No matter what, they were sure that buying a house was by far the best investment you could do.
How things have changed since then!
Until recent years, the problem was called inflation.
Inflation has several meanings, but, for the sake of simplicity, for our purposes it means that with 1 euro in your pocket today you can buy more things today than with the same euro tomorrow.
"So what?" you may argue.
Well, the generation of my parents grew up (and thrived) in a world full of inflation. So, when they asked for a fixed rate mortgage, they knew that
1. their house would appreciate year after year
2. their mortgage would be less and less heavy on their income.
Let's make an example.
In 1990, you wanted to buy a house.
Let's assume that the cost of the house was 50000 British pounds (in 1990, according to the graph depicted in Figure 1, this was the typical cost of a house in UK)
Figure 1You had to ask for a mortgage. At that time, a fixed intereste mortgage, ie a mortgage whose montly payment would be the same thorought the duration of the loan, was around 14% (oh my God! you would say, today it's less than 3%).
Let's suppose that the duration was 20 years.
So, the first monthly payment turns out to be roughly 621 British pounds.
How much was the average salary in UK in 1990? It turns out it was around 17600 Pounds per year, ie 1446 pounds per month.
So, on average, the weight of the mortgage in 1990 was around 43% of your wage.
Let's see if we can be confident about our maths (see Figure 2 below)
Well, it seems that in 1990 the mortgage payment was somewhere between 45% and 50% of one's salary. So we are not so far away from the results that others have published.
- Note: our approach is not very rigorous, but here we are interested in explaining the principle, we are not interested in the accurate figures.
Now, you start paying your monthly fee....and, magic!
Fig.1 shows that your house has started appreciating. So your house was a real asset, in that period. After ten years from the original 50000 pounds it raised to almost 75000 pounds (+50% in value).
It is not only that. What happened to your average wage?
In 1990 it was, as we have seen, 17600 pounds per year.
In 2000 it had raised up to 27700 pounds per year. Remember that the monthly payment is always the same, and now it is only 621/(27700/12)= 27%
In a nut shell, in ten years:
- the value of the house increased by 50%. Great.
- the percentage of the mortgage payment over a British citizen decreased from 43% down to 27%. Wonderful!
Yes, at that time the house was a real asset in UK.
Is there a catch? yes, there is a catch. There are no free lunches and there are always winners and losers.
Until next time.