Wealth Check: The race to buy while prices are tumbling
An entrepreneur hopes to purchase a home of his own next year, but he has debts to pay off and savings to build from scratch, writes Harriet Meyer
Sunday 15 February 2009
James Mitchell, 28, hopes to "pick up a bargain" as the housing market continues to plummet. "I'm waiting for the right time to buy a property," he explains, "although this will probably be next year when prices reach their low point and when I've managed to build up some savings."
He already has experience of the property market, because three years ago he bought a two-bedroom house in London with his girlfriend. However, they split up and the home was sold in 2007, with the profit bring split between them.
"Fortunately, we sold before the market began to sink," James recalls. "But after charges for getting out of the mortgage early, we only made a few thousand each, and I used this for a holiday to Thailand."
Since then, he has set up his own public relations consultancy and estimates that his fist year's earnings will be around £30,000. As he only started the company last summer, he has yet to tackle his first tax return. "The business pays significant dividends, which form a large part of my salary, and my accountant has arranged things so I pay as little tax as possible."
After ploughing all his spare cash into the venture, James hasn't managed to set aside any savings towards getting back on the property ladder. While he has a Nationwide cash individual savings account (ISA), this is currently empty. "Now my income is starting to rise, I hope to change this," he says. "I want to start paying into the account again."
Yet James pays a hefty proportion of his salary to rent a room in a two-bedroom flat in Docklands, east London, which costs him £1,100 a month.
He also has some debt to deal with. He is £2,000 overdrawn on a Barclays current account at 17.9 per cent, and has £16,000 in student loans.
At present, he is not paying into a pension scheme and has no protection policies in place. "When I can, I would like to make a variety of investments for my future, including pensions, property and equities."
If James is able to secure a decent mortgage deal in a year's time, buying a property could form part of a sound financial plan, agree our panel of independent financial advisers (IFAs). However, before taking advantage of a faltering housing market, he has debt to deal with, savings to make, and a business to build during tough economic times.
While James intends to make savings, he should first focus on clearing his overdraft, stress the advisers. The rate on this is hefty and far greater than any returns he could achieve on a savings account. "Any surplus income should be directed towards wiping this out," says Dante Peters of Magnus Financial Management.
The rate of interest on student loans fell from 3.8 per cent to 3 per cent in December following the cut in the base rate by the Bank of England, making it a particularly cheap debt. Yet there is no longer a compelling case for putting cash into a savings account instead of clearing a student loan because the rates on savings accounts are so low at present.
That said, making overpayments is not a priority for James, given his goal of buying a property. He should continue paying this debt off gradually.
As long as James kept up repayments and the mortgage debt was settled on his old home, along with any penalties for early repayment when the property was sold, this will have no bearing on any future purchase.
"However, he needs to be realistic about what sort of mortgage he will manage to get during the credit squeeze," stresses James Norton from IFA Evolve Financial Planning.
The combination of a decent deposit and a good earnings record over the next year would put him in a strong position, says Richard Morea from mortgage broker London & Country, adding that because James is self-employed, he may find the choice is limited. Many of the lenders that specialise in deals for borrowers who can't prove their income are withdrawing from the market.
"Yet with just one year's worth of accounts and a projection of future earnings from his accountant, he can access standard deals," says Mr Morea. "This way, he won't need a self-certification mortgage as he is providing evidence of his income."
With plans to buy around 18 months after becoming self-employed, this option should be a possibility for James. However, he should avoid buying a new-build flat as lenders are likely to restrict the amount he can borrow on these properties, adds Mr Morea.
To gain access to a reasonable choice of mortgage deals at the moment, James would need to put down 15 per cent of the property price as a deposit. "This, though, won't give him the best deals – and the more he can put down, the better," says Mr Morea.
Setting aside a regular sum will establish a good savings discipline for James. For example, Barclays has a monthly savings account paying a competitive 6 per cent on a maximum contribution of £250. After basic-rate tax, this amounts to 4.8 per cent, which is higher than the "best buy" cash ISAs. It is a worthwhile option for James considering he already has a current account with the bank.
Then he can also pay up to £3,600 this tax year into a cash ISA such as the one from Standard Life Bank, paying 3.5 per cent. "It is expected that there will be further interest rate falls this year, and an account like this will help insulate his money," says Philip Pearson from IFA P&P Invest.
As James is building funds for a property purchase, any longer-term savings should be left until this is completed. "Once finances allow it, regular saving into an equity ISA, using a selection of funds with managers who have good track records, would be wise," adds Mr Pearson. "History shows that over periods of seven or more years, this approach will achieve a greater return than cash."
The message on pension saving is that the sooner you start, the better, agree the advisers. "Even a modest monthly savings commitment will create a significant pension fund over the long term," says Mr Pearson.
The IFAs add that if James falls into the higher-rate tax bracket over the next few years as his salary rises, pension savings will become even more worthwhile. His contributions will be highly tax-efficient as he benefits from 40 per cent relief.
"The best way of saving into a pension would be for his employer to pay a contribution on top of his salary when he reaches the higher-rate band,"adds Mr Norton. "Otherwise, any income drawn above this will be taxed heavily."
A stakeholder pension plan would be a good home for this cash, with no initial charges and annual management fees capped at 1.5 per cent. Recommended providers include Norwich Union and Standard Life.
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