Should I buy a house or am I making silly assumptions that I can afford it?

Question

Having convinced myself that there is no point of paying someone's else mortgage I started looking at ways for buying my own place.

I'm 26, non-UK resident. My salary is £50,000 and I don't have to repay a student loan or have any personal debts. In my savings account I have roughly £17,000.

As of march 2011 the UK government has been pushing an equity-loan, a governmental scheme targeted at first-time buyers with household income under £60,000, where a house builder can lend you a 5-year interest free loan worth up to 30% of the property value thus leaving the rest 70% for you to finance.

I've been looking at 2-3 bedroom properties in East London worth about £450,000 with the idea that I could rent out one of the rooms and help myself with the mortgage repayments.

Am I too naive to think that I could find a mortgage of £300,000 and that I would be able to put aside £25,000 a year to repay the interest free equity-loan? Or is this something normal that most people in the UK, or should I say in London, have to go through when buying a house?

I would appreciate other people's opinions as I don't really have any experience in this. Thanks.

Answer 1

The (interest bearing) mortgage of £300,000 would be SIX times your salary. That's a ratio that was found in Japan, and (I believe) was a main reason for their depressed economy of the past two decades.

Even with an interest free loan of nearly £150,000, it would be a huge gamble for someone of your income. Essentially, you are gambling that 1) your income will "grow" into your mortgage, (and that's counting income from renting part of the property) or 2) the house will rise in value, thereby bailing you out.

That was a gamble that many Americans took, and lost, in the past ten years. If you do this, you may be one of the "lucky" ones, you may not, but you are really taking your future in your hands.

The American rule of thumb is that your mortgage should be no more than 2.5-3 times income, that is maybe up to £150,000. Perhaps £200,000 if £50,000 or so of that is interest free. But not to the numbers you're talking about.

Answer 2

The rules of thumb are there for a reason. In this case, they reflect good banking and common sense by the buyer. When we bought our house 15 years ago it cost 2.5 times our salary and we put 20% down, putting the mortgage at exactly 2X our income. My wife thought we were stretching ourselves, getting too big a house compared to our income. You are proposing buying a house valued at 7X your income. Granted, rates have dropped in these 15 years, so pushing 3X may be okay, the 26% rule still needs to be followed. You are proposing to put nearly 75% of your income to the mortgage? Right? The regular payment plus the 25K/yr saved to pay that interest free loan? Wow. You are over reaching by double, unless the rental market is so tight that you can actually rent two rooms out to cover over half the mortgage. Consider talking to a friendly local banker, he (or she) will likely give you the same advice we are. These ratios don't change too much by country, interest rate and mortgages aren't that different. I wish you well, welcome to SE.

Answer 3

Having convinced myself that there is no point of paying someone's else mortgage

Somewhat rhetorical this many years later, but I expect some other kid forcefed the obsession with propping up the housing market might be repeating the nonsense about "paying someone else's mortgage" and read this.

Will you be buying your own farm to grow your own food, or are you happy with people using the money you spend on food for a mortgage? How about clothes? Will you be weaving your own clothes because you don't want money you spend on clothes to pay someone else's mortgage? What's special about the money you pay for rent that you get annoyed at how someone else spends it?

Don't get a mortgage just because you don't like the idea of how other people might spend the money that's no longer yours after you pay them with it.

As an aside, at your age with your income and no debt, you could be sensibly investing a lot of money. If you did that for five years, you'd be in a much better position that you would be tying yourself to whatever current scheme the UK is using to desperately prop up house prices.

Answer 4

A common rule of thumb is the 28/36 ratio. It's described here.

In your case, with a gross (?) salary of £50,000, that means that you should spend no more than 28% of it, or £1,167 per month on housing. You may be able to swing a bit more because you have no debts and a modest amount in your savings.

The 36% part comes in as the amount you can spend servicing all your debt, including mortgage. In your case, based on a gross (?) salary of £50,000, that'd be £1,500 per month. Again, that is to cover your housing costs and any additional debt you are servicing.

So, you need to figure out how much you could bring in through rent to make up the rest. As at least one other person has commented, the rule of thumb is that your mortgage should be no more than 2.5 - 3 times your income. I personally think you are not a good candidate for a mortgage of the size you are discussing. That said, I no longer live in England. If you could feel fairly secure getting someone to pay you enough in rent to bring down your total mortgage and loan repayment amounts to £1,500 or so a month, you may want to consider it. Remember, though, that it may not always be easy to find renters.

Answer 5

When I bought my own place, mortgage lenders worked on 3 x salary basis. Admittedly that was joint salary - eg you and spouse could sum your salaries.

Relaxing this ratio is one of the reasons we are in the mess we are now.

You are shrewd (my view) to realise that buying is better than renting. But you also should consider the short term likely movement in house prices. I think this could be down. If prices continue to fall, buying gets easier the longer you wait.

When house prices do hit rock bottom, and you are sure they have, then you can afford to take a gamble. Lets face it, if prices are moving up, even if you lose your job and cannot pay, you can sell and you have potentially gained the increase in the period when it went up.

Also remember that getting the mortgage is the easy bit. Paying in the longer term is the really hard part of the deal.