Buying a home is one of the most common big financial goals that comes up when we talk to people about planning their finances. It’s likely the biggest purchase most people will ever make, but over the last decade it has become increasingly difficult for first time buyers to take the leap.
When Dave and Mike first came to speak to us at Hatch buying house seemed like a distant dream, but we showed them how it could be done much sooner than they thought, with just a bit of forward thinking.
We’ve changed their names and some identifying information in order to protect their privacy. Take a look below to see how we helped them.
Meet Dave and Mike
Dave and Mike are in their early 30s and have decided that the next big milestone for them is to buy their first property. However, they live just outside of Cambridge where house prices have soared over the last few years and although they have managed to save up a decent amount (just under £22,000), they felt a long way off their goal of having enough to buy a home.
After keeping an eye on their local property listings over the previous few months, they decided that their ideal house is likely to cost around £375,000.
They have a combined salary of £72,000 which means that the maximum they would likely be able to borrow as a mortgage is in the region of £320,400. So, they would need at least £54,600 as a deposit to make up the full amount, which is significantly higher than their current savings. Once you include legal fees and taxes, the full amount that Dave and Mike will need is £67,400. It’s easy to see why they felt so far off their goal!
Their current path
Once we had more specific details about how much they would need to achieve their goals, we put together a financial plan showing their current financial future. Supposing they changed nothing, how long would it take before they had enough saved to buy their dream house?
As they expected, and as you can see from the cashflow forecast below, if they made no changes then they they would be waiting 8 years until they are in their 40s before they are able to buy the house they wanted.
Please note - the big drop in pension assets is due to a simplifying assumption that John and Sally purchase an annuity to provide a retirement income
So what do you do in this situation? One option for Dave and Mike would be simply to modify their goal. If they were happy to buy a less expensive house, or move to another city then they could certainly buy their first home far more quickly. It is an unfortunate fact of life that sometimes we simply can't afford the things we want and have to compromise somewhere else.
However, we're also not ones to give up easily so we decided to make a new version of their financial plan with some changes to to show how they might move that timeline up by a few years. If they did decide that they weren't willing to compromise on house price, what could they do to be able to afford it more quickly?
Here is a summary of the changes we included in their second financial plan:
When we first spoke to Dave and Mike they had no investments. All of their savings were in cash savings accounts. So, the first thing we did was move 80% of their current savings into an investment ISA. Since savings interest rates are at an all time low at the moment, investing the bulk of their savings is likely to give a much better return, particularly because they are able to leave the investments to grow for a few years.
With 80% of their savings going into investments, this leaves 20% to remain in cash. This also ensures that they have some money in case of an emergency. However, their savings were earning just 0.05% interest. In their second plan, we suggested moving their cash savings into a new account which could earn at least 1.5% interest.
A option for first time buyers is the Lifetime ISA which was launched in April 2017 and offers a 25% bonus on anything you contribute (up to £4,000) per year. Since both Dave and Mike can open their own Lifetime ISA, this means that if they contribute the full amount each year they will get an extra £2,000 per year to use towards their house deposit.
Cutback on spending
With just the few changes above, we found that Dave and Mike would be able to cut down the time it will take to save up for their dream house by 3 years. However, if they are also able to cut back on their monthly spending by just £110, they would be able to shave off ANOTHER year as well.
After making these changes, here is their new and improved financial plan:
As you can see, the picture is much improved for both the near term goal of wanting to buy a house and how much they are likely to have saved up by retirement. Dave and Mike are able to HALF the time it will take to buy their ideal first house, without having to go to extreme lengths like living on baked beans and still ensuring that they are on track to have a decent retirement pot.
What are the risks?
Whenever you look at someone else's financial plan, it's really important to keep in mind that each person has different goals, priorities, circumstances and appetite for risk. While this plan was a great fit for Dave and Mike, it certainly isn't a one size fits all plan for anyone who wants to buy a house. Below are a few key points that Dave and Mike need to keep in mind.
- House Prices could change
The goal we created for the financial plans was based on the current housing market in their local area, but no one can be certain about how prices might change in the future. There is an argument to be made that it is better to buy any property you can afford as soon as possible to ensure that you're on the property ladder. Should the market see a sudden surge in prices over the next few years then they could find that they are still not able to afford the deposit. (Of course, if there is a dip, then the opposite could be true).
- Expected investment returns are not a guarantee
A key part of Dave and Mike's final financial plan is the investment returns that they might earn over the next 4 to 5 years. While it is possible to reduce risk and maximise returns by ensuring you have a properly diversified portfolio, ultimately there is always a risk that investments do not perform as well as you expected.
- Other goals
The main focus on Dave and Mike's financial plan is very clearly the question about how to go about buying a house, but there are likely to be many more financial goals that will impact their finances beyond the next few years. For instance their second financial plan leaves them much better off for retirement than the first plan, but this assumes, for example, no changes in salary, no big purchases and no children or dependents. These are all assumptions worth discussing and enhancing the plan even further.
Not as out of reach as you thought
Dave and Mike thought that it would take them another 10 years to buy a house. Now they see that they could do it in 4. That's why financial planning is so powerful. It's hard to remain disciplined with your savings when you don't know how much you need and how far you are from your goal. Once you have a concrete plan it becomes much easier to achieve you biggest goals.