Key Post Should I borrow the max and buy the most expensive house I can get?

Brendan Burgess

Brendan Burgess

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This comes up a few times, so I would like to suggest some principles which people facing the decision could apply and some other considerations.

Summary
1) Trading up is very expensive, very risky and very stressful, so on the one hand you do want to get as far up the housing ladder as possible, to avoid trading up too often.
2) Some people are too conservative and want to be mortgage-free by age 40. This doesn't make much sense.
3) While you should stretch yourself to avoid having to trade up later, overstretching has its own risks. What happens if you lose your job or interest rates rise?
4) If you do stretch yourself, then you should probably fix for a longish term to protect against interest rate rises.
5) Stretching yourself to buy a more expensive house closer to work will probably save you a lot of time and money in reduced commuting.
6) If your forever home will cost €700k and you can afford to buy that, you probably should not borrow more to buy a bigger house, just because you can.
7) Consider buying a house now which you can extend later.
 
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Couple aged 35
Two primary school children
Combined income €100k
Cash €100k

They could buy a home for €300k which would meet their needs.
Their forever home would cost about €700k

The bank will make an exception and lend them up to €400k so they could buy a €500k house.
Should they do so?

Option 1
Buy a €300k house with a comfortable mortgage of €200k.
Then trade up in 6 years to a house closer to better schools and work.
Mortgage cost €200k @ 2% over 25 years: €850 per month

Option 2
Buy a €500k house with a €400k mortgage
Mortgage cost €400k@ 3% over 25 years: €1,850 per month

Of course, there are options in between, but it's handy to look at the two extremes

The advantages of Option 1:
  • A very comfortable mortgage
  • A lower mortgage rate because of 66% LTV
  • More capacity to maximise pension contributions or pay off mortgage faster
  • Less impacted by rising mortgage rates
  • More flexibility - e.g. to take a career break
The advantages of Option 2:
  • A bigger/nicer/more convenient house immediately
  • Avoids the cost, stress and risk of trading up in 6 years
Factors to consider
  • Are the commuting costs lower with the more expensive house?
  • Are the running costs of the more expensive house higher?
  • Do you expect your incomes to rise over the coming years. A €400k mortgage on a €100k salary is very high, but it's a lot more comfortable if you expect your incomes to rise to €150k.
  • How secure is your job or business? If you are self-employed and your income depends on the economy, it argues strongly for borrowing a lot less.
  • How sure are you that the €500k house will be the right house for you? For example, if you might move to a different city with your job, then you probably should go for the cheaper house as there is no point in stretching yourself for a house which you may have to sell.
 
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Don't assume that house prices will rise indefinitely

Most people assume house prices will rise . If they thought they were going to fall, they would put off the purchase of the house.

A €500k house needs to fall by just 20% for you to go into negative equity.

A €300k house would have to fall by 33% for you to go into negative equity.

This does not matter a lot if you are able to meet your mortgage repayments and don't have to trade up. But it is uncomfortable to be in negative equity.
 
Should I draw down a bigger mortgage than I need so that I don't use up the full deposit?

It may make sense to take out a larger mortgage than you need temporarily. It's handy to have cash available to carry out repairs and any changes you would like. But when you have settled in, you should pay the cash off your mortgage. The problem is that most mortgages are fixed rates these days and you may face a penalty for part paying a fixed rate mortgage. Some lenders do allow you to pay up to 10% of the balance each year without penalty. And if you have a variable rate mortgage, you can pay any or all of it off without penalty.

You should not draw down a bigger mortgage than you need so that you have an education fund for your kids
It is very expensive to borrow money at 3% to put it on deposit at 0%. For example, a €50k current account would cost you €1,500 a year. Unless you have an immediate need for the money e.g. this year's college fees, you should not draw down a big mortgage.

You should not draw down a bigger mortgage than you need to invest in shares
The return on shares is uncertain and is taxable. Paying off your mortgage guarantees you a tax-free and risk-free return equivalent to the mortgage rate.

You could consider drawing down a bigger mortgage to make a pension contribution
This is a more complex issue and beyond the scope of this thread.

I think that there might be a Key Post on the topic

Max pension or overpay mortgage

I appreciate there is a similar thread just started today but I didn't want to hi-jack that and I also wanted to give our specific details. *** Age me: 40 Age spouse: 38 Income me: €115000 + ~50000 bonus Income spouse: €80000 Both private sector Mortgage 1: Balance €300000 value €365000...
www.askaboutmoney.com
 
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Investment considerations

There are often arguments about whether a house should be considered an investment or not. I am not sure whether you describe it as an investment or not makes any difference.

Making a capital payment off your mortgage is a very good investment. You get a risk-free and tax-free return by doing so.

If you prefer House A to House B, but for some reason, think that House A has less investment potential than House B, you should still buy House A. This is your home, and its suitability for meeting your housing needs is the primary consideration.

Should you buy "more house" than you need because it is a good investment?

You should buy the best house for your housing needs. If you need a 3 bed house, it's no harm buying a 4 bed. But you probably shouldn't buy a 6 bed because it's a good investment. By all means, buy a 6 bed if you may eventually need it.

There are aspects to home ownership which do make it a good investment
  • Exemption from CGT
  • Rental Income exempt under Rent-a-Room scheme
  • Value of house ignored for means testing
But on the flip side, you can't sell off part of your home if you need cash.
 
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