Consumer Debt: Being Debtfree - Renting vs. Owning( Mortgaging )?? Part Three

Consumer Debt: Being Debtfree - Renting vs. Owning( Mortgaging )?? Part Three

Is being debt free a pipe dream? Can it be done? Can a house be bought debt free? More importantly, is it necessary to buy a house? Is renting bad? Does it make more or less financial sense to rent??

In my previous blog, I wrote about the story of my friends and how they looked completely different on the day that they made the last payment on their mortgage. I am sure theirs wasn’t an isolated story and that this scenario has been witnessed by almost everyone in our daily lives ( our parents? ). When I started writing about the consumer debt and how it can be avoided or should be avoided, I got a very positive response from the readers. Most of my readers agreed that debt for consumer items is uncalled for and is best avoided. However, there was always an exception made to this rule for items that are deemed expensive i.e. generally cost more than 3-4 months salary. Car and house were the most common examples cited. In part 2 of this series ( ..) I had written about how if debt is avoided a car can be bought in less time than required to clear off the debt and also if things were to go bad how you will not lose you sleep over it. The problem with debt ( car loan ) is that if things do take a bad turn, no matter how many payments you have made your car will be repossessed and payments will be taken by selling it. The problem with this is that a new car is subject to roughly 20% depreciation every year. So the value of car drops more quickly then what you have paid off in the 1st, 2nd or 3rd year of your loan repayments ( typical 5 year car loan). This is called ‘negative equity’. Simply put, even when the car is sold, you still owe money to the bank! Imagine this scenario: you have lost your job, now lost your car and just to add insult to injury, you still owe money to the bank for a car that you no longer own! One of my family member is a car salesman and he would tell us how his firm had to repossess cars and then send bailiffs in order to secure the full payment, it was a common theme in car loan market. On the other hand ‘negative equity’ was an unheard phenomenon in the real estate market. Things have changed and how!!!

Most middle class people dabble in the stock market. They may or may not be good at it but still everyone likes to put some money ( may be negligible ) in some shares, if for nothing else than, to have another talking point at the pub! However, not many people dabble with the options and futures market. When asked, the common reason cited is that ‘leverage’ is a beast! Most options and future contracts can be owned by fronting around 10-20% ( called margin ) of the total cost of the asset i.e. a futures contract of £100 can be bought by putting up £20 ( sometimes even less – depending on your broker ). If the cost of the contract goes up by 10% i.e. £10 and you sell it, you make a 50% profit on your original £20 investment! On the other hand if the cost falls by £10 you make a 50% loss! This in short is leverage, it can make or break fortunes and hence common people tend to avoid these risky investment vehicles. And yet almost everyone buys a house ( and a holiday home! ) by fronting only 10% deposit on a £165000 ( avg. UK house price ). It means if the house price goes up by 10%, you stand to make 100% on your original investment ( £16500 ) however what everyone conveniently forgot ( until 2007 ) was that leverage is a b*tch! And works both ways i.e. 10% ( don’t even want to imagine 25% ) drop wipes out the original equity! A further drop can quickly be equal to or more than a years salary!!! If things go bad, you will not only lose your house, but still owe enough money to the bank that the debts will only be written off with your death!! Can anyone recall ‘Merchant of Venice’ and the demand of pound of flesh?? This demand of a pound of flesh or rather the its absence could be easily seen on my friends face when they paid off their mortgage ( although I have to say being close to 60 is not the ideal time to be debt free! Well actually there is no ideal time to be in debt! )

So then I hear you say, what’s the alternative?? Most of us don’t have the required £165000 required to buy the house. Does that mean we should never own one?? Is that not careless?? Also, isn’t renting throwing the money? If you have the mortgage, at the end of it, you atleast own a house!? These are all legitimate questions, some of which are typically used as sales tactics by real estate agents. Now I am going to provide you with an alternate scenario. This scenario will rival the standard way of ‘buying’. A 25 something couple buys a avg. UK home £165000 by paying 10% deposit £16500 and pays towards the mortgage. Rate of interest 4%. I used an app call mortgage calculator to find out what they have to pay per month. It is £785 approx. The home insurance, maintenance and property tax ( £1800 approx. per annum ) is another £100 per month i.e. they are liable to pay 16500 + ( 785+150 )*25*12= £297000!! Also the first 16500 down payment does not yield any interest ( 4% ) and that loss alone over a period of 25 years is more than £20000 which should be added to the eventual cost paid ( 297000 + 20000 ) taking the house price to £317000!!! I can go on and on, but I think my readers get the picture that when a house is bought at more than 180% of its cost price, it costs you precious time of your life ( lost in the extra repayments ).

Now look at the alternate scenario, you have £16500 instead of buying the house ( £165000 ) you decide to rent it at £500 a month ( again this is personal experience! I have done it for the past 5 yrs in one of the most sought after locations in midlands!) This saves you ( 285+150 ) £435 every month compared to your mortgage i.e. £5220 a year. Now all you need is some excel sheets and if you work it out, at 4% interest rate your initial £16500 and £5220 that you would add to it in 25 years, you will not only have lived in the same house but will also have £250000 as bank balance! Also, you will never have to worry about the house prices going up or down and in the worst case scenario, if one or both lose their jobs, they will have a bank balance to support them through their worst times!! I think it can be done. Most Germans rent. Only the really rich ( and most people who do not buy houses at 25 can be rich by 40!! ) buy houses.

I think there are lessons to be learnt. Living debt free in not a pipe dream. It is not privy of the very rich. Financial freedom truly is the best freedom! It can and will change your life.

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