Why you shouldn’t buy a house in your 20s.

I’m getting to the age now where everyone seems to think I should buy a house. Once you reach 25, conventional wisdom seems to dictate, if you’re not spending all your spare time saving for a deposit, watching bad home makeover shows and visiting auctions every Saturday you aren’t a real adult. Our obsession with the idea is so strong that when Joe Hockey suggested that to buy a house you needed a good job that pays good money (hardly a controversial statement when you consider that most first home buyers are now looking at properties worth more than half a million dollars) he was met with howls of outrage.

What makes all of this particularly crazy is that there has never been a better time than now to be renting. The below graph compares the changes in MRI, a DHS index of average rents in Melbourne to the RPI, an index managed by the ABS that charts changes in residential property prices in Melbourne. Over this period, average house prices have increased by 5.64% per year while average rental cost has only increased by 2.77%. 

To put this in more understandable terms, a house that would set you back $500,000 in 2009 now costs around $695,000, while a rental property at $250 a week back then has only increased to $295. As investors have poured into the housing market fuelled by record low interest rates, they have been forced to offer their properties to renters at lower and lower fractions of the amount they spent on the property.

However, instead of happily taking advantage of this disparity we seem more desperate than ever to enter the housing market. While there are no doubt complex psychological reasons for our fixation with owning houses, I think there are also some basic economic misunderstandings that fuel this obsession as well. Below I have outlined two main misconceptions and my own efforts to debunk them.

Rent money is dead money

This is one of the most common arguments against renting. Renting, the argument goes, is simply an expense, whereas mortgage payments contribute towards owning a house. I know of some people who believe this so feverently that they kept living with their parents until they had saved enough money for a deposit. While paying down a mortgage is different to simply renting a property, people who make this argument fail to understand is the sickening amount of interest the average mortgage holder pays. As an example, let’s say you took out a mortgage of $500,000 at a 4.75% interest rate for thirty years. Over this time, your monthly repayments would be $2,608

Now, a question for you. What percentage of your first year of repayments do you think was spent on interest vs paying down debt? 

The answer is rather depressing. After 12 months and $31,298 of repayments you have only reduced your mortgage by $7,715%. Just 25% of your repayments have actually gone towards reducing your debt.

Given that the average rent in Melbourne is around $15,080 a year, we can see that the average new home buyer is destined to waste more money on debt repayments than they would have spent on rent for a considerable number of years.

Safe as houses

Another argument for the benefits of buying a house is the idea that houses are a safer investment than shares.  While it is true that housing prices are generally less volatile than the stock market, people who make this argument often fail to understand the effects that leverage has on a heavily mortgaged home owner.  

To explain this, let’s imagine a 2007 style financial crisis was to hit Australia, and the effects that would have on both someone who had recently purchased a house and someone who had the equivalent of a deposit in shares. We will make our imaginary house 500,000 and our imaginary deposit 10%, or 50,000.

The investor.

The GFC wiped just over 55% off the S&P in around 18 months, meaning if a financial crisis of identical scope was to hit Australia our share market investor would have lost $27,500, leaving them with only $22,500 of their original investment.

The home buyer.

From our home buyers’ perspective, the GFC wiped off just over 30% of American house prices on average over a longer period of around four years. If we apply that to our $500,000 Australian property this would now only be worth $350,000. Not only would the homebuyer have lost their entire deposit, they would now have a mortgage on a property that was $100,000 higher than the underlying property was worth.

This is a perfect example of the effect of leverage; what was a 30% loss in the underlying asset has resulted in a 150% loss in the investor’s capital.

I don’t know about you, but this sort of scenario scares the shit out of me. Losing some money in the sharemarket I can live with, but having a mortgage worth more than your house leaves you with no get out clause. Even if you wanted to sell you wouldn’t be able to, as you would owe the bank more than the property was worth.

Some parting thoughts…

Obviously not all decisions are purely financial. Some people hate renting, some people are desperate for a place to call their own. I’m not trying to say that buying a house with a big mortgage is always going to be a bad idea for everyone. However, if you are still convinced you want to buy a house I have one more graph for you to consider. The below shows the average mortgage rate over the last 30 years. 

Due to the RBA’s near record low cash rate, interest rates have been lower than they have been for a very long time. If you are basing all your budgets off a 6% or lower interest rate, it might be worth considering what you would do if that rate rises.