Imagine you are a young guy and you want to buy a house.
You go to the Bank to borrow £250,000. After all, everyone else is doing it…how hard can it be? You are 25 and have the rest of your life to pay it back.
The bank manager looks at you, checks that you have a job (wearing a tie helps here) and are not a convicted criminal, shakes your hand and tells you £250,000 will not be a problem. Well that was easy!
But, as Steve Biddulph tells the story in Manhood, there is just one problem – something else happens that you weren’t expecting and wasn’t in the adverts.
The bank manager takes out a jar. You have to leave behind one testicle in the Jar which is then locked away in the Banker’s safe for the 25 year mortgage term, along with all the others.
Now you have future interest payments to meet. The other nasty side effect is this:
“If ever in your life you get the urge to do something risky, exciting, different or adventurous, chances are you will not because you won’t have the balls to do it. Somehow, to be a free man, you have to escape this trap.”
“You could live in the country where houses cost less. You could stop competing with your neighbours and drive the oldest car in your street. You could give your children more of your time, instead of a private school education…Even reducing this, claiming back some of your money and time, you can be a freer man”.
This captures the essence of what I am talking about on this blog.
When I bought my first house, aged 26, the “logic” went something like this:
1. My girlfriend said we should buy a house
2. Everyone says you can’t go wrong with bricks and mortar…and prices seem to be going up…best get in quick!
3. Am I not an upwardly mobile, tycoon of the future? Yes, indeed I am! I will therefore need a house that is befitting of my status
4. I therefore want to own the “best” (read most expensive) house possible
5. To buy the most expensive house, I’ll borrow as much as the bank will lend me
6. I will then be happier…because everyone knows that having more shit makes us happier.
Please note here the absence of any original thought, logic or financial analysis to back up one of the most important financial decisions of my entire life. Lemmings have jumped off cliffs with more analysis to back up their decision than this.
Now, here is one of the ironies of life. I ran a lousy decision making process but, thanks partly to luck, got a good outcome. So, how did this end up working out OK for me?
Firstly, a house is a productive asset – it provides shelter, security and a store of value that tends to rise over time along with growth in the economy. But be careful of the “stuff” that people associate with a house purchase. For the avoidance of doubt, plasma TVs, Xboxes and pink fluffy cushions do not count as productive assets.
Second, a mortgage can be a effective motivational tool. Once we’d moved in, I gradually realised the implications of what I’d signed up for. I feared default and eviction. I channelled this fear into action – this helped keep me focussed on work and chasing the next pay rise and bonus.
I respectfully submit to you that, if you have a large mortgage and you are not at least a little scared, then you do not fully understand your situation. There is an optimal level of mortgage fear. A little edge of unease can be helpful as motivation to get out of the hole as quickly as possible. Too much fear, however, can paralyse and persistent debt worries will eat away at you.
Repaying the mortgage provided a clear, achievable goal. I set aside a regular monthly amount (in addition to the minimum payment required by the banks) for paydown. Every time I went to the bank to do this, they would run off a little slip that showed me the new (reduced) monthly payment. Ker-ching!
All the bonuses and any other spare money that I could scrape together got thrown at reducing that mortgage. Slowly but surely, this created a virtuous circle. The more I reduced the mortgage, the lower the monthly interest became. The lower the monthly interest became, the more free cash flow I had available to throw at reducing the mortgage.
The potential escape artist pays themselves first. In other words, put the mortgage over-payment savings on auto-pilot with a direct debit that comes out of your current account straight after you are paid. That has a helpful side effect of helping to create an artificial environment of scarcity for the rest of the month that helps you control your spending. In contrast, the sucker waits until the end of the month and says they’ll save whatever is left. Guess how much that will be.
Third, having a mortgage always meant that I had a great investment opportunity in front of me. No need to scour annual reports, research companies or read the Financial Times. At an interest rate of, say, 6%, I always had a tax efficient and risk free way to put money to work by paying down the mortgage.
Tax efficient because the “income” from mortgage repayments (i.e. lower interest costs) is tax free. Whereas if I had saved the spare cash flow into a savings account, I would have paid income tax on it. For a 40% taxpayer, this turns a 6% (net return) investment into the equivalent of a 10% (gross return) investment.
On reflection, risk free is probably the wrong description for mortgage repayment as an investment choice – it makes sounds like it is risk neutral. Actually, its much better than that. You have reduced your leverage, reduced your stress and increased your robustness to future shocks.
There is a healthy debate to be had here for savers. Should they pay off the mortgage or should they use the cash to buy other productive assets (e.g. shares) in a SIPP or ISA?
There is no single right answer to this. The most important thing is to focus on saving as much as you can….whether you invest it into a pension or ISA, property or shares is a secondary consideration.
For me, the priority was to focus on smashing the mortgage whilst paying into a workplace pension and buying shares to learn as much as I could about investing. There is no one right answer for everyone but, if you invest whilst you still have a mortgage, this is equivalent to borrowing money to buy shares.
The potential escape artist prioritises their attention on the big wins and the quick wins. Housing costs (e.g. mortgage interest) are the big one for most people so this is a good place to start looking to attack your cost base.
My view is this. A mortgage is like a chainsaw. Its a powerful but slightly scary tool to be used carefully for a short period of time in a domestic situation. If you get it wrong, it might lop off a limb or two.
If you are in the hole with a large mortgage, the good news is that you can climb out.
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