Much of this financial independence thing is about rethinking things from first principles.
When you do this, you realise that a lot of conventional wisdom isn’t very wise. Often you must unlearn what you have learned.
Home ownership has come to be seen as A Good Thing. Mostly this assumption is implicit and unquestioned. Its easy to see the advantages of owning your own home. A roof over your head. No dealing with landlords that mess you around with deposit deductions. Somewhere to put down roots. It’s all obvious stuff.
Or is it? Perhaps we’ve been conditioned to treat getting on (and moving up) the housing ladder as if it were some combination of your civic duty (like voting) and an easy route to riches (as in all those TV property porn shows)?
There’s no doubt that a house is an asset. But there’s a bit more to it than that…so let’s unbundle what home ownership actually entails.
1. A house is somewhere to live
This is the most important aspect of what a house really is. I think people sometimes forget that the main purpose of a house is to stop you from freezing to death in the winter and keeping the rain off you. This is one reason why I don’t include my house in my asset allocation or net worth calculation.
Yes, you can buy, do-up and flip your way up the housing ladder. And we did some of that. But, these days, a house for me is primarily somewhere to live rather than a financial asset to be traded.
2. A house is a saving scheme
You can think of mortgage repayments as non-discretionary saving (the capital element at least). This is one reason why many parents are keen for their children to buy a house; it’s a way for them to get into the habit of saving. Habits are powerful things. Once the mortgage is paid off, that saving habit will serve you well if you push on to full financial independence.
A house is something that people can see, feel, touch… so the purpose of the saving is obvious. That’s the carrot. There’s also a stick. If you stop making the payments, the nice man from the bank is replaced with the nasty man from the bank (see point 7 below).
3. A house is a status symbol
Good! So let’s admit that most people think off their house as a status good to some degree. Even The Escape Artist is not immune from this sort of clownery. We bought our house about 12 years ago. If you asked me why we chose it back then, I would probably have muttered something about good schools, being handy for the rail station and being able to walk into town easily. I probably wouldn’t have said that I wanted somewhere big enough to project my ego and a base from which to plot Total World Domination.
But, if we’re honest, most of us have a bit of Doctor Evil’s attitude to housing in us. Its just that we have less money than him.
For Dr Evil a house is not about our basic need for shelter. It’s a statement that he’s a force to be reckoned with. And it must be massive to hold all his laser beams, nuclear bombs and other status-signalling possessions (see point 6 below).
Not for Dr Evil a shared apartment or small terraced house in a bohemian part of town. No, Dr Evil’s houses must be isolated, detached and bigger than the neighbours.
4. A house is a store of value
Although I don’t think of our house as a financial asset, one day we’ll downsize. Until then, the house acts as a store of value.
In the UK, houses have delivered average annual returns that are not that different to those from shares over the last 100 years or (although the data is patchy and may not fully reflect maintenance costs etc). In the US, with fewer supply constraints, returns from housing have underperformed those from stocks but have at least kept pace with inflation.
Despite boom-bust cycles, over the long run houses have historically provided a store of value, particularly in inflationary conditions. The way we see houses was shaped by high inflation in the 1970s (up to ~25%) and 1980s. If you have an asset whose value inflates alongside inflation, funded with a liability (mortgage) whose real value gets eaten away by inflation, then it can look like you can’t go wrong with houses.
5. A house is a source of risk
But the truth is that you can go wrong with houses. The housing market booms and busts like the stockmarket, its just been longer since we had a house price crash and, without quoted prices, its less obvious.
The value of individual houses can be even more volatile. Buying a house means putting a lot of eggs in one basket. A house is subject to the fortunes (or misfortunes) of one country, one county, one city, one town, one neighbourhood. The risks are many and varied and can be correlated with your other risks. As Jim Collins puts it:
A plant closes. A street gang moves in. A council goes crazy with taxes. An environmental disaster happens nearby. We could have an investment that not only crushes it’s owner’s net worth, but does so even as they are losing their job and income
6. A house is a space that gets filled
Nature abhors a vacuum.
If you buy a house, you (or your significant other) will fill it with
shit furniture, fluffy cushions, curtains and other toys. If you buy a bigger house, you will fill it with more shit. Shit that costs money.
It’s not entirely clear why this should be the case. I just know that it is.
7. A house is collateral for a loan
A house is (usually) bought with a mortgage. A mortgage is a form of debt or leverage. Leverage can’t turn a bad investment into a good investment. But it can turn a bad investment into a disaster. Its sensible to run the numbers and see what things would look like if interest rates went up a lot. Interest rates went to 15% as recently as 1993. Just saying.
One of the reasons people think that housing is a better investment than it really is, is because they don’t see the hidden risks of leverage. So they don’t see the alternative histories that could have played out where a job loss or illness bankrupted them. Coulda happened.
Mortgages in the UK have personal recourse…so even if they repossess your house, you can still be held liable for any shortfall on a sale. To put it more simply, if you can’t pay, they can take you away. How many people who take out a mortgage fully understand this?
A house provides security for the mortgage lender. For you as the borrower? Not so much. If you are buying with a mortgage, remember what’s in The Bankers Jar.
8. A house is a set of liabilities
Not only do you have to pay council tax and utility bills, houses require an endless parade of repairs and maintenance. Lawns need to be mowed, boilers break and roof tiles sometimes fall off. That’s fine if you are happiest when DIYing… but that’s not really my thing.
A house is not an invincible castle. It can be damaged by weather, fire, vandalism and floods. So people then buy a bunch of expensive insurance to cover these risks. And most insurance offers lousy value for money.
9. A house is a tax shelter
Because most home owners vote, the tax system is tilted in favour of home ownership. There is no capital gains tax on your house. You can rent a spare room out and the first £7,500 of income is tax-free.
You don’t pay tax on the rent saved by owning. And paying down your mortgage is a tax efficient home for your monthly savings. That’s because if the money just sits there in cash earning interest, you are taxed on that interest income*. So you receive a net return. If you pay off your mortgage, you save the interest before tax. So you receive a gross return.
This is not an argument for investing in a house versus investing in shares. There are also tax shelters for shares in the form of SIPPs (Self Invested Pension Plans) and ISAs (Individual Savings Accounts).
10. A house is an anchor (and a millstone)
People often talk approvingly of the advantages of growing up, settling down and putting down roots. And there’s some truth in that.
But its not the whole truth. When you’re renting, the world is your lobster. As soon as you buy a house, you are limiting your options. Even if you move and rent it out, be ready to take late night calls informing you that your tenants have broken the boiler.
Buying a house makes more sense if you know you are not going anywhere. We have children and want to give them a settled base for their childhood years. So The Escape Artist will not be moving to Hawaii or Ibiza just yet as that would make the school run difficult.
Buying a house keeps you locked in one geographical area. This limits your options and allows The Man to hold you down more easily. This is not so much of an issue if you live in a big city. But buying a house in the country and commuting long distances by car is not a smart move.
A zen buddhist might say that there are many paths to nirvana. But, as far as The Escape Artist is aware, no one ever discovered the secrets of true happiness whilst commuting.
*Basic-rate (20%) taxpayers can earn £1,000 interest with no tax. Higher-rate (40%) taxpayers can earn £500 interest with no tax. Additional-rate (45%) taxpayers have to pay tax on interest received (outside an ISA etc).