Where's The Flaw?

[warwickbloke]

I know a fellow aged 45

He bought a house 5 years ago £100,000 now worth £200,000 nice place.

Interest only with no insurance(sod it!) over 30 years(doesn't matter how long because the monthly payment is the same just gives a bit more time to allow for house price rise if required) approx £400 monthly.

This amount allows a decent lifestyle, holidays, fast cars etc. no need to pay into a pension.

By retirement in 15 years time (as has happened from the 70's, then the 80's then the 2000's) the house will have doubled in value to £400,000.

Sell the house, repay the £100,000 capital.

Put the remainder £300,000 in the bank & rent a small flat & live off the interest which with the state pension should last about 20 odd years at least.

At that point either it won't matter anymore or share the flat or go into a home at the states expense,whatever.

I have repayment mortgage to end when I reach 65 & pay into a pension, leaving me naff all for fast cars, holidays etc. or even savings at this point.

Where is the flaw in the other fellows reckoning?

[DTMark]

Just a few random thoughts:

He bought a house 5 years ago £100,000 now worth £200,000 nice place.

Interest only with no insurance(sod it!) over 30 years(doesn't matter how long because the monthly payment is the same just gives a bit more time to allow for house price rise if required) approx £400 monthly.

This amount allows a decent lifestyle, holidays, fast cars etc. no need to pay into a pension.

By retirement in 15 years time (as has happened from the 70's, then the 80's then the 2000's) the house will have doubled in value to £400,000.

If history repeats itself, yes. But it may not. What if it is still only worth £200,000 e.g. its value halves, not doubles, in real terms?

Sell the house, repay the £100,000 capital.

Put the remainder £300,000 in the bank & rent a small flat & live off the interest which with the state pension should last about 20 odd years at least.

The above assumption takes into account inflation. This one selectively doesn't. Taking off, say, £20kpa for the rent (equivalent of 10kpa now), that wouldn't leave any money for anything else, just to live in the small flat for 15 years. Rents would have to halve in real terms for that to work.

At that point either it won't matter anymore or share the flat or go into a home at the states expense,whatever.

Looking at the standard of care for the elderly now and with the looming pension crisis, I suspect the State would have him using his net profit to fund that and would not be paying for him. This is happening already.

[Swipe]

There is no flaw becuase the key factor is he bought 5 years ago. Anyone who bought 5 years ago whether interest only or repayment is quids in as long as they weren't stupid enough to MEW.

Edited May 14, 2006 by Swipe

[right_freds_dead]

there is also no flaw in doing the same thing right now.

but its a high stakes gamble. the reason i think i hold on is that i dont think current levels of prosperity will last the term of the mortgage. at some point we will hit a financial crisis. i would rather my savings be safe and mine, than be collected by a banking cartel. everything you ever put into the house via a payment will be lost forever, and you would probably still be chased for the remainder the rest of your life.

when your house price is sensible you are not open to such heavy risks. if you can only just manage a payment in a booming economy right now, what will you do when things slowdown a bit ?

i didnt come back here to gamble my entire financial future. i came back simply to settle down and buy a small 2 bed house with a modest garden. just like normal people do.

now this simple cheap dream has turned into some gigantic feat of financial engineering and risk. as if i were asking for a mansion house and swimming pool. i dont want to jump through 26 burning hoops of fire just to get a simple roof over my head. all i see is an entire country playing games with property.

and i dont see much else.

Edited May 14, 2006 by right_freds_dead

[warwickbloke]

Just a few random thoughts:

If history repeats itself, yes. But it may not. What if it is still only worth £200,000 e.g. its value halves, not doubles, in real terms?

The above assumption takes into account inflation. This one selectively doesn't. Taking off, say, £20kpa for the rent (equivalent of 10kpa now), that wouldn't leave any money for anything else, just to live in the small flat for 15 years. Rents would have to halve in real terms for that to work.

Looking at the standard of care for the elderly now and with the looming pension crisis, I suspect the State would have him using his net profit to fund that and would not be paying for him. This is happening already.

BUT..... houses doubling every so often is almost as safe a bet as backing Liverpool to win a penalty shoot out(or betting on England to lose a penalty shoot out for that matter).....

Rents aren't really rising that much due to excess BTL.....anyway this area, West Midlands, although has high house prices has fairly moderate rental prices, a small flat going for £6k p.a.

If funds were exhausted the state would fund a retirement home, if funds are not exhausted it doesn't really matter who pays if at that stage of your life you need care.....

Still a fairly powerful argument considering retirement is a 'might need' while fast cars & holidays are here & now & still youthful enough to enjoy them to the full!

[right_freds_dead]

property prices will double in 20 years possibly.

but you wont survive the term buying at todays bubble prices.

one slight hint of a slowdown and the house is repo'd and your savings are history.

[CrashIsUnderWay]

houses doubling every so often is almost as safe a bet as backing Liverpool to win a penalty shoot out(or betting on England to lose a penalty shoot out for that matter).....

hello 'mystic meg'.

Maybe you can also tell us where the FTSE will be in 20 yesr, and who will win the 3:30 at Kempton in 2037

I dunno.

This is why the boom has reached such ludicrously insane heights, because there are MASSES of UK 'citizens' so stupid they think they can predict the future.

We DON'T KNOW what its going to do in the future, all we can do is guess based on probabilities, past experience, and what is happening now.

What is happening now is that it's crashing. What will happen in the future is that it will go up, or go down, or wobble around.

Happy?

[DabHand]

Sell now.

Invest the 100k of equity now.

Even getting a miserly 6% gives a compounded final sum of £239,656 in 15yrs. No risk..with a bit more imagination you'll easily outstrip 300k and that's on the basic premise that inflation wont be much higher than it is now for the next 15 years. It will also give you capital to re-enter the market should it correct/crash etc..

Plus no costs. i.e. no interest repayments which may shoot up over next few years if IRs succumb and no maintenance costs on house.

He'll probably pay more on a rental property vs the IO repayments BUT you Vs this with the flexibility and opportunity cost of this equity in an uncertain future. I know what l'd do.

[warwickbloke]

hello 'mystic meg'.

Maybe you can also tell us where the FTSE will be in 20 yesr, and who will win the 3:30 at Kempton in 2037

I dunno.

This is why the boom has reached such ludicrously insane heights, because there are MASSES of UK 'citizens' so stupid they think they can predict the future.

We DON'T KNOW what its going to do in the future, all we can do is guess based on probabilities, past experience, and what is happening now.

What is happening now is that it's crashing. What will happen in the future is that it will go up, or go down, or wobble around.

Happy?

This is exactly why I am asking if anybody has any sound reasoning.....

I have presented two opposing actions one of which I have opted for & am wondering if I should perhaps go the other way?

If there are enough sensible facts presented to jump one way or the other that would be nice.

The main concern is the period leading to retirement & the quality of life enjoyed therein & the sense of saving for a maybe worthless retirement pot.

If it is really just a matter of viewpoint I'll just go along with my own opinion.

[Kid_a]

By retirement in 15 years time (as has happened from the 70's, then the 80's then the 2000's) the house will have doubled in value to £400,000.

Hi this is my first post.

You say that houses double in value every 10 years which they clearly have done in the past. Correct me if I'm wrong and I may be missing something but what was the rate of inflation over those periods quoted above? What was wage inflation?

I think thats your flaw.

[DTMark]

BUT..... houses doubling every so often is almost as safe a bet as backing Liverpool to win a penalty shoot out(or betting on England to lose a penalty shoot out for that matter).....

If ten years ago someone had told you that Dublin would become dearer to buy in than Central London, would you have believed them?

I'm not arguing with you - but would call the certainty into question. The World is changing very fast.

Rents aren't really rising that much due to excess BTL.....anyway this area, West Midlands, although has high house prices has fairly moderate rental prices, a small flat going for £6k p.a.

So you'd need to factor in the same inflation that would inflate the house price. It would not be 6kpa then.

If funds were exhausted the state would fund a retirement home

I'm still not convinced about that. In its favour the grey lobby will be very powerful then. On the other hand if resources are such that the best he could get should be some kind of shared dormitory, would that be enough? Again, people are having to sell their houses and use their equity *now* to fund state care, let alone in 20 years.

There is one other factor which is that younger people have one other thing to draw on, which is a little morose: their parents will probably die by then and they may inherit their home, provided that the parents haven't had to use the equity to pay for their care as above. I suspect though that that will become the norm as we go forward.

[warwickbloke]

Sell now.

Invest the 100k of equity now.

Even getting a miserly 6% gives a compounded final sum of £239,656 in 15yrs. No risk..with a bit more imagination you'll easily outstrip 300k and that's on the basic premise that inflation wont be much higher than it is now for the next 15 years. It will also give you capital to re-enter the market should it correct/crash etc..

Plus no costs. i.e. no interest repayments which may shoot up over next few years if IRs succumb and no maintenance costs on house.

He'll probably pay more on a rental property vs the IO repayments BUT you Vs this with the flexibility and opportunity cost of this equity in an uncertain future. I know what l'd do.

Interesting, thanks, I hadn't really considered this.

What if there is raging inflation soon which may well happen & the invested monies become next to worthless.

This is another reason why I am still not too sure if it is a good idea to save cash for retirement & interfere with my quality of life now. Anything I put aside will interfere with my quality of life.

Whatever may happen regarding the value of the £ a house is still going to be worth something of considerable value even if it never increases. It will still be saleable & the proceeds used for investment & rental.

Is the answer to only pay what you can sensibly afford & save what you can sensibly afford & try to preserve a sensible quality of life in the meantime.

On the plus side for me the kids have just all left home, I have a fixed rate mortgage for 10 years, so I guess things can only improve?

[DTMark]

Hi this is my first post.

You say that houses double in value every 10 years which they clearly have done in the past. Correct me if I'm wrong and I may be missing something but what was the rate of inflation over those periods quoted above? What was wage inflation?

I think thats your flaw.

I thought it went along the lines that the value of property roughly doubled every 8 years, but the value of money roughly halves every ten years. Hence property just outperforms inflation over the longer term.

As another poster said though it depends on when you buy. Try telling the above to someone who bought in 1989 and had to wait ten years to be able to sell. Timing is key and it is on the side of the original subject. That doesn't mean to say it can be repeated now not least because of, as you mention, wage inflation.

[warwickbloke]

If ten years ago someone had told you that Dublin would become dearer to buy in than Central London, would you have believed them?

I'm not arguing with you - but would call the certainty into question. The World is changing very fast.

So you'd need to factor in the same inflation that would inflate the house price. It would not be 6kpa then.

I'm still not convinced about that. In its favour the grey lobby will be very powerful then. On the other hand if resources are such that the best he could get should be some kind of shared dormitory, would that be enough? Again, people are having to sell their houses and use their equity *now* to fund state care, let alone in 20 years.

There is one other factor which is that younger people have one other thing to draw on, which is a little morose: their parents will probably die by then and they may inherit their home, provided that the parents haven't had to use the equity to pay for their care as above. I suspect though that that will become the norm as we go forward.

Interesting, thanks, the first two points are indeed guesswork & opinion although the length the money should last has taken into account a rent rise along with inflation.

On the Grey Lobby I am assuming that the proceeds from the house will be spent & he will have no assets so then I assume the state will provide. I cannot ever see a time when our policies will be to throw pensioners out on the street, but the fact they have ended up skint might go against them somewhat.

Still, youngsters who have never worked ever are taken care of so I assume oldies will also.

A lot of my friends/ family gained very little from parents shuffling off their mortal coils, I see no reason why the assets gained during your working life should not be used to aid a more comfortable retirement & if that means the kids have to fend for themselves instead of relying on your efforts then let the idle gits do it!

I intend to be still living an active life when my children retire so they have to look after themselves.

SKIing (Spending Kids Inheritance)is becoming more common now & why not?

I actually watched a programme once where some spoilt little cow was complaining at her parents going on a year long world cruise because they should have been watching paint dry at home instead of spending her inheritance.

I digress, basically it is still down to personal opinion isn't it?

[Guest muttley]

This illustrates another "side effect" of HPI. Owners no longer believe they have to save for a pension.Even if your friend is right 300k will not produce enough to live comfortably in retirement. Not now and certainly not in 10 years time.

Also consider the demographics. There will be more people reaching retirement age in 10 years time, than will be coming onto the job market, so who is he going to sell his house to?

[warwickbloke]

Hi this is my first post.

You say that houses double in value every 10 years which they clearly have done in the past. Correct me if I'm wrong and I may be missing something but what was the rate of inflation over those periods quoted above? What was wage inflation?

I think thats your flaw.

Interesting as are many replies, thanks.....

I must admit I have not researched the inflation rates, but from memory I recall some very silly wage rises going through the70's, one noteable occassion where we were called to a union meeting where we earned about £100 weekly & were told that we had been offered £10 a week rise but we should all hold out for £15, to which we agreed, were offered & accepted it. As I remember we also had council rents pegged for 3 years. Guess which party was in power at the time!

I reckon since then we have had fairly stable inflation rates except for when we had silly interest rates during the 80's??

This doesn't mean that raging inflation won't grip thus reducing to naff all what has been saved for pensions.

In fact, thinking about it, this situation may even be a benefit to the present government since if everybody ends up with nothing saved for retirement they haven't really stolen anything have they? so they may manufacture a state of inflation. Is this a bit simplistic.

Anyway, this is the point, does anybody think it is a good idea to not save a thing for retirement, spend it all now & rely solely on state aid & house price rise to sustain retirement.

[spline]

A long-term view on house prices boils down to looking the usual suspects – price, RPI, and earnings. So ignoring recent bubbles the trend is that prices follow earnings rather then the general price of other stuff – not surprising really, as this is what pays the mortgage. And earnings growth, at least since the 1950s, has outpaced growth in the RPI.

But the problem at the moment, obviously, is that the thing has got so far out of balance on back of the change to a lower rate (interest and %RPI) climate that any correction is going to be painful.

The Usual Suspects: Price, RPI, Earnings: A Long-Term View

[MarkG]

The flaw with this idea is that 'everyone' expects house prices to double in the next 20 years... so what are the odds that it will happen? When everyone expects something, how often do they get it?

For example, when my parents bought their house at the end of the 60s they expected the mortgage to take up a large fraction of their income for decades. But instead wage inflation pretty much wiped it out by the end of the 70s. They got the opposite of what they expected.

When, today, everyone expects wage inflation to wipe out their debts, what's the likelihood that it will happen? Unless there's something very unusual about that 200k house it's already significantly overvalued relative to wages: what happens to the great plan if wages _DROP_ over twenty years due to foreign competition?

SKIing (Spending Kids Inheritance)is becoming more common now & why not?

The only way most FTBs can afford a house even at today's prices is because their parents give them some inheritance money. How are they going to buy your 400k house if they don't get an inheritance?

There will be more people reaching retirement age in 10 years time, than will be coming onto the job market, so who is he going to sell his house to?

Poles on minimum wage, obviously.

As far as I can see there's a war coming between the young and the old farts, as the old suck all the wealth out of the younger generations to pay for their retirement. Anyone who thinks the next twenty years will be like the last twenty is deluded.

[dog]

I know a fellow aged 45 He bought a house 5 years ago £100,000 now worth £200,000 nice place.

Interest only with no insurance(sod it!) over 30 years(doesn't matter how long because the monthly payment is the same just gives a bit more time to allow for house price rise if required) approx £400 monthly. This amount allows a decent lifestyle, holidays, fast cars etc. no need to pay into a pension.

By retirement in 15 years time (as has happened from the 70's, then the 80's then the 2000's) the house will have doubled in value to £400,000. Sell the house, repay the £100,000 capital. Put the remainder £300,000 in the bank & rent a small flat & live off the interest which with the state pension should last about 20 odd years at least. At that point either it won't matter anymore or share the flat or go into a home at the states expense,whatever. I have repayment mortgage to end when I reach 65 & pay into a pension, leaving me naff all for fast cars, holidays etc. or even savings at this point.

Where is the flaw in the other fellows reckoning?

If the value of his house defaults to German property prices (which the same population density) the house will be worth less when he retires than it was when he bought it. Japanese house prices fell for 15 years.

[warwickbloke]

This illustrates another "side effect" of HPI. Owners no longer believe they have to save for a pension.Even if your friend is right 300k will not produce enough to live comfortably in retirement. Not now and certainly not in 10 years time.

Also consider the demographics. There will be more people reaching retirement age in 10 years time, than will be coming onto the job market, so who is he going to sell his house to?

Absolutely damn spanking right, I had considered this, what a dilemma.

Schools are now closing down & laying off teachers due to lack of kids, fewer being born

If we have raging inflation, then there will be nothing to pay off anyway as the sum of £100k will be pocket money.

Nobody will be there to buy the house, correct?

The present government is now pledging inflation proof state pensions, so is our generation the last one to have to save for pension?

Will what we have saved be worth anything anyway?

Will our houses be worth anything?

Who will be paying into coffers to sustain state pension.

Maybe a BNP vote will be unwise as we may need immigrants to keep us going?

If we do vote BNP will people breed more as a result of lower immigration?

Will immigrants even want to come to England if all they are expected to do is pay taxes to keep all the pensioners in clover?

I guess at the very least if all else fails & you have your house paid for you can continue to work till you die?

Maybe the best option is to ensure you have a rent free home & just have to work part time during retirement?

A long-term view on house prices boils down to looking the usual suspects – price, RPI, and earnings. So ignoring recent bubbles the trend is that prices follow earnings rather then the general price of other stuff – not surprising really, as this is what pays the mortgage. And earnings growth, at least since the 1950s, has outpaced growth in the RPI.

But the problem at the moment, obviously, is that the thing has got so far out of balance on back of the change to a lower rate (interest and %RPI) climate that any correction is going to be painful.

The Usual Suspects: Price, RPI, Earnings: A Long-Term View

This illustrates very well an important issue, thanks.

Absolutely agreed that something is going to give & there will be pain!

But, should we spend it all now & rely on house price, or save & hope.

If the value of his house defaults to German property prices (which the same population density) the house will be worth less when he retires than it was when he bought it. Japanese house prices fell for 15 years.

OUCH! I didn't realise this, maybe another factor to consider could be global warfare, perhaps all our properties will be blitzed, & none of this will matter anymore.

By the cringe, a big bag of worms is opening.

Could inflation in other countries figure in this, anybody??

[spline]

I think the effect of interest rates, or general growth levels, on houses is quite subtle – initially people just focus on the repayments so prices rise on the back of falling rates *but* the low rates actually break the housing ladder (as mentioned on HPC before) because when the debt burden relative to earnings is reduced quickly it’s possible to move up, i.e. eventually buy a house that’s expensive relative to earnings. So the ladder works better with higher rates.

But without this ladder/escalator it’s much more difficult to fund the second tier (and above) houses – I guess this must actually/eventually reduce the price-to-earnings ratio as people slowly “learn” how the new environment works.

This mechanism adds to the already painful problems that we know about - the slow unwinding of the recent low interest rates, and the already high level of prices relative to most other semsible measures of value.

Edited May 14, 2006 by spline