25 Feb 2012, 7:20pm
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    • Middle Class Finances – Death by A Thousand Cuts

    Another one in the complainypants section, but this one’s a more subtle object lesson in how not to lead a middle-class life. Perhaps the Ermine’s heart is softening as he gets older, or there’s a little bit of the there but for the grace of God since I screwed up with the toxic UK housing market too, though I don’t have 4 children ;)

    Let’s hear it for the Daily Mail’s Shona Sibary, who sold her house and considers herself now in the rent trap.

    Shona and family, before they got into the rent trap

    Now I was able to see her fundamental problem, just from looking at the picture. In Britain today, a middle class family with both parents working will find it hard to raise four children. We normally associate big families with the undeserving poor because of the headlines, but thankfully they are not the only section of society that has large families, otherwise we would long ago have succumbed to the premise of the movie Idiocracy. The unsung other sector of society that often has larger than normal families seem to be those with a bob or two. Like David and Samantha Cameron, who ain’t short of a bean, or even IDS and Nick Clegg. Other wealthy families include Victoria & David Beckham (4) and Boris Johnson (4)

    I first noticed this with older colleagues at work. The Firm was a prestigious operation in the 1970s and 1980s, and pay was probably upper middle class (in the eighth or ninth decile of the IFS income scales). There is a surprising prevalence of three-child families there, which I had found particularly surprising when I joined nearly a quarter of a century ago.

    It’s not surprising that nowadays it is the poor and the wealthy that can go beyond the one and two-child norm. The former get us all to pay for it, and the latter are presumably rich enough to pay for it themselves. Anyway, ’nuff about families. How did Shona screw up?

    Shona’s financial red cards

    By failing to watch her back. Shona had a couple of big red cards,  I suspect that family was living way beyond its means for a long time.

    Red flag #1 – they were remortgaging, not building equity in their home.

    Look at how an old-skool repayment mortgage builds up equity in the house, by repaying some of the capital.

    how a traditional mortgage builds equity

    I pinched this from the excellent Mortgages Exposed website, which unfortunately uses infernal frames so I can’t link to the source itself, it’s under Capital Repayment in part 1. Now there are other ways of doing it. My original endowment mortgage was interest only, so in parallel with the mortgage there was an investment that should have been slowly rising to match the original loan. Either way, you should be building up equity, even if it takes the form of a separate asset.

    Now the modern way to look at a mortgage is to take out an interest only loan, sit on your butt and whistle a dancing tune while the value of your house goes up. Voila, free money, you get equity without having to lift a finger. The catch is, of course, that the value of the house has to go up :)

    Shona asserts that

    After two decades of slogging to buy a house, maintain it and give our children security for the future

    No, you did nothing of the sort. You’ve had that mortgage for seven years. If you look at the graph above, you should have a quarter of the equity in the house, assuming house prices hadn’t gone up at all from the start.
    If you look at the equivalent graph for my mortgage career

    an ermine's inflation-adjusted income and mortgage stupidity

    You see that by 1996 I had at least reduced the total, by about a fifth in real terms (this graph is inflation adjusted to a nominal salary of 10k in 1984). That underestimates my repayment as it doesn’t show the value of my endowment.

    So what did you do Shona? You remortgaged. Taking that equity out, and spending it. Doing that once is a bad sign – nothing wrong with remortgaging per se, but spending the proceeds is bad. Doing it another two times is more than careless, it’s positively greedy.It’s a big red sign in your finances that says “Wrong Way, Do Not Enter, Turn Back NOW”.

    Your house is a place to live, it is not an ATM. Over the 25 year span of a mortgage, you will probably see at least two housing booms and busts. I bought in a boom, ate a 10-year bust, and discharged my mortgage in the next boom, that has now turned to a bust (my mortgage would have finished in February 2014 had I not discharged it early)

    It is the foreknowledge of that next bust that should make you say “I will not take the money I gain from remortgaging and use it for anything other than buying an investment which will go towards buying this house”. For most people that investment is reducing the total amount of the next mortgage, which is tantamount to saying “never withdraw equity from your house, unless you are trading down”. There are some people who can do better than that. They are few and far between. Otherwise that bust is just round the corner, waiting to bite you.

    Red Flag # 2 – your house is not your biggest cost!

    This is awesome. If you really are middle class, and buying your house, then that house is nearly always your biggest cost. If it isn’t, you are either not middle class, you are rich/wealthy. Or you are in deep, deep, trouble. Nowadays it’s pretty marginal for the ‘middle class’ to be able to afford the typical ‘middle class’ three or four bed detached family home in the ‘burbs. If your house isn’t your biggest cost and you’re not rich, you’re skint.

    Let’s take a look at what Shona spent the money on.

    In our defence, we weren’t spending the money on expensive designer clothes, luxurious holidays or flash cars.

    So glad to hear it. So what exactly was it that you overspent on then?

    Much of it was going on school fees and upkeep of the house.

    If you’re withdrawing equity from your house to keep the damn thing standing then you have got too much house for your income. However, that’s not really your problem. It’s the school fees. According to the ISC the average termly fee at a day school is £3655, about 11 grand p.a. A cursory look at your family photo puts three of those kids in school, ie £33k p.a. Assuming for sibling rivalry you aim to do that for all of them, you are looking at paying 4 * 11000 * (18-11) = £308,000 if you just pay school fees for secondary school 11 to 18 and £572,000 if you pay from 5 to 18.

    That’s more than your house was worth at the peak. The house is not your biggest problem. It’s a combination of having too many children and looking down on the sort of education that dragged up scumbags like me. So for all the mawkish whingeing about losing your home, Shona, you have failed to clock the real problem with your finances. ‘Tis the fruit of your loins and the style in which you’d like to keep them. With their own rooms, if you please, nothing else will do for Shona’s little ones ;) Since humans come in two genders and it is apparently not acceptable for brothers and sisters to share a room these days you actually only need three bedrooms if the family is boracic lint, fixed that for ya.

    Get real, Shona. You were on a middle class income but living a life not commensurate with your means. It’s hard enough for the middle class these days to buy one house in 25 years. To aim to do that and spend even more than that on the nice things in life on that middle class income is taking the piss. It cannae be done, and you’ve just found that out the hard way. To my eyes you’ve cut the wrong thing, but I respect it’s your call.

    Shona shows me I need a financial Distant Early Warning Line

    I learned something from Shona. Her family fell foul of slow changes that gradually overwhelmed them. Many things get imperceptibly worse day by day, as global imbalances right themselves but they’re resisted by the structures we have already built. The creeping rise of Digital Taylorism making the professional and technical job a stressful and unrewarding experience is an insidious change, little by little. I didn’t realise that until it became too much and my defences were overwelmed, hence the crash course over the last three years in becoming finacially independent as a counterattack.

    In the 1950s the US instigated a distant early warning line to scan the northern skies at the 69th parallel north of the Arctic Circle. It was standing sentinel for the signs of incoming Russian nuclear bombers, and was located in the harsh North to give enough early warning to mount a counter-attack.

    I need something analogous to stand watch for slow insidious creeping costs and sound the early warning. I plan to instigate an annual review of financial commitments as a percentage of resources. If I see a non-negotiable cost starting to rise proportionally I will consider that the alarm is sounding and it is time to attend to it. It is always easier to launch a counter-attack before it is upon you overwhelming your defences, and this annual review of commitments will be my distant early warning line against stealthy creeping costs.

    Shona’s family could have used something like that. Okay, the alarm would probably have sounded as soon as it was set up, but certainly on the second child’s school fees. It would have been an easier call to make at that stage – do we want a big house, or do we believe in the value of public school education* makes it worth getting the girls to share a room?

    While I am working I’ve generally lived sufficiently below my means that I didn’t need that sort of thing. Though I aim to have over 50% income in hand once I stop working, I’ve still got several decades, decades in which I believe living standards in the West will decline in a big way. Though I may be resistant to wages being eroded, I won’t be immune from inflation and its evil twin, rising prices and taxation. A financial DEWline will help me marshal resources ahead of time, and shift them to minimise taxation. Particularly with significant holdings in shares, it’s good to have as much advance warning if changes are needed, to average out the horrendous temporal volatility.

    *NB for non UK readers, bizarrely schools that you pay fees for, those that Americans rationally call private schools are called ‘public schools’ in the UK, because we’re strange like that.

    13 Feb 2011, 4:48pm
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    • The Road Less Travelled – A Better Way to Buy A House

    I read M Scott Peck’s The Road Less Travelled a few years ago. Like any powerful message, it can easily be distorted if received by someone not ready for the signal. If you are of a Calvinist worldview that work is good for you then you may find confirmation of your world-view in the “life is difficult” opener of the first chapter, Discipline. You’re only looking at part of the story there, but you have to get further into the book to find that out ;)

    In particular, he speaks for the virtues of grit and determination to achieve anything, to wit

    • delaying gratification – valuing future gains sometimes at the cost of present comfort
    • Accepting responsibility for one’s own decisions

    I was reminded of this book when I read Monevator’s guest post from Tejvan Pettinger titled “Reasons to buy a house instead of renting“. Now in my view, at the moment there aren’t any reasons to buy a house instead of renting, it’s one of those things I learned by doing it in 1989 at a similar time on the cusp of a recession.

    Mark Twain said

    A man who carries a cat by the tail learns something he can learn in no other way

    So it is with buying a house at a time like this…

    Way back in 1988 I was in the Broadcasting House BBC bar at lunchtime, sinking a few beers as one did at the time of the liquid lunch to send off a departing colleague. I was a lonely grunt engineer, surrounded by beautiful people, all talking about one damn thing, which was how much their blasted houses had increased in value, or their friends had made on the sale of theirs.

    I slowly drank myself to a stupor, trying to forget that at the end of the day I was going to get on my bike and cycle along the Western Avenue to Ealing, where I had a crummy bedsit with a electricity meter that took 50p pieces and I needed to get some salt to put round the perimeter to keep the shiny black slugs from invading the room.

    What is it with rented accommodation and black slugs?  I encountered similar blighters in someone’s rented room on the first floor in Ipswich. Do landlords install them to stop their tenants getting too comfy I wonder?

    Anyway, I managed to avoid standing up in the bar and hollering “STFU you smug lot, I am on an okay wedge working for this firm and I have no hope of buying a house in this damned city of my birth because of sleazeballs like you making a mint out of my misery”.

    The modern equivalent of that is to get on pricedout and housepricecrash and blame the baby boomers for it all. Plus ça change, plus c’est la même chose. I felt just the same pain, but I couldn’t yell it out to loads of people on the internet. And I’d have queered my pitch with the girls, though I probably didn’t improve my case on that front by sinking five pints of E.S.B. so that at least if the situation didn’t look any better it felt less bad.

    There’s actually a positive takeaway for this for the priced-out generation. Every young generation is “priced out” in their twenties, because the greybeards have all the money. How did the greybeards get it? The same way as I did – working for three decades! Despite manful attempts to spend it on holidays, booze and toys some of it stuck around ;)

    When I got home I resolved to tackle the situation. I could either try to find work with Goldman Sachs to get the pad I wanted (I fancied a cool flat somewhere in Bloomsbury, please) or I could get the hell out of London and find somewhere I could afford on the sort of job I could get with my skills. I had spent all my energy railing against the unfairness of it all, and only when I had independently discovered what M Scott Peck had to say about taking responsibility could I find resolution to the problem. The next year I was in a different job, in a different part of the country, and stupidly putting down money on a house at the peak of the Lawson boom. Less than 20 years later, I had paid off the mortgage on the house I bought after that, despite nursing a shocking loss on the first house.

    A Different Way to Buy a House

    What I found so delightful about “Reasons to buy a house instead of renting” was that Monevator himself pole-axed the argument, with a single sentence in the comments outlining a different way to buy a house – the road not travelled.

    I followed the traditional path, buy a house in my late twenties, spend the next 20 years paying for it. I was lucky to stay in the same job and location for 20 years, that sort of job is becoming less common now.  There’s another way.

    What you are doing in taking out a mortgage is gradually buying a capital asset, that eventually by the time you retire should be paying your living costs for you. I don’t pay rent, and I don’t pay a mortgage any more. There are some parasitic housing-related costs associated with wear and tear that I do have to eat, but they pale into insignificance compared to rent or a mortgage.

    The trouble with a house is that it is an illiquid asset, if you have to move for a new job you have to hope you can sell your house, or get stuck with the headache of being an amateur landlord.

    What about the idea of pumping up your ISA and using the income from that to pay your rent? You get two things there, one is you build up a capital asset that roughly goes in line with house prices (house prices are usually high in booms and take a hit in recessions). You could use that to buy a house. The second is that once you have a capital asset enough to buy the typical house you would be able to afford on your salary, the income from those shareholdings probably makes a decent attempt at paying your rent.

    I was in my late forties when I paid the last instalment on my mortgage. Monevator, by contrast, is out there in front 10 years ahead of me

    As it is I’m in my late 30s with a portfolio big enough to buy a flat in London outright

    Jammy b***d, good for him! Now there are significant differences – he is more entrepreneurial that I am, and I would imagine on what works out to be a better income – that is one of the advantages of working for yourself whereas I took the conservative and at the time safe approach of having an employer hedge all the business risks for me. Look at that difference in timescale. I did pretty well, discharging a 25 year mortgage in 20 years including one house upgrade, whereas Monevator has set himself up to be able to buy if he wished a decade earlier in his life, and in London, where he’s competing wit hthe financial whizz-kids and foreign shipping magnates inflating house prices.

    There is much to be said for the investment asset approach rather than the bricks and mortar approach. With the latter, you are exposed for the full duration of the mortgage to losing your job and possibly having to sell up into negative equity or losing the house. Obviously with investments you can screw up royally or suffer a Great Depression, but provided you play safe and keep your wits about you then you won’t suffer a forced sale where your assets are marked to market.

    Once you have the money to buy a house, and once you are old enough to retire/no longer need a job to survive financially, you can consider buying at a time of your convenience. For a house is a real asset, it is not purely a financial asset. That means it does something for you – it keeps the rain off your head and means you aren’t beholden to somebody else’s whim for accommodation. There are great advantages to non-financial assets in times of trouble, like the potential end of the eternal growth that industrial civilisation is predicated on.

    They hold some of their value, unlike paper assets which can get rendered down to toilet paper by inflation or monetary disasters. But because of its illiquidity, if you have enough money to buy a house cash using the value of an investment portfolio, you are much better placed to tackle the modern world of insecure work and needing to move than you are as a mortgage holder.

    I’m in awe of the road less travelled. It wouldn’t have worked for me (and many others) because I was an unsophisticated investor well into my thirties, so I wouldn’t have been able to build capital like Monevator.

    My sophistication now is hardly much better, but my results are better, because I have learned so sit on my hands and do not churn my portfolio, and seek income which screens some of the wilder excesses (it’s not as simple as chasing yield which often drives you to excesses).

    So the road less travelled is less travelled for good reason. It is hard, and it needs self-discipline and keeping one’s wits about you. Most people do not measure up to the requirements, so the conventional way of exposing themselves to the risk of negative equity and taking twenty or thirty years to pay down a mortgage is perhaps right.

    But as M Scott Peck would be only too happy to remind us, there is value in the discipline of gaining the understanding of another way, and developing the skill to do it. Buying young and subjecting yourself to the whims of an increasingly dysfunctional workplace for two decades is not the only way. M Scott Peck would have the hordes of pricedout et al take heed, and perhaps look for the road not travelled. They could take their capital asset with them as they travel the country or continents seeking work. It is hard, because you have to forego the iFads and knuckle down to saving, a discipline which is forced on many in their thirties by the need to pay the mortgage or lose the house.

    So I tip my hat to the intrepid travellers on the lonely road less travelled It is hard, but it looks like it may serve some of them well, and they deserve to get to the destination quicker.

    11 Jul 2010, 9:34pm
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    • Why You Shouldn’t Buy a House

    I ought to make a declaration up front that I have bought my house and own it outright.  It’s taken me nearly 20 years to get there though, and the world has changed. And obviously it’s not up to me as to whether you should buy a house, I’m just playing devil’s advocate because nearly everything else you’ll read says go for it :)

    Here are some reasons you might set against buying a house in today’s market:

    1. Houses are overpriced
    2. You need over 9 years of net income to pay it off
    3. In London? Forget it unless you work for the likes of Goldman Sachs
    4. Paying just the interest? You’re renting from the mortgage company, but unlike with a landlord you can’t make it fix the boiler for you.
    5. You may need to move to follow work.

    There’s a strong emotional attachment to home ownership in the UK. It may have served us once, but there is much to be said for a model where renting is more widespread in a world where jobs are less secure than they used to be. Let’s take a look at these items -

    Houses are overpriced. A mortgage used to be given on an income multiple of 3.5 times gross earnings for a single person, or 2.5 times joint earnings. This income multiple has stood the test of time; if you need to borrow more than that then the houses you’re looking at are overpriced for you. You can:

    • earn more
    • stump up more capital
    • be less ambitious in your house aims (I wanted a detached 3-bed in ’89, I bought a mid-terrace two up two down :) )
    • move to a cheaper area (I left London – couldn’t compete with the über-rich)
    • give up the idea
    • take ridiculous chances with your personal finances and risk losing money and your home.

    Housepricecrash has a chart of real house prices varying over time.

    House prices in real terms over time

    At the moment it looks like this. From the trend line, perhaps they are not as overpriced as they have been for the last 10 years, however, there is a recession on so I wouldn’t bet on a switchback, personally…

    I bought in 1989, and had to sweat through the 1990-2001 hole. There’s no fun whatsoever in paying down on a mortgage that is ‘underwater’ and my net worth is down by about £40,000 in 2010 terms from buying at the wrong time. People even warned me that there were specific factors inflating prices but I was too cocky to listen. You never hear from the people that lose money on buying houses. It happens, but people usually keep schtum about it because success has many fathers but failure is a bastard.

    I’m an exception to that because I’ve managed to pay off my house, so I can view this from the other side, it doesn’t still trap me in debt-slavery. Buying that first house was what is so far the one most monumental personal finance cock-up of my life. It dwarfs my second worst PF mistake -  endlessly churning my portfolio and then losing my shirt in the dot-com bust. At least I got some excitement out of that, and learned what not to do!

    Everybody talks up the Kodak moments about buying a house. Nobody talks about grinding years of looking at your mortgage statement at the end of the year and making an annual capital repayment of about the price of a secondhand car  so you can at least see an end to it in decades hence. This was around the time when they started to tell me my with profits capital repayment vehicle wasn’t going to repay the capital… A bonfire of fresh twenty pound notes every December would have been more fun than that.

    You need over 9 years of net income to pay it off. This mortgage calculator shows that at an average 6.5% interest rate you get to pay back twice the amount you borrowed. So if you borrow 3.5 times your gross salary, you get to pay back 7 times your salary back.

    The Government relieves you of about a quarter of gross for a typical basic rate taxpayer, leaving you with 75% of it. Kiss goodbye to 9 years of it if you want to pay the mortgage off in 25 years at an average interest rate of 6.5%.

    Things that work in your favour here is that your salary may increase in real terms through job switches, promotions etc. Inflation also reduces the real value of the loan, if we manage to stick with the 2% targeted rate of inflation the real average interest rate is 4.5%, provided your salary keeps up with inflation. That means in real terms you get to pay back 1.67 times what you borrowed, which take out nearly eight years of your net salary.

    London prices? They kicked me out of the city 20 years ago and are still causing Londoners problems. The problem is that you’re competing with serious money in the Smoke, both UK wealth from the City and foreign wealth too.

    Paying just the interest? You’ll never own your home. Not only that, but you have to fix the damn thing if something breaks, and you can’t up sticks and leave it behind (unless you are in America, where apparently you can simply surrender the house to the bank and walk away debt-free). Seems a lose-lose situation, I can’t understand why anybody goes interest-only without having a strategy to pay the capital, other than for a short period of financial stress. As for those nutters that kept on ramping up their mortgages in equity release schemes to go on holiday, well I not sure they should be licensed to drive any financial instruments whatsoever ;)

    You may need to move to follow work. Work is much less stable now than it was in our parents’ generation. Globalisation and the associated ‘creative destruction’ churns companies and job roles faster and faster. Buying and selling a house is stressful and costs money in estate agents’ fees, removal costs and stamp duty. Owning a house makes it hard to get on your bike for a new job. That can seriously damage your wealth, and your health if you end up with a long and stressful commute.

    The pros of home ownership are often promoted without a hat tip to the darker side. And one fact is inescapable – nobody who has a mortgage owns their own home. They only own their home when they release the dead hand, by paying the last installment and redeeming the loan. Without a strategy to do that, they might be better off renting instead.

     
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