20

I am a single male in my mid twenties, based in the UK and looking to buy my first home. I see this home as a 'stepping stone' home and intend to live in it for 5-15 years until I get a partner and plan on having children and then upgrading to a better house.

I have a budget of around £180k for a house based on my deposit and what the bank would lend me as a mortgage. I feel now is a good time to buy due to a volatile housing market as well as low interest rates on mortgages.

I have seen some houses in a great area for around the £180k mark and I believe due to the area these would rise in value. I have also seen a slightly better specification house in a worse area for around £130k - which is significantly under my budget. This would mean I could buy the house and still have a lot of additional deposit left over as well as the monthly repayments being lower. With the surplus money I would consider 'overpaying the mortgage' in order to reduced the mortgage term and therefore build up more equity in the house. I am aware overpaying the mortgage sometimes comes with penalties and / or restrictions.

So my question is - is it worth going for the much cheaper house in order to build up more equity or should I go for the more expensive house in the hope that I would still build up equity and the house value would also increase more than the cheaper house? Or am I overlooking some major details?

blahdiblah
  • 277
  • 1
  • 5
Jsk
  • 1,668
  • 1
  • 11
  • 23
  • 8
    Did you arrive at the 180k amount by looking at houses that suit your housing needs? Or is 180k the most expensive you can afford to buy with the largest loan a bank will give you? If the former, there are arguments to be made for both options; if the latter, then one option is almost certainly going to be seen as the "wrong" choice by anyone answering your question on this site. – yoozer8 Jun 29 '20 at 16:29
  • 1
    If two properties increase by the same percentage, then yes, the more expensive property gives you a larger return when you sell. However, assuming the size of the mortgage is not the same for both properties, you are paying more in interest on the more expensive house, which will offset your return. And this is assuming the property increases at all, never mind by how much. – chepner Jun 29 '20 at 17:17
  • 22
    You will always regret living in a bad area, no matter how nice your own house is. – Valorum Jun 30 '20 at 00:21
  • 3
    A note: having a partner and children is very expensive. If the house you’ll be looking for will be significantly more expensive than your current one, remember you will need a deposit for that too. Normally the deposit is smaller for second tune buyers, but a) we live in unpredictable times and b) if the house is more even a smaller percentage can end up larger. You’ll want to keep the attitude of saving, ready for these costs (marriage, children, bigger house) (and also retirement). Make sure you’ll be able to do that on whatever mortgage you get. – Tim Jun 30 '20 at 09:28
  • Two caveats related to the current situation, which I would summarize as follows: The economic future of Europe -- and this includes the UK -- is unknown. The current economic crisis may well become (more, or more obviously) catastrophic, which will have two effects influencing your question: (1) Your income may not be as secure as you and your bank appear to think. (2) Real estate value may tank. -- This is an argument to delay a purchase altogether. – Peter - Reinstate Monica Jun 30 '20 at 12:02
  • 3
    @Valorum Or vice versa: You may always regret living in a shitty house no matter how nice the area. People have different priorities. The typical person spends more time indoor than in the neighborhood. – Peter - Reinstate Monica Jun 30 '20 at 12:04
  • 1
    @Tim As a broad statement, I disagree. If your partner earns the same or more than you, it is not expensive at all :) I've seen similar comments to this before, it's a lazy stereotype, probably not reflective of the situation of many people on a site like this. – awjlogan Jun 30 '20 at 13:37
  • 3
    You should buy the property that you can afford to live in even if the housing market crashes and the value of your home drops by over 30%. Once you own one of those properties then you can feel free to buy additional properties for speculation. – MonkeyZeus Jun 30 '20 at 14:59
  • 1
    Setting your budget based on what a bank is willing to lend you is probably naive. They have different goals than you do, and will set a budget that meets their goals, not yours. – jpaugh Jun 30 '20 at 15:47
  • @Valorum the saying in real estate is "3 most important things are LOCATION, LOCATION, LOCATION!" – Hatman Jun 30 '20 at 15:56
  • 7
    @Valorum that depends on why the area is "bad", and who you talk to. A young man isn't as worried of being assaulted in a bad neighborhood as a young woman would be, and with no kids he is completely indifferent of the lack of good schools. If OP really considers this a stepping-stone for the next 5 years, the downsides may not affect him as much as they would affect other people, and the cost-savings may outweigh the downsides for him. – Aubreal Jun 30 '20 at 16:09
  • 3
    @AlexandreAubrey: ... and there are other ways of how areas may be considered bad by the average home owner but may be desirable for particular subsets of home owners. E.g. how rural the area may be. – cbeleites unhappy with SX Jun 30 '20 at 18:02
  • 12
    You're overlooking what I think is the most obvious point: do you want to live there? – jamesqf Jun 30 '20 at 18:44
  • 1
    @Peter-ReinstateMonica the fact that most banks and building societies in the UK have, in the last few weeks, withdrawn their 85% and 90% mortgage products tells you everything you need to know about what they think the market is going to do: Any big mortgage lent will now will be in negative equity within 12 months. – Darren Jun 30 '20 at 19:48
  • 1
    As you could be moving out in the short term (5 years) i would do a calculation for how many years of rent the fees for buying. moving into, maintaining and selling this property equate to in a property you would be comfortable in.

    A very Rough calculation for my personal circumstances and living preferences puts me needing to live in a 180k house for 7 or more years before id truly be gaining financially by purchasing a stepping stone home and that is assuming property value stays the same. Dropping property value could exponentially increase that period.

     – J.Doe Jul 01 '20 at 05:59
  • @J.doe - that's a great idea! I will have to do a rough calculation. I naively assumed that buying would almost certainly be better than selling for this period of time. However, especially given the current circumstances, this might not be the case at all. – Jsk Jul 01 '20 at 06:50
  • 2
    You have to define 'worse area': longer commute/fewer amenities/worse schools, or 'regular shootings'. We don't know your personal criteria, and they may differ from the average homebuyer, i.e. how they affect valuation vs your personal utility... – smci Jul 01 '20 at 08:19

9 Answers9

30

Welcome to Money.SE. You know, questions like this can help point out good/bad for a given choice, but there isn't likely to be a 'right' answer. I can offer a well reasoned answer, only to find another respected member offers the exact opposite.

Given the way you frame the question, I'd prefer the 'worse' house in the 'better' area. As you suggest, its prospected for holding its value and appreciating are far higher than one in a less desirable area, unless the neighborhoods change as well.

Regarding the 'overpaying' - given the low interest rate environment across the world, and the fact the long term inflation isn't dead, most low rate mortgages now have an effective rate close to zero. I'd think twice about paying faster on what may be the lowest rate you may see in your lifetime. Unless, of course, you are so risk averse, or don't trust that you will save the difference, that this advice isn't useful to you.

JTP - Apologise to Monica
  • 172,273
  • 34
  • 296
  • 560
  • Assuming I do not use the money to invest and the money would otherwise just be sat in an ISA / bank account, which I suppose would make me risk averse, would paying off the mortgage debt not be a better option? – Jsk Jun 29 '20 at 14:45
  • 8
    If money is going to sit in a nearest zero interest account, I would suggest keeping only the amount you consider a “emergency fund“ which will let you sleep well at night. In that case, earning the 3% by paying the mortgage early is a better choice. The size of that emergency account is the subject of a dozen other questions here. – JTP - Apologise to Monica Jun 29 '20 at 14:47
  • @Jsk You're risk averse, and yet you are planning on borrowing all you can afford and investing in a falling housing market? – richardb Jun 29 '20 at 15:03
  • @richardb I would not say I am completely risk averse. In my personal situation, a tangible asset is more much important to me than an intangible asset. – Jsk Jun 29 '20 at 15:09
  • 12
    Note that the OP appears to be in the UK, where fixed rate long-term mortgages are uncommon. It's likely that they'll have to pay higher interest rates in the future. – Brian Borchers Jun 29 '20 at 15:23
  • 2
    Thx, Brian - yes, I was unaware of that. I knew Canada doesn't have the US common 15/30 year mortgages. This changes the math a bit. – JTP - Apologise to Monica Jun 29 '20 at 15:50
  • 1
    I can understand the real estate market is not fully efficient due to illiquidity, but find it odd that buyers and sellers would be so naive as to leave a systematic profit opportunity based on "quality of neighborhood" as suggested here. If it's clear that the one house has a better chance of appreciating, why isn't its price already bid up by people who know this? And likewise, the one in the less desirable area already bid down because the seller wants to get out, knowing prospects are dim? In equilibrium, there should be little difference in expected returns from current prices. – nanoman Jun 29 '20 at 17:52
  • 3
    Only three things matter with residential property: Location, Location, and Location. So I agree with this answer: buy the worse house in the better area. – Peter K. Jun 29 '20 at 19:53
  • 2
    At the moment in the UK, it's not massively easy to find savings rates with same order of magnitude (mortgages at 1.5%-4% vs saving 0.01% - 1%) . I'd strongly recommend overpaying the mortgage instead of holding the cash. – Neil P Jun 30 '20 at 07:38
  • A rule of thumb I've heard is "you don't want the nicest house on the block". If you get an OK house in a great neighborhood, your neighbors' high property values will tend to bring yours up. If you get the best house in a bad neighborhood, on the other hand, it's tougher for your home's value to go even higher. – Nuclear Hoagie Jun 30 '20 at 13:26
15

Leading up to the last big housing dip, many people borrowed near their limit planning on increased home values to provide them with equity, many of them were stuck in a bad spot when home values dropped.

I don't know UK bank policy, but in the US a standard mortgage can be issued that makes your total monthly debt payment up to 45% of your gross income. In my view, for many people borrowing the maximum they qualify for makes them over-leveraged. It can be fine if they have ample savings, if home prices increase, or their wages hold up/increase. A good way to avoid financial stress is living well below your means. Buying the cheapest house you can be comfortable living in and having more liquid assets is a good way to set yourself up to weather tough times.

It's impossible to know which strategy is best financially, it could be that the more expensive home doubles in value over the next 5 years while the cheaper one barely increases. Maybe both houses drop in value by 25% over that time which would leave you in a much bigger hole if you got the more expensive house. It could also be that the savings from buying the cheaper house would have gone up 20x if invested in the stock market over those same 5 years. There's always something better you could have done with your money in hindsight, so the best you can do is make a decision that you're comfortable with even if things don't go in your favor.

Hart CO
  • 70,420
  • 9
  • 171
  • 214
  • I like this answer because when you are young and you don't particularly care where you live on any practical level living well below your means is probably even more so the best advice. – crasic Jun 30 '20 at 06:43
  • 5
    Sound advice. I repeat for emphasis: "A good way to avoid financial stress is living well below your means." In addition, a primary residence should not be considered an investment. Its main purpose is to provide shelter, and it is encumbered with all kind of additional expenses from property taxes to HOA fees to insurance premiums to repair bills. – njuffa Jun 30 '20 at 18:31
5

The correct answer to this is nobody knows.

The reasons for this are simple:

  1. You are assuming that the "worse area" will never become a "better area". There are some places in the UK which historically have been seen as poor areas and then received investment and become "re-generated" such that house prices have risen significantly, when that was otherwise an unexpected event. You can find examples of this in the North East and North West of England, amongst other areas.

  2. You are assuming that house prices will continue to rise. In the medium/long term, historically, this has been a general trend in the UK. You've referenced a time period of "5 - 15 years". It's not possible to say how the housing market will fare during this time.

But most importantly:

3. A house is only worth what a buyer is prepared to pay for it.

You don't know what you could sell a house in either area for 5 - 15 years in the future. It doesn't matter what you feel your house is worth. If nobody is prepared to pay that amount any questions on whether it was a good or bad decision financially are a moot point.

An extreme example would be if literally not a single buyer wanted to buy your house, technically it is "worth" £0. You will receive that amount, i.e. nothing, if nobody will buy it. That's a very unlikely scenario, but highlights the point that the worth/value can differ for a buyer and seller. In terms of gaining money through a sale, it depends on what the buyer considers it is worth - not what you as a seller think it's worth.

Since nobody can tell you the answers to these points, either option could be seen as good or bad. It really is that simple.

4

I think there are two factors to balance out here:

  • Buy the most house you can afford
  • Be realistic about what "afford" means

In general, it is a good idea to buy as much house as you can afford - effectively taking a step-and-a-half on the housing ladder rather than just a step.

However, in working out what you can afford, don't just take the bank's word for it on what they will lend you - even with all the post-2008 affordability checks etc., to my mind you can still borrow way more than would be sensible. You have to bear in mind that interest rates are at a historic low and have been for a long time - use some mortgage calculators to test what the monthly payment would be if rates rise to 7%, for example. Even if you get a 5 or 10 year fixed rate deal, when that deal ends you will need to shop around and find an affordable option, and on that kind of timescale it's perfectly possible for rates to be 7% or even higher. When we did our own affordability checks we used 5%, 10% and even 15% to make sure we could afford the highest option even for a few months if we had to.

Vicky
  • 23,982
  • 4
  • 60
  • 86
  • 4
    +1, even if I disagree. It's too easy to buy bigger than one needs. If I could wave a magic wand and have my house location, but 2/3 the size, I'd be far better off. I know there's a cost to buy/sell/move, but would suggest that a single person living in a 'too big' house is throwing a lot of money away. (and OP already suggested a move after getting married) Unless they rent out rooms which turns everything upside down a bit. Again, why finance is all personal. Second bullet point, 100% agree. – JTP - Apologise to Monica Jun 29 '20 at 20:29
  • 3
    "In general, it is a good idea to buy as much house as you can afford" in general this is not correct, depending on personal situation investing the saving into stock market is usually a better idea. – NoSenseEtAl Jun 30 '20 at 01:10
  • 2
    "buy as much house as you can afford" only if you would otherwise have to upsize at some point. We have a 4-bedroom house for a family of five, so having two or three extra bedrooms just because I can afford it does sound a bit wasteful. – TooTea Jun 30 '20 at 08:11
  • @JTP-ApologisetoMonica a single person living in a 'too big' house is throwing a lot of money away + @ TooTea having two or three extra bedrooms just because I can afford it does sound a bit wasteful - why, is it because larger properties have higher initial buying prices, or because of higher maintenance costs (repairs, heating etc.?) – WhatHiFi Jun 30 '20 at 10:35
  • 1
    Let me offer an example. I have $300,000 to spend on a home. On one side of the street is a $300,000 house on 1 acre parcel, on the other side are two townhouses. Smaller homes side-by-side with the same total living area both sitting on a combined 1 acre. I can either live in the big house or buy the two small houses and rent one out. Over the long term, homes appreciate approximately with inflation. The total return and the reason that real estate can be lucrative is when you include the rent. When you buy a big house, more than you need, you are losing that difference. – JTP - Apologise to Monica Jun 30 '20 at 11:06
4

From the purely monetary viewpoint in which you are asking the question, I agree with Vicky that you should consider what "can afford" really means - calculate what you will be comfortable paying at the moment, what you can pay if Covid lasts another 2 years and the housing market tumbles into chaos or if a vaccine is available tomorrow & the mortgage starts skyrocketing. Also consider what happens if you meet your partner tomorrow and end up moving out within one to two years.

Then add the personal factor - do you want to live in the nicer area or would the "worse" area actually be better for you (close to work, places you want to go, transport hubs etc). Do you like the more expensive houses or would you want to go with the cheaper one and be able to afford nicer furnishings within it?

Dragonel
  • 797
  • 4
  • 9
4

The real estate market will have its ups and downs and there's no guarantee property prices will go up but buying a good house in a bad area (that's showing no signs of improvement) is always a losing bet. Buying a "lesser" house in a good area will, at least, give you a fighting chance.

Choose the best area you can afford, even if the house requires some repair. You're young and if you have the time and talent, you can upgrade the house yourself (paint, reno of kitchens and bathrooms) and increase its value. Old fashioned as it might seem, sweat equity is the best way to start in the real estate game.

In any event, you're young and have plenty of time to recover if you make a mistake.

40+ years of successes (and failures) in real estate investing have taught me a few things...

grant ingraham
  • 41
  • 1
2

I am not sure buying is a good idea at all in your situation. You say you want to buy it as a 'stepping stone', that you intend to keep it for 5-15 years. This suggest to me:

  1. You expect the house price to go up in the next 5-15 years, i.e. you see buying a house as a better investment than a diversified market portfolio
  2. You probably see renting as 'throwing money away'

Both of these are very questionable assumptions. If you were renting instead, how much would it cost you compared to the price of a house? When you count all the expenses and opportunity costs, chances are renting and putting the rest of the funds into a diversified market portfolio is financially a better bet. Add to that the fact that you are very young and may very well want/need to move in the next few years (say, for a better job).

If you simply want to enjoy owning a house, that is fine. But I would see buying a house as consumption, not as a way to build wealth to afford a better house in 5-15 years.

rinspy
  • 271
  • 2
  • 6
2

Octavian mentioned it already but - whyever - got downvoted. I only want to emphasize that the location matters most. I would even say it is clear obvious. Consider you own 10 squaremeters at the NY Times Square or 10 squaremeters somewhere in the outback. Even when you build only a dog house in NY and the most impressive mansion in the outback, the location in NY will be much more precious. In addition to that, as gentrification is an ongoing topic, I wouldn't buy premises where people leave over time. But when you buy space where the people move to, and even if it is "only" in the suburbs, its value will increase. Because you own something that is requested.

Ben
  • 121
  • 2
-2

A famous saying around real-estate agents and real-estate developers about what decides the worth of a property is

Three of the most important things to consider:

  • Location
  • Location
  • Location
Simson
  • 117
  • 4
Shōgun8
  • 133
  • 4
  • 1
    Why is this so downvoted? It is a famous saying around real estate developers and agents. – Simson Jul 01 '20 at 08:57
  • 1
    Yes and there is a very good reason for that; it's because location is the #1 priority in a real estate purchase. You're kidding yourself if you think it;s not. – Shōgun8 Jul 01 '20 at 09:30
  • 1
    @Simson It's a poor quality answer because there is no reasoning. There are good arguments that can be made against stretching your budget to buy a house in a more expensive area during a recession. OP might be correct in thinking it might appreciate more than one in a poor area. Worst case, it loses more, he gets laid off and he ends up in negative equity. Some analysis of the trade offs is needed. – richardb Jul 01 '20 at 12:14
  • 2
    It's voted down because members likely think it's more appropriate as a comment, not a full answer. – JTP - Apologise to Monica Jul 01 '20 at 12:32
  • @richardb the reason why this refrain is the industry standard is exactly for a situation like this. Whenever a person questions whether they should save a little bit of money by purchasing real estate in a less desirable area, like an old kindergarten poem this refrain should come to mind. LOCATION is by far the most important qualifier. Any value tradeoff you can get in lieu of location is just not a balanced exchange. – Shōgun8 Jul 02 '20 at 00:13