You’re always better off as a homeowner, even if house prices fall

by Neil Faulkner on 03 November 2011  |  18 comments
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House prices are forecast to fall but for many peak buyers, it'll work out ok in the end.

Both Capital Economics and estate agents Knight Frank have forecast that house prices will fall by 5% in 2012.

You can read more on those forecasts in House prices to fall 10% by 2013, but both of these forecasters have a terrible record, having consistently got it wrong. Indeed, the dozens of forecasters I've followed have yet to prove their reliability. But say that these two are right this time and prices fall 5% to 10%. What does this mean?

I don't need to tell you that for those wanting to get on the ladder, it's great news. It's also potentially good news if you want to upsize and still have decent equity, provided your desired property falls in price around the same percentage as your own.

However, for those who have overstretched themselves and are struggling, these are hard times. The same is true for those in or close to negative equity.

Or is it?

Why do we buy homes?

What’s the financial damage if you buy a property and then house prices fall? For every £10,000 more you bid for your home than someone else at a better time, you'll possibly pay another £10,000 to £15,000 in mortgage interest on top.

But should we really see this as financial damage? Let's consider the two financial reasons that make buying a house worthwhile:

The two financial reasons to buy your own home

1. You expect to pay less in housing costs over the course of your entire life than someone who rents the whole time.
2. You have something to pass on to your heirs – whatever it is worth at the end.

There are non-financial reasons to buy, too, not least of which that no one can kick you out with just  three months' notice, but I’m sure you can think of these yourself.

Fluctuating mortgages versus lifetime rising rents

Let's take the first financial reason to buy: it costs less than renting over your lifetime.

You can think of mortgage costs as a yo-yo. Since they're forever connected to your purchase price, they have a central point that keeps them within a range.

As wages rise, those mortgage payments will get easier, even if interest rates are higher in 24 years than at the beginning. What's more, the payments end in a few decades.

The high initial costs of a mortgage work against you, but this reverses quite starkly in the long run. Compare it with rents. Imagine a set of stairs going up and up, into space. That's your viewpoint until you buy. Rents rise almost every year till eternity, and will continue to do so as long as we have inflation.

Yes, you will likely have more costs on than a renter would. But a large part of that will be for personalising your homes, which is a choice that should enhance your quality of life.

That leaves essential maintenance costs, which can be considerable for homeowners – but renters should also expect to pay for these things for their landlords eventually, if not immediately, in their ever-rising rents.

Having something or having nothing

Now let's look at point two: having something at the end to pass on to your children.

If you rent all your life, you will have nothing to give to your heirs. If you buy, you will have something.

Let's say that prices don't just fall 10% over the next two years, but the absolute unbelievable happens, and 50 years from now your property is still worth 10% less than you paid for it. Here's your situation:

ñ  You've probably still paid less in housing costs than a renter over the period.

ñ  You have a property that your heirs can inherit, whereas renters don't.

Although the price is lower, you've had lower outgoings over the period than renters, and you still have something that you can give to your heirs.

Buying at the peak doesn't make renting better

What if you had bought at the peak in 1989/90, all costs included? Where would you be today?

Even though prices fell from that peak and did not recover for nearly a decade, the average buyer could easily expect to be better off, or well on the way to being better off, than if they were still renting.

Peak buying reduces your gains

I asked earlier if we should see the extra burden of buying at the peak as “financial damage”. Maybe I'm just merry, but I think it would be more accurate to say that you have gained less than those who bought at a better time – but you and your heirs will still probably be better off than if you rented till you died.

Watch the mortgage payments versus rents

I think that more of us would do better to stop looking at house price fluctuations and focus more on mortgage costs versus rent costs.

I think the key factor to think about before you buy a place is: what would the rent be on a place like this? You should expect a mortgage and additional costs to be considerably higher than rental costs, but if it is vastly higher, you might be better off renting. This is even more likely if you begin your large mortgage with unusually low interest rates, and you're unable to lock in a low rate for a long time.

So long as you don't agree to pay a monthly mortgage that is astoundingly higher than the rent would be, I think you'll get a good return in the end.

Tying up loose ends

Two caveats: always make sure you could afford the mortgage even if rates rise (which today might mean locking in a good long-term rate), and that buying is right for your circumstances. This means: you're willing and able to stay in the property for a long time, your job is secure, or you have plenty of extra emergency savings, or you're confident of getting another job in your area even if the job market is tight.

Finally, I think I'll take the opportunity to spell this out, because some readers with strong wants and feelings sometimes misinterpret my glass-is-half-full attitude: I have not made a forecast in this piece, and I do not know what will happen to house prices in the next few years. Not a clue.

And, no, I didn't buy at a peak.

More: Compare mortgages through lovemoney.com | The £20,000 cost of constantly switching mortgage