Introduction
In the UK, we are brought up on the concept of the property ladder. The idea that you buy a property and then in a few years time, buy a larger property, has been spoon fed to almost all British people since birth. There are even TV shows about the property ladder. However, what if I told you it was dead? What if £600k wasn’t enough to even buy a house? I look at the benefit of going against conventional wisdom and skipping the first rung of the property ladder.
What is the property ladder?
The central idea behind the property ladder is that you are better buying than renting at all costs. The conventional thinking is that firstly, you will be paying down the mortgage loan, and therefore increasing the proportion of the property that you own. Secondly, you can use the ‘equity’ you build up as a deposit on the next rung on the ladder. By that time, you may have a higher income, and therefore be able to borrow more to buy the next property.
This kind of thinking was great in the 1990’s when property values were around 3-4 times the average income. Nowadays, in the UK, the earning to house price ratio is around 5-7 times the average income. In London, the earning to house price ratio is probably around 10-28 times average earnings.
John wants to buy a property
Let’s consider an example (what I aim to be a fairly average example). John lives in London, and is doing well in his career. After starting on £30k, he’s managed to increase his income to about £54k a year. John has been able to save on average £7-8k a year (less at the beginning and more latterly). Over about 4-5 years he has saved up £30,000 and is ready to buy his first property.
The deposit will get him a 90% Loan to Value (LTV) mortgage on a one bedroom flat somewhere in Zone 3 and beyond. Banks will typically lend five times the income for a mortgage to a single person, which gives him £270k loan.
He will benefit from the first time buyer stamp duty discount so will pay no stamp duty.
John takes the leap and steps onto the first rung of the property ladder and buys a £300k leasehold flat in a new block.
John then lives in his flat, gets a partner, gets married and wants to have children. His party days are over, and he wants to settle down. He sensibly waits around 5 years before considering moving. He now wants a house to give space for a family.
His income has moderately improved in the time he lived in the flat and due to the high mortgage payments, he hasn’t been able to save terribly much. Also, his flat has only increased in value by about 15% since he bought it. It is now worth about £345k
Even with the dual income and equity, buying a house at around £700k, the average price of a 3 bed house in London, is going to be a huge stretch. He now has around £80k equity (£30k deposit + £50k equity), and another £10k savings. His partner has around £30k savings. In total they have £120k deposit.
That is around 15% LTV on a £700k property; however, the loan will be £580k. A bank will typically lend about 4 times a joint income which would require a joint income of £145k.
John now earns £70k and his partner also earns £70k (total £140k) which would only allow them to borrow £560k. They can’t afford the next rung as the bank will not lend them enough to afford the property. Also, they will need to pay stamp duty, which will be around £25k, up front. Therefore, they are stuck on the first rung of the property ladder in the one bed flat. They could move to a two bed flat, but it’s a lot of money to pay for something John and his partner consider unsuitable.
The other issue is that John bought a leasehold flat and hasn’t been able to save terribly much as the agent has been charging £2k per year on “maintenance”. John thinks it’s a scam, but has no choice but to pay. He can’t afford the legal fees to challenge the service charge in a Tribunal. His neighbours don’t want to make a fuss or join up with him. He is fed up and wants out.
Another thing that will eat into his money is he also needs to pay about 2% for estate and legal fees to sell his property (£6k).
Summary of numbers
Original deposit – £30k
Equity (increase in value) – £50k
Savings (John and partner) – £40k
Total deposit – £120k.
Selling costs – -£6k
Stamp duty on £700k property- £25k
Remaining deposit – £94k
Property affordable at 85% LTV = £626k.
Actual property John can afford = £94k + (4x140K) = £655k.
Their choice is either to move out of London and take a pay cut, or sell up and rent a house. Or wait longer to get his dream of a proper house.
What if John had waited a bit longer before buying?
Let’s consider if John had just kept renting. He would be able to move in with his partner and rent a place. They could save money as they wouldn’t have a killer mortgage. Rents actually fell in London so they were able to save more per month. Then when it did come to buy the £700k property, they would have more deposit and only pay £10k tax as first time buyers.
However, as John now earns £70k, he can save more than the average £7-8k he managed in the first 5 years of his career. He is now saving £10-12k a year which would give him about £90k (£30k + 5x12k), and combined with his partners savings of a similar amount over 5 years and they would jointly have £130k.
He’s saved on legal fees and stamp duty, and all the extra service charges.
They have a deposit of £130k and will only pay £10k tax (first time buyer stamp duty) on the £700k house. They can at a stretch, afford the house, but are free of the burden of selling a leasehold flat that no one wants to buy. In fact as a buyer not in a chain, he can move fast. So he can put in a cheeky offer on the £700k property and get it for £680k.
Summary of numbers
Deposit – £90k
Partner saving – £40k
Stamp duty – -£10k
Total deposit – £120k
Value of house at 85% LTV = £800k
Affordability at 4x joint income = £480k loan.
Total house price = £120k + £560k = £680k.
By being patient, and missing the first rung of the ladder, John has actually saved himself stress, and agro of a leasehold property. Financially, he is in a slightly better position, has a freehold property and is much happier. He can actually afford more property now as he isn’t spending money on tax.
He still can’t really afford the £700k dream home, but if he and his partner save another £20k and get pay rises, they will get their dream.
Discussion
The main issue is that most starter properties tend to be leasehold properties. This form of property ownership is risky for the buyer as you are not buying a property, you are buying the right to occupy a space for a time frame. It’s a difficult concept to understand legally, but that’s the point. It’s rigged against the leaseholder.
John, in his desperation to fulfil the societal expectation of owning a property, bought a property without fully understanding what he was buying. He has made his financial situation significantly worse by being unable to sell the property.
Also, consider who it is that is telling you that you should buy a property as soon as possible? Does it happen to be ‘property experts’ who have something to gain? Or is it developers and estate agents?
Make your own decisions. Consider risks. Don’t get yourself trapped.
The other elephant in the room is that property is wildly unaffordable in the South East of England. That’s another issue. John and partner have access to £680k but can only get a 3 bedroom house in a reasonable area only slightly stabby area in London. This is ridiculous.
Conclusion
I am not advocating not buying a property, but I am saying that it’s not always clear cut that one should buy at all costs and as soon as it’s possible. You might be putting yourself in a worse situation by buying.
If you live in a more affordable part of the country, it may be a no brainer to buy a property.
However, in this scenario, it seems that it is really not a good idea to buy as soon as you can afford something. Being patient pays off as you can buy a more desirable property and will be able to sell it after wards.
I have not even considered those who are caught up in the awful cladding scandal. They are trapped in properties valued at zero and will not be able to sell or borrow against the property and have bills of £100k to fix a problem that wasn’t their fault.
I am saying that we need to ditch the concept of the property ladder and stop feeding this to young and impressionable people. What worked in the 90s doesn’t work now.
What do you think? I wrote this to prompt discussion and realise it’s a complicated area. I’d love to hear what you think or your own personal experiences in the comments below.
I’m not a fan of the obsession around ‘the ladder’. I’d rather have no mortgage on a small decent property than a large mortgage on a McMansion.
My friends in their 20s are incredibly willing to gamble money in the property market, but completely reject fund investing as being too ‘risky’. Makes no sense – but that’s this county’s obsession with property being fed down to the next generation in a nutshell.
The idea of a ladder also fuels the idea that you should always be looking for bigger and ‘better’, which is something I completely despise. I’m happy being content and would rather have no mortgage and more options to reduce work.
But what do I know, average properties in my area are around 14x my wage and I don’t even live in London or the South East.
huh that’s odd, I was casually reading your blog and the photo you have used is the block of flats I live in!
Good piece, but would question the maths around the equity in the initial flat purchase scenario.
Bought at £300k with a 10% deposit, so a £270k mortgage. After five years at 3% interest rate (which is probably slightly higher than he’d have actually got) he’d have c.£231k remaining so would have equity of £114k in the flat rather than the £80k you’ve got it at and bumps that ‘can afford’ number up to £689k.
Totally agree with all the other points around not being in a chain, not having a leasehold to sell on and the fact that the ladder is a myth – the amount of people that think their £300k property going up 15% to £345k is amazing without considering the ‘next house’ therefore has also gone up 15% from £500k to £575k and the gap is now £30k more in total is staggering!
The calculation for the second scenario is inaccurate as first time buyer stamp duty relief only applies to properties 500K and below. So unless John is hoping to buy a 3 bed house that is 500k and below in London, it makes no difference.
Historically, people used to buy property fairly young and often pre-marriage. They often had large wage increases and so were able to fund the next property. What has changed now is wage inequality has grown- top earners in london earn 6 figures by age 29 (or even younger) and often couple up with each other. They also have hefty inheritances on top.So they are able to afford to pay 7 figure amounts for houses. At the same time, the majority of people have not enjoyed salary increases in real terms. So in a sense, it is not strange at all that they are unable to buy larger properties – it is just an indication that London houses have become the preserve of higher earners/investors/people with inheritances. Areas and demographics do change with every generation.
https://www.gov.uk/government/publications/stamp-duty-land-tax-relief-for-first-time-buyers-guidance-note
‘At Budget 2017, relief from SDLT was introduced for first time buyers. The relief applies from 22 November 2017 to purchases of residential property for £500,000 or less, provided the purchaser intends to occupy the property as their only or main residence.
On 29 October 2018 the relief was extended to first time buyers purchasing through approved shared ownership schemes who choose to pay SDLT in stages. This will apply from 22 November 2017.
From the 8 July 2020 until 30 June 2021, the relief for first time buyers is temporarily disapplied due to the introduction of temporary reduced rates for residential property. First time buyers purchasing their first home between 8 July and 30 June 2021 should use the reduced rates. The relief will then apply from 1 July 2021.’
Its is also important not to generalize leasehold flats. My 1930s mansion block flat is managed by the residents, including a sink fund for the roof, my husband is on the board of directors for the resident management company. A house with the same floor area costs 200K more in my area, which is a crazy amount for the same floor space! This is also why I am hoping to buy a 3 bed flat as opposed to a 3 bed terrace house for my next property because I am not willing to pay the house premium, I would rather scrutinize the lease and check up on the freeholder, ensure that the block is well managed. New builds are a bad investment, but thats mainly because you cannot benefit from the new build premium once you sell on the property and also most of them seem to be owned by dodgy freeholders.
A share of freehold is still considered a leasehold. You may jointly own the freehold title, but the flat in itself still comes with a lease. You might have more control over costs, and you don’t need to pay a premium when you extend a lease but legally its still a leasehold flat. and of course as everyone has to pay service charges, they have an incentive for it to stay affordable.
I am not certain there is such a price difference. I bought my property at £392k, there are many flats in the same area at a higher price than mine which are leasehold and owned by an external freeholder. And some flats in my block don’t own the freehold, but they have the similar prices to those that do!
Certainly because it is in the suburbs, there are many purpose built Edwardian maisonettes as well as flat conversions from houses (house split into 2 flats, 50% share of freehold), those seem to command a higher premium as the ongoing service charges tend to be very low and repairs are done on an adhoc basis which most people seem to prefer plus they look very nice on the outside and the bottom floor flat has a garden. However, the soundproofing on those properties can be poor (but probably not worse than your average Victorian terrace) and the layouts are not as good (my husband hates them), so it has its pros and cons.