Hello and welcome back to Mortgage Advisor on F.I.R.E. This week I will be talking about the complexities of mortgage advice. I will also touch on the politics of the coronavirus and the NHS. First of all, in the weekly update I will be talking about my biking challenge to raise money for the NHS in Sheffield.
I have now completed 712.77km of my biking challenge. I am using my home exercise bike to cycle the distance from Sheffield, UK (my home city) to Snagov, Romania (my girlfriend’s home village). It’s a total distance of 2,858km and I have a deadline of June 7th to complete this. So far, I’m ahead of the game having completed roughly 25% of the distance in a little under two-weeks. I needed to average 45km a day to complete the distance on time, but I’m averaging 57.97km a day so far. My JustGiving page sits at £100 as I type this, so I’m just £20M behind Captain Tom, give or take a few thousand.
What more can be said about Captain Tom? A true example of British resilience, courage, humility and charity. His efforts have been nothing short of heroic, and his efforts have raised a huge sum of money for the NHS. What he has achieved is phenomenal. It shouldn’t have been necessary though.
A meme has been doing the rounds on Facebook, although it apparently originated on Twitter from an unnamed nurse:
The NHS is a huge organisation, and something that should be a shining beacon of our country. It’s failing though. There are all sorts of measures and data that can be used, and they can be spun to fit any agenda that you want. If we break it all down, one thing becomes clear – the NHS needs more money. It needs more money to run. It needs more money to train new doctors and nurses. It needs more money to grow and develop to face new changes. This money can either come through a bigger budget, more efficient use of its existing budget, or a combination of both.
When the NHS was created in 1948, the life expectancy in the UK was 66 for men and 70 for women. The current UK life expectancy is 81. I’ve not spent a huge amount of time searching for this, and my quick google-fu did not present separate data for men and women in 2020, but for the purposes of my general point, it doesn’t matter too much. The point I am making is that the NHS is having to cope with an aging population. It’s having to cope with much higher levels of obesity related ill-health than in 1948, and it’s also having to cope with providing mental health support.
The NHS should not have to rely on charity, that much I agree with. But if the money is needed in a time of crisis, it’s needed. If the NHS was to be abolished and private healthcare was the only option available, I honestly think I would be done with the UK. I don’t trust the political establishment not to fuck it up, and I don’t trust the mega corporations not to fuck it up. I look at what the healthcare system is like in the United States and it’s terrifying. We need to avoid that. The NHS might cost a lot, but it has such an important purpose. The cost of not having the NHS will be much, much higher.
As for my biking challenge, it’s not entirely altruistic. I needed a reason to get off my ass and get back in shape. If I can raise money in the process, so be it. You will see links throughout this blog to my JustGiving page. If you can afford to donate, please do.
Premium Bonds: £15,000 (no change from last week).
Stocks and Shares ISA: £8,026.15 (down £72.86 from last week).
F**k It Fund: £4,481.15 (no change from last week).
Property Value: £181,626 (no change from last week).
Total Assets: £209,133.30 (down £72.86 from last week).
Residential Mortgage: £144,906.05 (no change from last week).
Total Debts: £144,906.05 (no change from last week).
Total Wealth Figure: £64,227.25 (down £72.86 from last week).
Investment Income in 2020: £31.44 (up £2.77 from last week) (target £2,000).
The week before payday is always a little uneventful. My monthly investment into my ISA is complete and nothing else happens on my financial calendar until my next payday. I had a small dividend payment from a bond fund I started investing in a short while ago, but I’ve not got many units in that fund yet. The coronavirus is going to impact on my dividend income this year, but that’s a small issue in the grand scheme of things.
I always brace myself when I tell a person I’ve just met that I’m a mortgage advisor because I know what’s coming next. More often than not, it’s a request for advice. This in itself is not frustrating. The frustrating part is when people want advice without disclosing anything about their circumstances. A couple of weeks ago a woman sent me a message on social media out of the blue. She had seen me posting something in a group about mortgages and asked me if I felt she should have a two-year fixed rate or a five-year fixed rate. I answered “it depends” and then listed a number of factors that can determine what is best. I did not get a reply.
What I’ve found from speaking to friends, family and just random people I meet in day to day life is that they want an easy answer, and they don’t want to have to think too much. I’ve known people spend hours comparing what mobile phone to buy next, but then just shrug their shoulders and fail to give their mortgage the attention it deserves. In any setting where professional advice is given, the advice is only as good as the information it is based on. If you don’t work with your advisor, you’re going to get a lesser quality of advice. There is something about mortgages that freaks a lot of people out, and I don’t understand why. For the vast majority of people, their mortgage is the biggest financial commitment they will ever make, but people don’t understand how they work, what they are and what their obligations are.
What is a mortgage?
“It’s a loan from a bank used to buy a property.” No. It’s not.
A mortgage is the security for the lender’s debt; in most cases the property purchased with the loaned funds. For the sake of everyday discussion, most people refer to the loan as the mortgage. That’s fine for everyday discussion, so long as we understand it’s not technically correct. For ease of discussion, I will refer to a mortgage in the way that most people understand it; as the debt itself.
When you have a property with a loan secured against it, many people assume they can just do what they want with the property. This is not correct either. Mortgage terms and conditions booklets are not that long. I would put good money on the fact that less than 1% of people with a mortgage have actually read their T&Cs. It blows my mind. It’s a commitment that could last the majority of your adult life. It will probably be the biggest debt you ever take on. It’s the means for you to have a home you can call your own. Why wouldn’t you want to know what you’re signing up for?
If you have debt secured against your property, you have to understand that the property is not simply yours to do with as you want. With a mortgage agreement both sides get something in return for abiding by T&Cs. The customer gets the money to buy a house. The lender gets interest on the loan.
Back to Mortgage Advice
There are many factors that can determine what is most appropriate for you to do with your mortgage, ranging from your employment status, how long you plan to live at the property, how many children you have, and the age of your children, and your retirement plans. Many people are purely fixated on the headline rate because that determines the monthly payment in the present. With a mortgage that can potentially run for decades you have to be smarter than that. An example:
Mr and Mrs Customer are a young couple who are buying their first home. They have decent jobs and earn a combined £50,000. They are borrowing £250,000 to buy a house and are putting down a £25,000 deposit. The purchase price is £275,000 and so they are taking out a loan that is for 90% the value of the property. We call this calculation loan-to-value or LTV. The lower the LTV, the better the rates you get.
Mr and Mrs Customer want to take the maximum term so their payments are as low as possible. Let’s assume a typical rate of interest of 2% (this will probably not age well as rates change over time, but the principle is the same). Many lenders will now offer a mortgage over forty-years, and so their payments will stack up as follows:
£250,000 over forty-years at a 2% rate of interest results in a monthly payment of £757. The total cost of the mortgage is estimated to be £363,391.
What happens if they pay more each month? Well, the term comes down. Increasing the monthly payment by £100 would pay the mortgage off over six years early and save in excess of £20,000 interest. Sounds like a good idea. Well, it depends…
With the above calculation you are paying off the mortgage six-years and eight-months early; which means you still make thirty-three years and four-months of payments. To pay the mortgage off early you have to keep paying those £100 extra payments each month. Are you starting to see the issue? Those extra £100 payments each month over the term of the mortgage add up to 400 x £100; a result of £40,000. You are paying £40,000 to save £20,000 of interest.
This is where the calculations become complicated and subject to what is best for the person in question. It’s important to remember that the £40,000 “extra payment” is actually an “early payment”. People talk about “extra payments” and “overpayments” but you are simply paying part of the original debt back ahead of schedule. So, it’s not an “extra” payment as such. It’s just an “early” payment, hence why mortgages have “early repayment charges” for when you pay too much, too soon, and reduce the amount of interest the bank earns from the mortgage. Granted, you are saving yourself over six-years of payments of £757, but that’s where the £20,000 saving in interest comes in. For people who are averse to risk and investing it’s fine. If you are wanting the biggest bang for your buck, then there are other ways to look at this.
I used to think that paying off your mortgage early was the golden rule of mortgage advice. The earlier you pay the mortgage off, the less interest you pay. In isolation this statement is true. Finances do not exist in isolation though. If we look at this another way and assume the extra £100 each month was being invested in a low cost index fund, you see the following outcome:
As stated earlier, £250,000 over forty-years at a 2% rate of interest = £757 per month. The total cost of the mortgage is estimated to be £363,391.
£100 per month invested in a low cost index fund for forty-years, assuming a 7% annual return (historically it’s closer to 10%), means you will have accumulated a fund worth £248,550. Instead of spending £40,000 to save £20,000 interest, you have spent £48,000 and earned £248,550 interest. Which scenario looks more appealing?
You can even mix and match the strategies and use some of the compounding from your investment to pay off the mortgage early. As always, seek independent advice from a financial professional before starting any investment.
Mortgage advice operates in a vacuum but it shouldn’t as it is impacted by lots of other factors. I’ve explained a fairly complex issue here, but most people don’t think about it this deeply. Many people are just concerned with the headline rate and do not take into account longer-term plans. A lower rate is not always a better rate. A higher rate can make more sense in some circumstances if it secures a payment for a longer period. Some people are obsessed with as long a rate as possible, even though a shorter deal would suit them fine.
A slightly longer post than normal this week. I hope you enjoyed this post. Please leave a comment and if you can, donate to my NHS fundraising effort. Stay safe and see you next week.