How big a mortgage do you need also leads to another question, how big a house do you need.
There is an old saying from around the 1950s or 60s, “Buy the most expensive house that is right for you that you can afford”.

This has often proved to be good advice right up until recent times. The reasons being:

  • House prices have risen fairly steadily throughout this time.
  • General prices (inflation) have risen at a fast rate throughout this period. Often it is the rates were actually the low rate of price rises. Prices rose some years as much as 15% or more in the 1970s and early 1980s. So if you were a borrower, part of your loan was paid for by the savers whose savings were reducing in value even though they were getting a decent rate of interest of 10 to 15% per annum. This caused a dramatic effect. If you bought a house for $12,000 in 1975 with a mortgage over 25 years of $10,000. If you were on average wages, the repayments represented about 30% of your after tax monthly income. By 1990, your repayments were only 5% of your monthly after-tax income and your house was worth $200,000 and you only owed $3000 to the lender. Your net worth had increased by $197,000.

Does the same advice still apply today.

Well things have changed so the answer is it depends. In the last few years the world has changed a whole lot. It is unlikely that today’s generation of house buyers will be as lucky as those in the past.

The main changes being:

  • In recent years house prices have risen faster than ever before. They can’t go on rising forever at this rate and could easily fall back.
  • Interest rates are low at present, compared to the rates of the last 50 years. This has meant that repayments on the average mortgage as a proportionof borrower’s incomes are very low compared with earlier years. In the 1970s it was usual to get a loan of up to 2 1/2 times your salary. In 2004 it was notdifficult to get loans of three are four times your salary and sometimes more. That is all fine if interest rates stay low, but if they rise, a lot of people will be forced to sell their houses and move to a smaller or cheaper house.
  • Since the late 1990s overall inflation has been at the lowest level for years. If this continues, the size of outstanding mortgages will only bereduced by capital repayments and not by inflation as they have been from the years 1965 to 1995.

The decision you take will depend on the type of house that you need, but there is a choice to be made with that as well.

  • Do you still go for the most expensive house and the biggest mortgage that you can afford?
  • Or do you offer something less expensive so you can keep back some savings and have cash to spare from your salary every month?

You will have saved money for the deposit on your house and you will now have to decide if you were to put all your savings into the purchase of the house or keep some back for furnishings, decorating and any emergencies. You might need some money to do alterations or any repairs before moving in. The lender might not give you the money for these. If your house is old or in a state of poor repair, the lender might limit the mortgage to only 75 or 80% of the purchase price. This means that you will have to put up the other 20 or 25%.

Keep in mind these points when making your decision:

  • The smaller that the loan is as a percentage of the total house value, then the better the deal that you’re likely to get from the lender in terms of interest rates and any other fees or discounted rate periods.
  • What about the condition of the house. Even if the house is okay or seems to be okay it might be best to keep a decent amount of cash put past just in case any unexpected problems come out of the woodwork, or the roof leaks or your central heating system goes wrong.
  • If the mortgage rate starts to rise you could have problems if you already stretched yourself with maximum loan.
  • Then on the other hand, the higher the percentage that you borrow, then the bigger will be the return on the money that you have put into the house if the value of the house goes up.
  • Always remember, that is the price of the house falls, the amount that you have to pay back to the lender will stay the same even if the house is worth less.