A<\/span> lament regularly heard in school playgrounds across the land goes something like this:<\/p>\n \u201cEeeeeuuugggh! Shuuuttttt up!\u201d<\/em><\/p>\n<\/blockquote>\n \u2026followed by:<\/p>\n \u201cGirls are gross!\u201d<\/em><\/p>\n<\/blockquote>\n So proclaims generation after generation of little boys \u2013 only a few years before the hormones kick in and they spend the rest of their lives obsessing over women.<\/p>\n As goes the birds and bees, so goes home ownership.<\/p>\n People love to debate renting<\/a> versus buying<\/a> a home, the imminent collapse of house prices, or the stupidity of tying themselves to a mortgage when they could be travelling the world.<\/p>\n If they\u2019re young and politically-aware, they may even decry the whole thing as a capitalist con. (Been there, probably still have the T-shirt). <\/p>\n But in practice nearly everyone buys their own home as soon they\u2019re able to. And if they can\u2019t then they aspire to.<\/p>\n What\u2019s more, most of us buy our homes with little more thought than went into that five-minute mumbled lecture from your parents that they hoped would pass for sex education.<\/p>\n We simply buy our homes like our parents did \u2013\u00a0and their grandparents did before them.<\/p>\n I\u2019m not going to argue for a big change in the mechanics of how to buy a home.<\/p>\n Innovation in home ownership is usually cancerous\u00a0\u2013 mostly doing local damage (timeshares, endowment mortgages) but sometimes metastasising (think Great Financial Crisis).<\/p>\n But I would like to remind you of some different ways to think about home ownership and having a mortgage, and how both can fit into your overall investment posture.<\/p>\n We all need somewhere to keep us and our stuff dry. Somewhere safe to sleep at night. You can either own this home or rent it.<\/p>\n If you don\u2019t own a home then you\u2019re effectively \u2018short\u2019 one, in financial terms. You have to borrow a home off someone else who owns it, and you pay the going rate to do so (the rent).<\/p>\n Shorting residential property is risky. In the UK house prices and rents have risen inexorably for many generations.<\/p>\n You close this housing short when you buy. If house prices fell while you rented then you benefitted from being short. If they rose you lost out. (Ignoring transaction costs).<\/p>\n Once you\u2019re a homeowner you have a market neutral position. If you choose to buy more homes \u2013 via buy-to-let<\/a> say \u2013 then you become overweight residential property.<\/p>\n People tend to think of a repayment mortgage as a monthly expense.<\/p>\n They know they will own their home outright at the end of the mortgage term.<\/p>\n But they see the regular repayments as an expense that they mentally bucket exactly the same way as they would rent.<\/p>\n They usually don\u2019t think of their repayment mortgage as contributing to their savings rate.<\/p>\n However repaying a mortgage on your own home is a very different financial move compared to paying rent.<\/p>\n Your monthly repayment mortgage direct debit consists of two parts:<\/p>\n This graphic from our\u00a0mortgage calculator<\/a>\u00a0shows these two parts for a repayment mortgage:<\/p>\n Here we see a \u00a3100,000 repayment mortgage that costs 3% being paid down over 25 years.<\/p>\n In the early years you can see you\u2019re paying interest more than paying down capital.<\/p>\n But towards the end, capital repayment \u2013 effectively savings \u2013 makes up most of the money sent to your bank.<\/p>\n You might think of an outstanding mortgage as a savings account that starts deeply in the red.<\/p>\n As you save money by repaying your mortgage<\/a>, you move this \u2018negative savings account\u2019 towards a breakeven \u00a30 balance.<\/p>\n The market value of your home as house prices fluctuate has no bearing on your mortgage being effectively a savings account.<\/p>\n And the balance of that savings account does not affect your exposure to property.<\/p>\n Your house is an asset and an investment that is worth whatever someone will pay for it.<\/p>\n This is true however you financed buying it \u2013 whether with cash, an interest-only mortgage, a repayment mortgage, or some other less legal arrangement.<\/p>\n Separately from this, your repayment mortgage is a debt that you\u2019re paying off over time.<\/p>\n True, this debt is secured on your home. But unless something goes very wrong \u2013 you lose your job at the same time that house prices crash and your bank decides to foreclose \u2013\u00a0house price fluctuations don\u2019t impact your existing mortgage.<\/p>\n By the same token, paying off a mortgage doesn\u2019t change your exposure to property one jot.<\/p>\n Having a smaller mortgage will make your finances more secure (because you have less debt).<\/p>\n But the affect house price moves have on your portfolio and your net worth is independent from how you happened to finance your home, and of the balance on your mortgage.<\/p>\n When you\u00a0buy a house<\/a>\u00a0with a mortgage, the bank gives you money to make the purchase.<\/p>\n Let\u2019s say it gives you \u00a3200,000.<\/p>\n Party time! You\u2019ve swapped \u2018wasting money on rent\u2019 for owning a home of your own.<\/p>\n Well, yes, but you might want to turn down the music \u2013\u00a0because it turns out the bank didn\u2019t give you that \u00a3200,000 for nothing.<\/p>\n No, it wants interest on the mortgage.<\/p>\n It\u2019s\u00a0as if the bank leased you the money<\/strong>. You\u2019re paying to\u00a0rent the money<\/strong>\u00a0off the bank.<\/p>\n You have swapped rent payments to your landlord for rent payments to your bank<\/a>.<\/p>\n Note that if you only ever pay your money rent and nothing else (like with an interest-only mortgage) then you must give back the \u00a3200,000 borrowed at the end of the mortgage term.<\/p>\n Just the same way as you hand back a rented house to your landlord when your lease is up.<\/p>\n To avoid this, you must repay the bank\u2019s capital, too.<\/p>\n Seen another way, with a repayment mortgage you\u2019re effectively buying \u00a3200,000 in cash from the bank, in monthly instalments, with interest.<\/p>\n Instead of thinking of your landlord as someone who owns the house or flat they rent to you, you might think of a landlord as someone who borrows \u00a3250,000 or \u00a3500,000 or whatever to buy the property on your behalf.<\/p>\n They borrow the money required, and as a result you don\u2019t need to do so.<\/p>\n You pay them rent in return for them borrowing this money. The cost is usually marked up for their trouble, so your rent is higher than if you\u2019d rented the money from the bank yourself.<\/p>\n In addition, your renting hands the\u00a0option<\/a>\u00a0on any rise in the property\u2019s price to your landlord.<\/p>\n Then again, you\u2019re also insulated from the risk of falling house prices.<\/p>\n You can go quite far down this rabbit hole<\/a>.<\/p>\n A fixed-rate mortgage is like a bond.<\/p>\n From the point of view of the lender it\u2019s an asset which pays an income, secured against an asset to reduce the risks of default.<\/p>\n Hence when you take out a fixed-rate mortgage \u2013 which is for you a liability, not an asset \u2013 it\u2019s as if you\u2019re shorting bonds.<\/p>\n Of course you might also own bonds in your portfolio. Maybe you have a typical 60\/40 asset allocation, for instance.<\/p>\n Factor in your sort-of short bond position as represented by your mortgage, and your bond exposure will go down. Your overall posture may be riskier than you thought.<\/p>\n You can get very cute and calculate the money-weighted duration and interest rate exposure represented by your mortgage and your bond portfolio.<\/p>\n That\u2019s probably not worth it though. Bonds are typically in a portfolio to dampen risk from equities, not to express a view on interest rates. And you got a mortgage to buy a house!<\/p>\n I\u2019ve seen people do it though.<\/p>\n Unless you have a tracker mortgage that is explicitly linked to the Bank of England\u2019s Bank Rate, your mortgage rate is not set by the UK\u2019s central bank.<\/p>\n Rather, mortgage rates are based on swap rates<\/a> \u2013\u00a0effectively the clearing price of debt of various durations in the open market.<\/p>\n Of course, the Bank of England is a player in this game. But we\u2019ll leave debating whether it\u2019s a leader or a follower for another day.<\/p>\n It\u2019s also worth noting that mortgage lenders make their return via fees as well as the interest rate they charge. <\/p>\n And given that nearly all mortgages are two-year or five-year fixes \u2013\u00a0so they\u2019re renewed several times over any mortgage term \u2013 these fees add up.<\/p>\n Indeed researchers have shown that lenders often explicitly lower mortgage rates but jack-up fees<\/a> to appear more competitive in the market.<\/p>\n Lots of people don\u2019t think their home is an investment or asset.<\/p>\n I\u2019ve burned thousands of words trying to explain why this is wrong. Please read them<\/a> if you still don\u2019t get it.<\/p>\n No, your home being an investment and an asset doesn\u2019t mean it\u2019s exactly like shares, or that you\u2019re explicitly speculating on house price gains, or that you thought of it as an investment when you bought it, or that house prices can\u2019t go down, or that you don\u2019t need to repair the roof \u2013\u00a0or any of the other handwaving people do when they\u2019re busy being wrong about this.<\/p>\n It means your house is an investment and an asset.<\/p>\n Nothing more, nothing less.<\/p>\n A big advantage of looking at all your assets as being part of your investment portfolio is that it enables you to see where you stand in the round.<\/p>\n For example, you\u2019ve secured a mortgage against your house. But when you choose to invest in shares instead of paying off your mortgage, you\u2019re effectively leveraging up your portfolio because you\u2019re not paying down the debt.<\/p>\n Congratulations! You\u2019re running a DIY hedge fund<\/a>!<\/p>\n Personally I think this is not a bad idea for young people with strong earning prospects, tax shelters to fill<\/a>, and a long investing time horizon ahead.<\/p>\n But it is a risk\u00a0\u2013 and one many people don\u2019t appreciate when they do it blindly.<\/p>\n Indeed many times I\u2019ve been chided for running my interest-only mortgage while investing, only for it to transpire that my critic is saving in a pension while they too have a mortgage.<\/p>\n Nothing wrong with that, but it\u2019s more or less the same thing.<\/p>\n Investors spend a lot of time fretting about how to hedge their portfolio against inflation<\/a>.<\/p>\n It\u2019s time well spent. Keeping ahead of inflation is a prime mover<\/a> when it comes to investing.<\/p>\n However I seldom see home ownership mentioned in these discussions. Perhaps that\u2019s because as we\u2019ve just covered, many people think of their home as something other than an asset. (What, we might wonder? A daydream? A mirage? A poem?)<\/p>\n As a result they put the mortgage in a separate mental bucket<\/a> to the rest of their portfolio, too.<\/p>\n However a house is typically the biggest asset most people own for most of their lives.<\/p>\n And happily, property prices have outpaced inflation for many, many decades.<\/p>\n Better still, you typically buy a home with a mortgage. This debt is partly paid off \u2013 in real terms \u2013\u00a0by inflation. The nominal money you owe is worth less in the future as inflation erodes the real value of each pound.<\/p>\n In my view a mortgage is such a great inflation hedge that it seems worth continuing to run my big interest-only mortgage<\/a> indefinitely, despite the extra risks from doing so.<\/p>\n I\u2019ve previously explained why for most people their own home is their best investment<\/a>.<\/p>\n This has nothing to do with the prospect for house prices today, or whether shares are cheap or the stock market is about to crash.<\/p>\n Rather it\u2019s that buying your own home closes a risky short position, as we discussed above, and then imposes the toughest saving and investing regime most people will ever muster.<\/p>\n Still, it\u2019s interesting to think about how well your grandparents who made a fortune buying a \u2018cheap\u2019 property a gazillion years ago might have done from the stock market if they\u2019d treated shares the same way as home buying:<\/p>\n You\u2019ll notice of course that Monevator<\/em> readers who invest in index funds within ISAs and SIPPs and ignore the market noise are actually doing most of this\u00a0\u2013 just absent the leverage. (Because you can\u2019t get a mortgage to buy shares).<\/p>\n And global equities have delivered far higher returns than UK property prices after costs over the long-term.<\/p>\n Perhaps even with the lack of explicit gearing for share portfolios, choosing the \u2018best investment\u2019 crown will be a tougher call in the future?<\/p>\n To be clear I don\u2019t think you should walk into Nationwide and ask for a bond-like mortgage so you can leverage your portfolio by renting money, instead of having your landlord do it for you.<\/p>\n Not least because it\u2019ll see them asking you to please leave the premises.<\/p>\n These are simply different ways to think about money, investments, and mortgages, which can help you see where you stand in interesting new ways.<\/p>\n That said though, more flexible thinking can deliver concrete real-world outcomes.<\/p>\n When I struggled to get a traditional mortgage based on my pretty unimpressive annual earnings, thinking differently saw me borrowing backed by my portfolio<\/a>.<\/p>\n Today my portfolio is far bigger than when I took out the mortgage and I\u2019m earning more, too. <\/p>\n If I was assessing myself like a public company, then my debt-to-equity ratio is lower and my interest cover ratio is improved.<\/p>\n I do own some bonds as well as having a mortgage. As we\u2019ve seen above the bonds are effectively negated by the debt, but they enable me to keep my ISAs fully-loaded and they might deliver a rebalancing bonus now and then.<\/p>\n In the meantime inflation continues to erode the real terms value of my mortgage.<\/p>\n Hopefully my active investing<\/a> returns will outpace my own home as an investment though!<\/p>\n\n
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Other ways to think about home ownership and mortgages<\/h2>\n
If you don\u2019t own your own home then you\u2019re \u2018short\u2019 one house<\/h3>\n
Repaying a mortgage is the same as saving more cash<\/h3>\n
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![\"\"](\"https:\/\/i0.wp.com\/monevator.com\/wp-content\/uploads\/2021\/10\/repayment-mortgage-graphic.jpg?resize=734%2C468&ssl=1\")
<\/a><\/figure>\n\n
Paying off your mortgage does not reduce your exposure to property<\/h3>\n
A mortgage is money rented from a bank<\/h3>\n
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A landlord is someone who rents money on your behalf<\/h3>\n
You can also think of a fixed-rate mortgage as like a bond<\/h3>\n
The Bank of England does not set mortgage rates<\/h3>\n
Your own home is an investment and an asset<\/h3>\n
Running a mortgage while investing is like leveraging your portfolio<\/h3>\n
A mortgage is a hedge against inflation<\/h3>\n
Most people\u2019s own home is their best investment<\/h3>\n
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Bringing it all back home<\/h2>\n
Applying the principles<\/h4>\n