Thursday, 23 May 2013

Is it Time to Buy a Home

On the 24th of April 2013 the Bank of England and HM Treasury announced that the Funding for Lending Scheme (FLS) would be extended until January 2015.  It was also modified to include selected non-bank providers of credit to the UK economy.  Between the FLS Scheme, a Bank of England Bank Rate of 0.5% and £375 billion of Quantitative Easing mortgage rates have fallen a long way.  Let’s look at the data.

The Bank of England publishes a number of datasets on this topic and I have picked 5 which cover the more common mortgage types available today.  They are the sterling monthly mortgage interest rate of UK monetary financial institutions (excluding Central Bank) covering:

  • Standard Variable Rate (SVR) mortgages.  These were starting to rise at glacial speeds but have now pulled back a little.  Today they sit at 4.34%, flat month on month and up 0.24% year on year. 
  • Lifetime Tracker mortgages.  These have been flat for some time now.  Currently they are 3.56% which is flat on the month and sees a decrease of 0.04% on the year.
  • 2, 3 and 5 Year Fixed Rate Mortgages with a 75% loan to value ratio (LTV) continue the falls that appear to have accelerated in a downwards direction at the same time the original FLS was announced.  Today we see these mortgages at 2.87% (down 0.04% on the month, 0.79% on the year), 2.98% (down 0.32% on the month, 1.05% on the year) and 3.61% (down 0.02% on the month, 0.68% on the year) respectively.  Since the FLS scheme started the falls are 0.82%, 1.03% and 0.50% respectively.

A history of these mortgage rates can be seen in the chart below which also shows the announcement dates of the Bank of England Bank Rate of 0.5%, 4 tranches of Quantitative Easing and Funding for Lending.

UK Standard Variable Rate Mortgages, Lifetime Tracker Mortgages and Fixed Rate Mortgages
Click to enlarge 

With inflation currently running at 2.9% you can now get an average real inflation adjusted 2 year fixed mortgage for -0.02%, a 3 year for 0.09% and a 5 year for 0.72%.

I’m currently out of the UK property market in rental accommodation but with my Assured Shorthold Tenancy coming up for renewal in the near future plus a Letting Agent that treats me slightly worse than belly button lint every time the annual negotiation begins, it’s time to reassess whether it’s time to buy.  Today is not meant to be a comprehensive piece of data analysis in typical Retirement Investing Today style, that will probably come later as I formulate my thoughts, but more some musings of what is currently running through my mind in the hope of generating some comment from you the valued reader.

Before musing about whether to buy let’s briefly get a summary of some of my economic opinion and data analysis that has been covered over many previous posts on the table:

  1. The previous models I have used to examine UK housing predict that houses are affordable but not good value
  2. The UK Government and Bank of England are actually trying to engineer a Financial Repression and not Austerity.
  3. House prices have been flat in nominal terms since the start of 2010 but are falling in real inflation adjusted terms.  
  4. The government wants to protect nominal property prices as allowing property prices to fall would greatly damage re-election chances.  I don’t believe they are protective of real inflation adjusted prices as it’s a great way to improve value without the majority of the population noticing.  They've shown their hand on this topic with the original FLS scheme plus the extension, Help to Buy Equity Loans and the Help to Buy Mortgage Guarantee which will start on the 01 January 2014 to name but four.     
  5. On a personal side I, along with many readers I'm sure, utilise NS&I Index Linked Savings Certificates (ILSC’s).  Their RPI + X% plus tax free status has served me well since I started aggressively buying in 2007 resulting in a significant portion of my wealth now being tied up in them.  The problem I have is that the 3 year variants have now been rolled over once and are starting to reach the end of their second term.  At the end of the second term you aren't given the option to reinvest but are forced to take the cash back.  [Edit 26 May 2013.  Readers have highlighted that I’ll be able to reinvest for a third term.  I can no longer find where I read that I was only eligible for 2 terms and the T&C’s aren’t clear with “After any term a Certificate may be eligible to earn interest for a further term of the same length.  The Treasury will decide...”  All I can say is that I hope so as it will take some pressure off and I will find out very soon.]  Unfortunately, NS&I aren't offering any new tranches to invest in and so that money has to be found a new home.  It can’t go into the stock market as my strategy is currently telling me to reduce equity holdings.  That’s therefore going to leave a savings account paying something like 1.4% which after tax and inflation will see this wealth will be going backwards at the rate of a real 2.1% per annum.  Alternatively other low risk options like UK government bonds are also going to send me into negative territory after taxes and inflation.

So what’s stopping me running out and buying a home today?  Essentially it boils down to two main risks – mortgage rates and house prices.  Let’s look at each in turn.

Mortgage Rates

My original plan was that at some point I’d buy a home and then manage the loan so that at age 55 (15 years hence if I was to buy today) I’d end up on an SVR mortgage still owing the equivalent of 25% of my pension pot.  I could then use the 25% tax free lump sum from the pension to pay off the mortgage.  This strategy allows me to maximise my pension contributions while working and then maximise my ISA contributions, between early retirement day and 55, which I've highlighted the importance of previously.  It’s only 15 or so years ago that average mortgage SVR’s were nearly 9%.  Were they to return to somewhere near that level over the next 15 years, say if the market doesn't like the Financial Repression it’s seeing and responds with vengeance, then my early retirement plans would certainly be in jeopardy.

Can I protect myself from this rate rise risk?  Given my current position I think I may have found a way.   Some mortgage providers are now offering extended fixed rate mortgages at what look like pretty competitive rates when you consider the average fixed rates above.  For example, Leeds Building Society is offering a 10 Year Fixed Rate Mortgage for 3.99% fixed up until 30 June 2023.  Firstly, take a mortgage like that.  Secondly, use my current cash holdings plus imminent ILSC’s cash returns for a very healthy deposit instead of taking a negative return elsewhere.  Thirdly, use the continual ILSC cash returns that will continue over the next few years on top of some new savings to pay off the mortgage quickly while still continuing to maximise ISA contributions and it looks feasible while protecting me from interest rate risk.

Price Risk

There are really only three scenarios’ that can play out here:

  • The market rises in nominal and real terms.  I think the chances of this occurring are low but I've been wrong in the past.  Could, for example, The Help to Buy mortgage guarantee engineer this.  Only time will tell.  If this occurs then I win by buying now instead of later instead of wealth being eroded by inflation if I don’t buy.
  • The market continues to tread water nominally but falls in real terms as is the current trend.  This is in my opinion is starting to look like the likely scenario given it’s also the scenario I think our government want.  There is a saying in the US, Don’t Fight the Fed.  Will the same hold true in the UK?  If it does I’ll call my position a wash.  I might lose a small amount of wealth as I can currently get a very small nominal return on my investments but that will more than be made up by being able to drill a hole in a wall or plant a fruit tree in the garden for my family to enjoy.
  • The market falls in real and nominal terms.  I will have a reduced retirement “salary” as I've had to use more of my stored wealth to put that roof over my families head.  However that said the cost of a home will be known (as I’ll be living in it) meaning I can plan my early retirement with much more confidence.  Additionally I’ll still have a very early retirement and be living comfortably.  It just might be a little later than if I had waited longer to buy.

As always DYOR.

What would you do?  Is anybody buying or considering buying right now?  Your comments are valued as always.


  1. We are looking to buy and considering a long term fix of 7-10 years. I am currently playing with different repayment scenarios, such as part interest only and part capital repayment. We have some ILSCs (RPI+0.5%) due in a few years, so am thinking of going I/o with part of the loan and having the option of clearing it with ILSCs, I don't want to sell any investments or remortgage. I agree that houses are still expensive, but we want to move, we have no mortgage, but we have plenty of capital so are in a good position, we could borrow a large sum but looking at about twice my income as a maximum. Many years ago a very wise accountant told me to never borrow more than 2.5x your annual income, I have always stuck to this rule with mortgages.

    1. It sounds like we are in a similar position. The main difference seems to be that I'm not considering interest only. What type of mortgage rate are you finding on the 7-10 year interest only option?

  2. HSBC are offering 3.99% for 10 years and 3.49% for 7 years. This is around the current rate RPI so inflation can help to kill the capital. I am happy with the risk.

  3. BeatTheSeasons24 May 2013 at 13:08

    Good news RIT.

    Don't forget you buy one individual property, not the average property market. Therefore the type of property and location are really key. If you can find an area with a lot of potential and/or a type of property with an increasing demand then you increase your margin of error to offset the risks you've identified.

    Location of jobs seems to be important but prices should also be supported by buyers and residents with non-linear sources of income - hence places like London and Cambridge do well on both counts. There seems to be no sign of demand slowing down (immigration, people living longer, etc) and supply constraints remain, with restrictive planning policies and nimbyism. If you buy somewhere with a physical constraint like the sea or something more artificial like a green belt then that supports prices as well. Height restrictions make a difference for the same reason.

    A big unknown for me is what will happen in rural areas, which are often very cheap if they're not close to a city with lots of jobs. On the one hand rising fuel costs make commuting ever more expensive, but conversely as we start to see more computer-controlled cars we can hope that congestion will become a thing of the past. And peaceful out-of-the-way locations are getting rarer, almost by definition.

    Having said all of that I personally believe we're going to see a lot of inflation over the next 10-20 years, I think the property market will start to pick up again, and therefore it will be hard to go wrong. So don't spend too long prevaricating!

  4. "At the end of the second term you aren't given the option to reinvest but are forced to take the cash back." Are you sure: that's not been our experience; have they changed the rules on that? (I've found the wording of some of the rules a bit of a bugger to decrypt, I must admit.) Worth a phone call, I suggest.

  5. This is what financial repression is meant to do isn't it, force people out of cash?

    Seems to be working doesn't it?

    So it seems to me you can't beat the bank of england if you have to live here (unlike Soros)

    Every sale generates a nice bit of stamp duty and VAT for the government

    Very difficult to keep your nerve until 2016 and see what the new government does

  6. I would have thought buying is the lesser of the evils all things considered. But it is a massively brain-aching decision given that by most estimates house prices are still inflated.

    I sat down to do some discounted cash flows etc, but quickly realised someone cleverer than me had already produced very useful spreadsheets. See:

    Obviously, the underlying assumptions to put in to these models are tricky at best, but it is interesting to do scenario analysis and there is a good 'buy or rent' spreadsheet.

  7. From an outside the UK point if view:
    - Low real rates make a compelling case, especially if you can lock them in for a long period and pay down principal during that time (the reset might be high if there is in fact high inflation then)
    - As a commenter above highlighted, the specific property has more impact than the market generally
    - The nonfinancial benefits of having your own home should be factored in. Treating a home as an investment makes it harder to stack up financially relative to investing that capital. Not to be morbid, but I know of someone who sacrificed a great deal to set themselves up for retirement and then died suddenly just before retirement age - my point being that you can't take it with you, and being able to live a better life every day counts for something.
    Good luck.

  8. "Their RPI + X% plus tax free status has served me well since I started aggressively buying in 2007 resulting in a significant portion of my wealth now being tied up in them. The problem I have is that the 3 year variants have now been rolled over once and are starting to reach the end of their second term. At the end of the second term you aren't given the option to reinvest but are forced to take the cash back. "

    This hasnt been my experience? l got a 3 year that just rolled into a third 3yr term in april @ RPI + 0.15. I have another ending its second term in October this year which l was intending to cash out anyway. Can you confirm your findings?

  9. Chelsea are offering a 7-year fix @ 75%LTV at 3.59%, which looks good value.

  10. Or you could hedge your bets by purchasing a BTL. Avoiding risky areas (high yield by more chance of voids) and hot spots (low yields) but still on a main line to London or somewhere, you should get get 7% (after costs and tax works out nearer 4%). The advantage is you still have diversified into property, but if you choose wisely the yield covers the cost whatever the capital value does.
    Other risks with this strategy would include bad tenants, damage, voids, etc....
    This is very much a DYOR strategy.

  11. @BeatTheSeasons
    Thanks for highlighting the importance of location. It’s one of the big considerations for me. If I buy now (pre-retirement) I’ll be forced to buy close to where the work is but if I was to wait a few years (post retirement) then I could look at those rural areas which give more value for money.

    @dearieme and DabHand
    I’ve re-read the T&C’s and they are as clear as mud. I can no longer find where I read that but it’s great news that I can roll for a 3rd term. It certainly takes the pressure off.

    @Anonymous 1
    I agree with the “can’t beat the Bank of England” as I alluded to with my can’t beat the Fed comment. The question is will the Bank of England make a mess of it.

    I agree that this is a brain-aching decision and one I don’t want to make a mess of. Given it looks like I can roll my ILSC’s for a 3rd term I’m going to take my time and make sure it’s the right one for my family and I.

    @Anonymous 2
    The non-financial benefits are now one of my main considerations. I would like to get a vegetable patch, plant some fruit trees and start working on a more energy efficient lifestyle. My current rental accommodation provides no opportunity for that where I can’t even put a nail in the wall to hang a picture.

    @Anonymous 3
    Thanks for highlighting

    I appreciate that BTL is a path chosen by many but I’m not sure it’s for me. I may change my mind sometime in the future but right now having been on the end of Assured Shorthold Tenancies I really don’t want any part of it again from either side of the coin.

  12. The best time to buy was in 2007, or 2006, or 2005, for most people in most places.

    Provided of course, you took on a low margin above base tracker.

    Anyone that did (outside of the few areas like NI that have properly crashed) is already ahead of the game versus renting the comparable house since.

    The game is over.

    Those that thought a severe crash would happen were wrong.

    Those that thought a severe shortage of housing combined with a low rates response to recession would protect values were right.

  13. You've missed one of the potential scenarios which is the most dangerous one. As with the OPEX crisis in the 70s the worst scenario is the one where prices increase rapidly, suckering you in to a major investment then drop as capacity comes online as was the case with the major oil companies.
    In the case of housing probably you may be right that option B is the most likely in the long term. However the variations along the way can cause havoc if people get in and out at the wrong time. Say you had to move country for work after 5 years for example which coincided with a 20% (temporary dip) in nominal values.... In the light of such regulatory and financial instability flexibility has value.