What is a mortgage? How have people made so much money from property?
The world of property investment often sounds like a story of impressive gains and smart moves. At the heart of this world lies a fundamental tool: the mortgage.
nderstanding what a mortgage is and how it can be a stepping stone to wealth creation is crucial for anyone eyeing the property market.
What is a mortgage?
Houses are expensive, and cost far more than a normal person has in their bank account. To afford the house, we therefore need to borrow money.
A mortgage is simply a loan to buy a house, and the money is usually lent buy a bank or building society.
In return for lending the money to you, the bank charges interest. Every month, you make a payment which is made up of some interest and some of the mortgage balance (or “principal”). The interest is a percentage of the principal.
The interest is only charged on the amount of principal left outstanding. As you pay off more principal, the less interest there is to pay.
How have mortgages led to huge wealth for some people, especially in comparison to working a job for a salary?
Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.
- Archimedes
Leverage
A mortgage is a type of financial leverage. Borrowing money to buy something means that a relatively small change in the value of the house can mean much larger returns (or losses) on our investment - in the case of buying a house, this is the deposit or down-payment.
Simple Example
Imagine you bought a house for £100k and had £10k saved up for a deposit. You’d need to borrow £90k in the form of a mortgage to buy the property.
Ignoring fees and interest, if house prices went up by 10%, you wouldn’t make a 10% return - you would make a 100% return!
The £100k house would now be worth £110k. After paying back the £90k mortgage, you’d be left with £110k - £90k = £20k. That’s double your original £10k deposit!
Conversely, if the house price goes down by £10k and is worth £90k, after paying back the £90k you are left with zero.
The UK has seen an almost relentless house price increase, as new supply has not kept up with increased demand.
From the Property Value Estimator, the average house price increase over the last ten years has been around 65%!
If you bought a house for £200k with a 15% deposit (£30k), and sold it for £330,000 (or 65% increase), you would have made £160k - over five times your money!
Of course this is before interest payments and the fees associated with buying, selling and maintaining property.
And just because this has happened historically, does not mean that it will continue forever.
But for a tax-free sum in the common case of the property being your main residence, it is in many cases, comparable to take-home salaries.
To buy a house with a mortgage you first need a deposit, otherwise known as a down-payment or equity.
Use the Savings Goal Calculator to build a plan to get that deposit and step-up the property ladder!