Fool's Eye View

[ December 5, 2000 ]

Beware A Big Mortgage

By Nigel Roberts

Chippenham, Wiltshire -- With interest rates at levels that only a few years ago most mortgage holders could have only dreamed of, many of us are being tempted into taking out bigger and bigger mortgages on our homes. Lower interest rates naturally lead to lower monthly interest payments, and with ever-increasing wages the average mortgage is becoming more and more affordable.

According to a speech yesterday by Howard Davies, chairman of the Financial Services Authority, first time buyers are now borrowing on average 2.29 times their annual salary to buy a home, which is even higher than the 2.2 salary multiple that was reached during the house price boom of at the end of the 1980s. If you go into almost any bank or building society to get a mortgage they will offer you 3 times your salary, or 2.5 times joint income. This is often taken by borrowers to be the target that they should aim for, rather than a maximum. A couple on a joint income of £40,000 a year will look to borrow £100,000, with a 95% mortgage this means that they could aim to buy a house valued at up to about £105,000. But is this sensible?

While interest rates are low, multiples of this sort are easily affordable by most borrowers. But should interest rates rise then we could be storing up a problem for the future, and none of us want to see a return to the problems of negative equity that we saw in the 1990's. The other worry that Howard Davies highlighted was the increasing amount of high mortgage-to-house-value loans, and, in particular, this is coupled with lenders who advance 95% or more of the valuation of a house. While house prices are rising, these high ratio loans are possibly justifiable, but borrowers must never forget that a small fall in the value of their homes could easily leave them owing more money than their house is actually worth.

Howard Davies put the onus for ensuring that mortgage lending was at a sensible level on the mortgage lenders, but in a competitive mortgage world it is hard for a lender to turn away business just because someone wants to borrow 3 times their salary, and 95% of the value of the house. After all if they refuse the customer will simply walk out and find a mortgage lender who will give them these multiples. No, it should not be simply the lender's responsibility. The real responsibility lies with borrowers.

If you are borrowing money to fund a house purchase you have to be sensible in the amount you can borrow. When you work out how much you can afford each month, consider if you could afford it if the mortgage rate was to double. What if it was to treble? Could you tighten your belt and cut spending elsewhere to be able to keep up the payments on the mortgage? If the answer is no, then don't borrow so much money. If that means that you can't buy that dream home then so be it! Don't mortgage yourself up to the maximum possible; mortgage yourself to a sensible level.

It can be very tempting to try to buy the best and most expensive house that you can buy, with the maximum possible mortgage, but the most sensible option is to actually take out the smallest possible mortgage. Remember -- house prices can fall as well as rise, as those of us who lived through the late 1980s and early 1990s can testify!

Where Next?

• Guide to Foolish Home Owning
• The Fool's Guide to ISAs
• Mortgage discussion board
• Mortgages, Investment and Tax - pay off the mortgage first!
• Duelling Fools - should you pay off the mortgage early?
• Full text of Howard Davies speech -- http://www.fsa.gov.uk/pubs/speeches/SP66.html