. Apply distorting measures to starter homes? Starter homes will go up more than second-rung homes. It’ll be harder for those that don’t qualify for the distorting measures, and the distorting measures will go into the pockets of house builders. It will take longer for the ‘beneficiaries’ of the largesse to pay off the increased prices they paid, because the largesse comes in the form of mortgage guarantees, encouraging them to overpay.

It’s about time the government discovered the value of the one of the principles of Hippocratic Oath in meddling in the housing market.

Primum non nocere – First, Do No Harm

Just leave it alone, Dave, let it be. That way existing house owners that benefited from the rising prices in the past get to take the hit, as they have to drop their prices to get a sale at all. The history of UK government intervention in the housing market is littered with epic fails.

Let’s hear it for:

1. Mrs Thatcher in the 1980s selling council houses for below cost price to buy votes. What could possibly go wrong? Britain has no effective social housing any more, inflated property prices, and people so poor they would never buy houses elsewhere in Europe end up overpaying for houses they can’t afford and can’t maintain properly. They used to be able to rent from professional landlords on a reasonably stable basis. Now they have to rent from BTL amateur landlords on 6 month shorthold tenancies.
2. Mortgage Interest Relief At Source What could possibly go wrong? Make mortgages less expensive and the punters will bid up the price of houses till the amount they pay is the same. At least this was axed a while back
3.  95% taxpayer-backed mortgages for first time buyers to buy new build homes. What could possibly go wrong? So we’ve subsidized foolish banks like Northern Rock that lend people more than they could buy, then flogged them to Richard Branson at a loss. Hey, let’s just cut out the middleman and lose the money straight off. What’s going to happen? People will bid up the cost of first time starter homes and expose themselves to the risk of negative equity, but never mind, the taxpayer will underwrite the losses.

Twits. When is government going to learn to butt out of the housing market. Their job is to provide equitable contract law, building controls, town planning and a Land Registry so that buying and selling houses is safe for both parties and the necessary disclosures and titles are made. Some basic regulation of rents, requiring some professionalism in landlords and taxing BTLers on their capital gains is probably as far as they need to go.

We’re about to enter a second long recession. Jobs will go. The last thing we should be doing is influencing people to take a long term illiquid investment on at a higher price than the market would normally set. It took me 10 years to recover from the cock-up of buying a house at a price inflated by stupid government intervention, Nigel Lawson, you know who you are. I wouldn’t do that now, but you can’t put an old head on young shoulders. I was lucky enough to keep my job and not need to move for those 10 years, the likelihood of that happening to a first-time buyer now is a lot less.

We probably shouldn’t actually stop house buyers acting foolishly in the face of market volatility, but as society we really shouldn’t wilfully add to that volatility. The housing market is a zero-sum game. Make it easier for today’s first-time buyers to buy a house, and you make it harder for the next bunch that comes along. What’s so hard to understand about that?

No more Interest-Only Mortgages from the Halifax

Every so often you come across an amazing piece of news, something that makes you wonder if people have been asleep at the switch for the last few years. Let’s hear it for the good people at Halifax, who have just woken up and decided that perhaps they would like to have some documentary evidence of people being able to pay back the money they lend to them, as opposed to just being able to pay the interest.

Uh? What part of liar loans did they not get at Halifax? Let’s hear some of the excuses for interest only loans from Melanie Bien, representing some bunch of charlatans delivering empty promises mortgage brokers:

“High-street lenders have been tightening their interest-only criteria since the downturn because they regard these loans as more risky than repayment deals. If this continues, interest-only mortgages could vanish, or become so limited in scope that they are available to only a handful of borrowers.

Interest-only loans aren’t inherently bad. What about first-time buyers who don’t have a repayment vehicle but are due an inheritance? Or someone with a modest income but sizeable and regular bonuses which can comfortably be used to clear the capital?

‘One size fits all’ does not work when it comes to mortgages. For some borrowers, not all, interest only is the right choice.”

Melanie, my dear, I don’t know if you really were born yesterday or you are thinking of your commission, but you are wrong. The tragedy is that if a borrower needs an interest only loan to be able to afford it, then an interest-only loan is inherently bad for that customer. That is because it is allowing them to live beyond their means, and they are also driving up house prices in general with the other people living beyond their means, achieving a drive-by shooting of many people’s personal finances.

There are some people that know how to use interest only mortgages. They are few and far between, and will have uncommon characteristics, like having large share portfolios and accumulated capital wealth. The sort of punter that needs Melanie’s services is not one of them, so when she says “you can afford this house if you start with an interest-only mortgage” she is always wrong.

There’s no money in it for her to say “you can’t afford that much” but the rule is simple. If you have to ask whether you can afford it, and the answer is “yes, if you go interest-only” then simply replace that statement with “Do you feel lucky, punk? Well, do you?”

Buying a house is a big commitment. It’s hard enough to rely on having a job for 25 years. If you are relying on a bonus regularly then you are playing Russian Roulette with your finances. The whole point about a bonus is that it’s a bonus, so it can’t be relied upon…

It’s really staggering that it has taken getting on for three-and-a-half years for the Halifax to realise that interest-only mortgagees aren’t so much high-risk as they are bad risk.

Let’s face it, if you really want an interest-only mortgage, it’s hardly as if the Halifax are really raising the bar that much. Tell them you will pay off the loan with an ISA, and have the presence of mind to be able to produce evidence of having had that ISA. You can always cash it in after you have secured the loan if you really want to rent your house from the mortgage company. The new rule isn’t so much documentary evidence of having a strategy to repay the capital, more documentary evidence of having had savings for a year. If you really can’t drum up the savings then borrow the money from a credit card and put it in an ISA. You would be absolutely dead-certain certifiably mad to do that, but it would probably work.*

*please, please don’t do this. Halifax may check your total credit score and see the card loan, your ISA may fall in value by the time you want to cash it in to repay the loan, there’s just so much that could go wrong. If it still looks like a good idea, back away slowly from your computer, and seek independent financial advice as soon as possible. Oh and you probably can’t afford the house, BTW…

The Road Less Travelled – A Better Way to Buy A House

I read M Scott Peck’s The Road Less Travelled a few years ago. Like any powerful message, it can easily be distorted if received by someone not ready for the signal. If you are of a Calvinist worldview that work is good for you then you may find confirmation of your world-view in the “life is difficult” opener of the first chapter, Discipline. You’re only looking at part of the story there, but you have to get further into the book to find that out 😉

In particular, he speaks for the virtues of grit and determination to achieve anything, to wit

• delaying gratification – valuing future gains sometimes at the cost of present comfort
• Accepting responsibility for one’s own decisions

I was reminded of this book when I read Monevator’s guest post from Tejvan Pettinger titled “Reasons to buy a house instead of renting“. Now in my view, at the moment there aren’t any reasons to buy a house instead of renting, it’s one of those things I learned by doing it in 1989 at a similar time on the cusp of a recession.

Mark Twain said

A man who carries a cat by the tail learns something he can learn in no other way

So it is with buying a house at a time like this…

Way back in 1988 I was in the Broadcasting House BBC bar at lunchtime, sinking a few beers as one did at the time of the liquid lunch to send off a departing colleague. I was a lonely grunt engineer, surrounded by beautiful people, all talking about one damn thing, which was how much their blasted houses had increased in value, or their friends had made on the sale of theirs.

I slowly drank myself to a stupor, trying to forget that at the end of the day I was going to get on my bike and cycle along the Western Avenue to Ealing, where I had a crummy bedsit with a electricity meter that took 50p pieces and I needed to get some salt to put round the perimeter to keep the shiny black slugs from invading the room.

What is it with rented accommodation and black slugs?  I encountered similar blighters in someone’s rented room on the first floor in Ipswich. Do landlords install them to stop their tenants getting too comfy I wonder?

Anyway, I managed to avoid standing up in the bar and hollering “STFU you smug lot, I am on an okay wedge working for this firm and I have no hope of buying a house in this damned city of my birth because of sleazeballs like you making a mint out of my misery”.

The modern equivalent of that is to get on pricedout and housepricecrash and blame the baby boomers for it all. Plus ça change, plus c’est la même chose. I felt just the same pain, but I couldn’t yell it out to loads of people on the internet. And I’d have queered my pitch with the girls, though I probably didn’t improve my case on that front by sinking five pints of E.S.B. so that at least if the situation didn’t look any better it felt less bad.

There’s actually a positive takeaway for this for the priced-out generation. Every young generation is “priced out” in their twenties, because the greybeards have all the money. How did the greybeards get it? The same way as I did – working for three decades! Despite manful attempts to spend it on holidays, booze and toys some of it stuck around 😉

When I got home I resolved to tackle the situation. I could either try to find work with Goldman Sachs to get the pad I wanted (I fancied a cool flat somewhere in Bloomsbury, please) or I could get the hell out of London and find somewhere I could afford on the sort of job I could get with my skills. I had spent all my energy railing against the unfairness of it all, and only when I had independently discovered what M Scott Peck had to say about taking responsibility could I find resolution to the problem. The next year I was in a different job, in a different part of the country, and stupidly putting down money on a house at the peak of the Lawson boom. Less than 20 years later, I had paid off the mortgage on the house I bought after that, despite nursing a shocking loss on the first house.

A Different Way to Buy a House

What I found so delightful about “Reasons to buy a house instead of renting” was that Monevator himself pole-axed the argument, with a single sentence in the comments outlining a different way to buy a house – the road not travelled.

I followed the traditional path, buy a house in my late twenties, spend the next 20 years paying for it. I was lucky to stay in the same job and location for 20 years, that sort of job is becoming less common now.  There’s another way.

What you are doing in taking out a mortgage is gradually buying a capital asset, that eventually by the time you retire should be paying your living costs for you. I don’t pay rent, and I don’t pay a mortgage any more. There are some parasitic housing-related costs associated with wear and tear that I do have to eat, but they pale into insignificance compared to rent or a mortgage.

The trouble with a house is that it is an illiquid asset, if you have to move for a new job you have to hope you can sell your house, or get stuck with the headache of being an amateur landlord.

What about the idea of pumping up your ISA and using the income from that to pay your rent? You get two things there, one is you build up a capital asset that roughly goes in line with house prices (house prices are usually high in booms and take a hit in recessions). You could use that to buy a house. The second is that once you have a capital asset enough to buy the typical house you would be able to afford on your salary, the income from those shareholdings probably makes a decent attempt at paying your rent.

I was in my late forties when I paid the last instalment on my mortgage. Monevator, by contrast, is out there in front 10 years ahead of me

As it is I’m in my late 30s with a portfolio big enough to buy a flat in London outright

Jammy b***d, good for him! Now there are significant differences – he is more entrepreneurial that I am, and I would imagine on what works out to be a better income – that is one of the advantages of working for yourself whereas I took the conservative and at the time safe approach of having an employer hedge all the business risks for me. Look at that difference in timescale. I did pretty well, discharging a 25 year mortgage in 20 years including one house upgrade, whereas Monevator has set himself up to be able to buy if he wished a decade earlier in his life, and in London, where he’s competing wit hthe financial whizz-kids and foreign shipping magnates inflating house prices.

There is much to be said for the investment asset approach rather than the bricks and mortar approach. With the latter, you are exposed for the full duration of the mortgage to losing your job and possibly having to sell up into negative equity or losing the house. Obviously with investments you can screw up royally or suffer a Great Depression, but provided you play safe and keep your wits about you then you won’t suffer a forced sale where your assets are marked to market.

Once you have the money to buy a house, and once you are old enough to retire/no longer need a job to survive financially, you can consider buying at a time of your convenience. For a house is a real asset, it is not purely a financial asset. That means it does something for you – it keeps the rain off your head and means you aren’t beholden to somebody else’s whim for accommodation. There are great advantages to non-financial assets in times of trouble, like the potential end of the eternal growth that industrial civilisation is predicated on.

They hold some of their value, unlike paper assets which can get rendered down to toilet paper by inflation or monetary disasters. But because of its illiquidity, if you have enough money to buy a house cash using the value of an investment portfolio, you are much better placed to tackle the modern world of insecure work and needing to move than you are as a mortgage holder.

I’m in awe of the road less travelled. It wouldn’t have worked for me (and many others) because I was an unsophisticated investor well into my thirties, so I wouldn’t have been able to build capital like Monevator.

My sophistication now is hardly much better, but my results are better, because I have learned so sit on my hands and do not churn my portfolio, and seek income which screens some of the wilder excesses (it’s not as simple as chasing yield which often drives you to excesses).

So the road less travelled is less travelled for good reason. It is hard, and it needs self-discipline and keeping one’s wits about you. Most people do not measure up to the requirements, so the conventional way of exposing themselves to the risk of negative equity and taking twenty or thirty years to pay down a mortgage is perhaps right.

But as M Scott Peck would be only too happy to remind us, there is value in the discipline of gaining the understanding of another way, and developing the skill to do it. Buying young and subjecting yourself to the whims of an increasingly dysfunctional workplace for two decades is not the only way. M Scott Peck would have the hordes of pricedout et al take heed, and perhaps look for the road not travelled. They could take their capital asset with them as they travel the country or continents seeking work. It is hard, because you have to forego the iFads and knuckle down to saving, a discipline which is forced on many in their thirties by the need to pay the mortgage or lose the house.

So I tip my hat to the intrepid travellers on the lonely road less travelled It is hard, but it looks like it may serve some of them well, and they deserve to get to the destination quicker.

Why You Shouldn’t Buy a House

I ought to make a declaration up front that I have bought my house and own it outright.  It’s taken me nearly 20 years to get there though, and the world has changed. And obviously it’s not up to me as to whether you should buy a house, I’m just playing devil’s advocate because nearly everything else you’ll read says go for it 🙂

Here are some reasons you might set against buying a house in today’s market:

1. Houses are overpriced
2. You need over 9 years of net income to pay it off
3. In London? Forget it unless you work for the likes of Goldman Sachs
4. Paying just the interest? You’re renting from the mortgage company, but unlike with a landlord you can’t make it fix the boiler for you.
5. You may need to move to follow work.

There’s a strong emotional attachment to home ownership in the UK. It may have served us once, but there is much to be said for a model where renting is more widespread in a world where jobs are less secure than they used to be. Let’s take a look at these items –

Houses are overpriced. A mortgage used to be given on an income multiple of 3.5 times gross earnings for a single person, or 2.5 times joint earnings. This income multiple has stood the test of time; if you need to borrow more than that then the houses you’re looking at are overpriced for you. You can:

• earn more
• stump up more capital
• be less ambitious in your house aims (I wanted a detached 3-bed in ’89, I bought a mid-terrace two up two down 🙂 )
• move to a cheaper area (I left London – couldn’t compete with the über-rich)
• give up the idea
• take ridiculous chances with your personal finances and risk losing money and your home.

Housepricecrash has a chart of real house prices varying over time.

House prices in real terms over time

At the moment it looks like this. From the trend line, perhaps they are not as overpriced as they have been for the last 10 years, however, there is a recession on so I wouldn’t bet on a switchback, personally…

I bought in 1989, and had to sweat through the 1990-2001 hole. There’s no fun whatsoever in paying down on a mortgage that is ‘underwater’ and my net worth is down by about £40,000 in 2010 terms from buying at the wrong time. People even warned me that there were specific factors inflating prices but I was too cocky to listen. You never hear from the people that lose money on buying houses. It happens, but people usually keep schtum about it because success has many fathers but failure is a bastard.

I’m an exception to that because I’ve managed to pay off my house, so I can view this from the other side, it doesn’t still trap me in debt-slavery. Buying that first house was what is so far the one most monumental personal finance cock-up of my life. It dwarfs my second worst PF mistake –  endlessly churning my portfolio and then losing my shirt in the dot-com bust. At least I got some excitement out of that, and learned what not to do!

Everybody talks up the Kodak moments about buying a house. Nobody talks about grinding years of looking at your mortgage statement at the end of the year and making an annual capital repayment of about the price of a secondhand car  so you can at least see an end to it in decades hence. This was around the time when they started to tell me my with profits capital repayment vehicle wasn’t going to repay the capital… A bonfire of fresh twenty pound notes every December would have been more fun than that.

You need over 9 years of net income to pay it off. This mortgage calculator shows that at an average 6.5% interest rate you get to pay back twice the amount you borrowed. So if you borrow 3.5 times your gross salary, you get to pay back 7 times your salary back.

The Government relieves you of about a quarter of gross for a typical basic rate taxpayer, leaving you with 75% of it. Kiss goodbye to 9 years of it if you want to pay the mortgage off in 25 years at an average interest rate of 6.5%.

Things that work in your favour here is that your salary may increase in real terms through job switches, promotions etc. Inflation also reduces the real value of the loan, if we manage to stick with the 2% targeted rate of inflation the real average interest rate is 4.5%, provided your salary keeps up with inflation. That means in real terms you get to pay back 1.67 times what you borrowed, which take out nearly eight years of your net salary.

London prices? They kicked me out of the city 20 years ago and are still causing Londoners problems. The problem is that you’re competing with serious money in the Smoke, both UK wealth from the City and foreign wealth too.

Paying just the interest? You’ll never own your home. Not only that, but you have to fix the damn thing if something breaks, and you can’t up sticks and leave it behind (unless you are in America, where apparently you can simply surrender the house to the bank and walk away debt-free). Seems a lose-lose situation, I can’t understand why anybody goes interest-only without having a strategy to pay the capital, other than for a short period of financial stress. As for those nutters that kept on ramping up their mortgages in equity release schemes to go on holiday, well I not sure they should be licensed to drive any financial instruments whatsoever 😉

You may need to move to follow work. Work is much less stable now than it was in our parents’ generation. Globalisation and the associated ‘creative destruction’ churns companies and job roles faster and faster. Buying and selling a house is stressful and costs money in estate agents’ fees, removal costs and stamp duty. Owning a house makes it hard to get on your bike for a new job. That can seriously damage your wealth, and your health if you end up with a long and stressful commute.

The pros of home ownership are often promoted without a hat tip to the darker side. And one fact is inescapable – nobody who has a mortgage owns their own home. They only own their home when they release the dead hand, by paying the last installment and redeeming the loan. Without a strategy to do that, they might be better off renting instead.

Interest only mortgage – Do you feel lucky, punk? Well, do you?

Monevator has a good post about using an interest-only mortgage as an investment tool. You have to live somewhere, and if you have the discipline then it’s a great way to build up an investment portfolio over the term of the mortgage which will pay off the capital.

Hey, where did I hear that before? Ah yes, as a late-twenties starry-eyed young pup in the market for his first mortgage. Abbey National’s estate agents at the time, Cornerstone, sold me a mortgage. I went in wanting a repayment mortgage, like my Mum and Dad used to have. Lovely LAUTRO saleswoman, Sue she was called, gorgeous green eyes…

“You can do better than that. with an endowment you just pay the interest, but look at this Friends Provident with profits fund. Look at these lovely growth figures. At the end of your 25 years you’ll have twice as much in the endowment as you’ll need to pay off the capital”

Sucker. I was had. These were the years of Gordon Gekko, Greed is Good. Beware pretty saleswomen promising the earth. I was single, so the one benefit of an endowment, the life insurance part, was worthless to me or anyone I cared about. But 100% profit in 25 years, well, that had me. That’s the takeaway message I got, I am sure somewhere in the fine print there was the usual past history is no guarantee yadda yadda. But I was lost to the green eyes and the promise of lots of moolah. I hope it was the moolah that swung it rather than the eyes…

A few years later, the house underwater on the mortgage, Friends Provident demutualised and I got seven grand. Which, having gotten wiser, I paid down to the capital. On the principle that there were now nasty shareholders rather than cuddly mutuals so I would be ripped off and enjoy poorer with profits performance, so I better at least use it to reduce my interest payments.

Then the letters came saying “sorry old chap, but we were a tad overoptimistic in our predictions it seems. You, mate, will be lucky to get half towards your capital, so you better raise the amount you’re putting into our rotten with profits fund to catch up. Ta-ra”. Or words to that effect. I saw red and wrote the MD of Friends Provident a stinking letter telling him their salesperson had promised me a guaranteed return. He, or rather some lowly grunt on his behalf, wrote back after a while saying “no we didn’t, but you can moan to us, then the Ombudsman if you like”

So it was that after moving I ended up with an interest only flexible mortgage from those nice people at Birmingham Midshires. Nobody wanted to sell me a repayment mortgage in those heady days of the dotcom boom.Every year I’d pay off a lump I’d saved to reduce the capital.

Some lengthy time later, Friends Provident settled with me to put me back in the position I would have been had if I’d taken a repayment mortgage, which was sixteen big ones they’d lost me in ten years. I paid this towards the capital of the new house. No foreign holidays, kitchen refits or cars were involved here 🙂 Having screwed up royally in the dotcom boom I learned, do not churn, sit on your hands, and continued to pay down the mortgage. From 2003 I changed tack, and started investing in a dead boring Legal & General tracker fund, using some of the money I’d otherwise be putting into the mortgage capital repayments. That did help me steal a march on the mortgage, and it 2006 I reduced the mortgage to the minimum BM would allow me to have. This was a flexible mortgage, so I could ring them up, and they would transfer to me any amount from 10k up to my overpayment into my bank account by BACS.

People often advocate an offset mortgage, where your savings with an institution are offset against your mortgage, so if you have a mortgage of 100k and savings of 50k you only pay interest on 50k. That sounds great, except in the credit crunch. Because the small print says they can forcibly use your savings to pay down some of the mortgage. So the general rule is never hold your stash of cash with the same organisation or banking group that holds your mortgage. This happened to someone I know, which screwed them royally.

I liked the disconnect of the flexible mortgage. Although I used shares ISAs to save my capital (effectively doing myself what Friends Provident had so miserably failed to do on my behalf) I never tackled this with the intent and savvy that Monevator proposes. But I can vouch that it works, I paid my mortgage down with about 10 years left to run. And paid the mortgage company  less than a tenner a month while I mulled over whether I wanted to discharge it. Monevator would make a good case that I shouldn’t have, I could have invested in 2008 and made a mint, and indeed could have had 11 years more use of this cash, currently at rock-bottom rates. But I don’t have his edge and ambition, and in the end I wanted my house to be truly mine.

2007 mortgage statement. BM didn’t get fat off my back that year 😉