The first time buyer conundrum, to buy or not to buy?

At the moment in Ireland there is a conundrum for first time buyers: should you buy now and potentially over-pay on purpose?

It’s an unusual one and it partly related to property prices, it is a combination of taxation changes that will occur from the start of 2012 and expectations of interest rate changes from both banks and the ECB.

The argument of ‘rent or buy‘ is well established, we produced report on it with Peter Stafford (now of the IAVI/SCS) and Frank Quinn of Senior College Dun Laoghaire, but this is different – buy now or buy later isn’t taking the default of renting as an assumed continuous option, rather it is a case of delaying for the sake of market timing.

The changes in tax are on the tax expenditure side, namely TRS (tax relief at source).

Currently it is applicable to a maximum of €10,000 p.a. and the rates applicable are 25% in year 1 and 2, then 22.5% in year 3, 4 and 5 then 20% in years 6 and 7. That is set to change from 2012 whereby the maximum applicable amount of interest will go down by 70% to €3,000 per buyer p.a. with a rate of 15% being applied.

The second issue is about rates, today the papers carried a story stating that PTsb would hike their variable rates by a full 1% and our Mortgage Market Trend Outlook 2011 predicted a 1% increase in variable rates with rates to rest at or north of 5% by 2012.

Then you have the ECB who may well enter the scene as well, they tackle headline inflation as opposed to core inflation and the issue with that is when you have things like rising oil or other commodity prices (currently a large part of the reason Egyptians are overthrowing their government) it causes inflation which they then must address with their single mandate. The Federal Reserve looks at core inflation (then strips out even more to make everything appear rosy!) and has a general economic and now a price target remit.

So with all of these things factored in you might find the following scenario.

Buy today and your mortgage is €200,000 (which will get you a 3 bed semi in any city now)
with a fixed rate of or wait until 2012 for a 10% price drop and do the same thing a year later using a mortgage
of €180,000.

Both terms are going to be calculated over 25 years we’ll take a 5 year fixed in both examples so for the 2011 mortgage we’ll go with 4.39% and the 2012 one will be 5.7% which factors in about a 1% from the Irish banks and 25bps from the ECB.

Gross Costs: 2011             2012
Mortgage        200,000        180,000
Rate                4.39              5.7
Term               25                 25

Monthly         1099              1126

That is already a compelling comparison from a cost perspective but then look at the Net figure when you factor in TRS

2011 mortgage: 200,000 x 4.39% = 8780 x 25% = 2195 pa which is 183 monthly
2012 mortgage: 180,000 x 5.7% = 10,260 but the cut off is 6,000 so it’s 6,000 x 15% = 900 pa or 75 monthly.

The bigger the mortgage the bigger that difference becomes, and inversely the smaller it is the smaller the divergence, but compare net figures now

Net Costs: 2011             2012
Mortgage       200,000        180,000
Rate               4.39              5.7
Term              25                 25

Monthly         1099             1126
TRS                183               75

Net Cost    €916pm        €1,051pm

That’s 135 per month! And that will continue because when we called revenue to research this they confirmed that the person starting on TRS in 2011 will be on the old system (25% yr 1,2 etc) and the person from 2012 will be on the new one for the duration of TRS – which will end in 2017 entirely. The buyer from 2013 gets ZERO!

So it is vital to consider this if you are thinking of buying and not sure whether to buy now or hold off. Do the sums, it may be best to wait, it may be best to move now but you have to know so it is well worth a few minutes with your consultant here to work this out!

Comments

  1. John McCabe

    Good article Karl. There are some good points in there but the biggest problem facing first time buyers this year is that obtaining mortgage approval is getting harder. Are mortgage lenders going to change their lending rules for better or worse to help first time buyers this year?

    John – Raheny

  2. Mark Bailey

    Sounds a good idea to buy now so, but the big problem I see with mortgage approval is Job security, nobody feels safe. If you were to buy now, and your company was to let you go, then you’re in real trouble. I think a change of government might make people feel safer about, and provide a bit of confidence to the market.

  3. Oliver

    Karl, wont the interest rates for each example above converge in year 6? Both moving to a standard variable rate for example. Therefore the interest cost on the 200k mortgage will be more from that point on? So, lower monthly costs for the 1st 5 years but higher for the next 20?

  4. @Oliver great point (and thanks for reading the post, of course- you can tell the CFA from the question asked!)

    Anyway, in month 60 the balance on the first loan is 175k vs. 161 in month 60 on the second lower loan, but you also have to live somewhere in yr1 in the second case, if that is c.€1,000 p.m. then you have bridged most of the 14k capital gap (and the person who moved first will have a year rent free at the end before you) then you also have the €8,000 cash savings during the 5 years which if you had the diligence to put on deposit could grow into something significant, in particular if you made (for instance) pension contributions bearing in mind that there is a tax efficiency there that after tax money used to pay mortgages doesn’t have.

    Totally accept the point though – and on that note it seems I have more work to do because I should probably do a ‘whole of life’ example to be fair!

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