Bidding that extra €10k and the financial consequences.

khards

Hi all,

I started this thread in the hope of educating a few of the boards readers.

Every week I encounter people who are hell bent of borrowing as much money as they can to outbid others.
I would like to show you in this post exactly how this will cost you over the term of your mortgage and how this will affect your long term finances.
I feel this post is necessary since this simple math is deliberately not taught in schools. (Any teachers reading this then please do your students the honor)

When you borrow money over a long and interest is charged it will cost you a lot of money, in the case of a 25/30 year mortgage you will payback around double the amount that you borrowed.

Here are a couple of worked example of the typical situation that I run into:

1) We have been looking at a nice house in a nice part of town and we have put a bid in for €200,000. There is lots of interest and another person has outbid us by €5,000 so we are going to go in €5,000 over their bid at €210,000.

Initial bid, based on a €20,000 Deposit. (€200,000)

Amount borrowed:€180,000
Term: 30 years
Total repayment: €367,927.27
Total cost of buying the house: €387,927.27 (inc. Deposit)

Second bid, based on a €20,000 Deposit. (€210,000)

Amount borrowed:€190,000
Term: 30 years
Total repayment: €388,367.68
Total cost of buying the house: €408,367.68 (inc. Deposit)

So you can see above, buy increasing the bid on a average priced house by €10,000 will cost you somewhere in the region of €20,440

A worse case would be where the term of the mortgage has to be increased because the repayments would be too high.

Amount borrowed:€190,000
Term: 35 years
Total repayment: €428,538.99
Total cost of buying the house: €448,538.99 (inc. Deposit)

You can see in the above example that bidding an extra €10,000 could cost you an extra €60,611!

That kind of money could put your kids through collage or buy you several new cars.

There is a mortgage amortization spreadsheet here:
https://docs.google.com/spreadsheet/ccc?key=0AqxYygT-6URedEF0bWt6dzh2b3hCdkx3YWpUYWxiZlE&usp=sharing

There is a good mortgage calculator here showing you how much the total mortgage will cost you, you can also compare costs.
http://www.thisismoney.co.uk/money/mortgageshome/article-1633400/Mortgage-calculator-True-cost-calculator--fees-charges-rates.html

Remember: It is no good 'hoping' that your mortgage will get paid off by inflation or other means.

If anyone wants help with this or other calculations, please post below.

air

A worthwhile post OP and hopefully an eye opener for those looking to buy.
Is there a case to be made for restricting mortgages to a maximum term of 20 years?

It would lead to a reduction in house prices but in the end it would affect everyone equally and would surely just mean that everybody spends less of their lives paying for their home.
A possible exception would be for self builders (for whom there may be a more direct link between the quality of their build and the amount spent on the build).

Bigcheeze

You give us a finance "lesson" but you completely fail to comprehend the principles of the time value of money. :rolleyes:

khards

You are essentially saying that because of inflation house prices will go up.

"The time value of money is the value of money figuring in a given amount of interest earned or inflation accrued over a given amount of time. The ultimate principle suggests that a certain amount of money today has different buying power than the same amount of money in the future. This notion exists both because there is an opportunity to earn interest on the money and because inflation will drive prices up, thus changing the "value" of the money. The time value of money is the central concept in finance theory.

For example, $100 of today's money invested for one year and earning 5% interest will be worth $105 after one year. Therefore, $100 paid now or $105 paid exactly one year from now both have the same value to the recipient who assumes 5% interest; using time value of money terminology, $100 invested for one year at 5% interest has a future value of $105.[1] This notion dates at least to Martín de Azpilcueta (1491–1586) of the School of Salamanca."

Thus not always the case and cannot be guaranteed:


Ireland wage growth:

Bigcheeze

khards wrote: »

You are essentially saying that because of inflation house prices will go up.
]

I'm not saying anything about future house prices.

NinjaTruncs

What's the different between the 2nd and 3rd example? The only difference I can see is that you bumped the repayments up by 40K.

Schnitzel Muncher

Hardly a revelation. No mention of overpayments.

khards

NinjaTruncs wrote: »

What's the different between the 2nd and 3rd example? The only difference I can see is that you bumped the repayments up by 40K.

The term was extended by 5 years and the borrowing was increased by €10k.

ted1

Don't go up in blocks of 5k, estate agent knows that there is money available ,make it a struggle to beat the existing quote.

If it is a case of a phantom bidder he'll know not to push you to far.

Make each raise of 500 or 1k a struggle

gurramok

If you need to bid up, use it from cash reserves not on borrowed money.

Grandpa Hassan

Schnitzel Muncher wrote: »

Hardly a revelation. No mention of overpayments.

Agreed.

I bought in 2001, so not screwed like many with respect to huge NE (and obviously I hace paid down capital), but I pushed out that extra few €10k, and got as long a term as possible...basically did exactly what the OP is warning about.

But that was to get me over the initial 'hump'. Now having made overpayments and shorterning the term, I am in decent shape.

Just because you start out with a 30 year mortgage, it doesnt mean you have to keep the original mortgage terms for 30 years. It should be pro-actively managed.

air

Overpayments certainly help, however it's probably better not to shorten the term at all.
If you leave the agreed term as it was originally it can help with cash flow if things ever get tight.
There is no downside risk as long as you overpay every month at such a level that your repayment is the same as that which you would have with the shortened term.

Duckjob

Great post OP.

Even in the boom years, I never stopped being amazed by the ease with which people would lash out an extra 10k on their bid without any appreciation of what use that money would come to elsewhere - like they were playing with monopoly money.

Galego

Bigcheeze wrote: »

You give us a finance "lesson" but you completely fail to comprehend the principles of the time value of money. :rolleyes:

Ha ha, totally thought the same when I read it! :-)

He needs to bring those values to present time and then see what those extra 10k really cost in today's money.

Schnitzel Muncher

air wrote: »

Overpayments certainly help, however it's probably better not to shorten the term at all.
If you leave the agreed term as it was originally it can help with cash flow if things ever get tight.
There is no downside risk as long as you overpay every month at such a level that your repayment is the same as that which you would have with the shortened term.

You can choose whether the overpayment shortens the term or not.

My current mortgage interest rate is less than the net rate I get on most of my savings after DIRT, so no point in my overpaying for the moment, and I retain flexibility.

jester77

Would you not have to also take future inflation into account? If you were to fix your mortgage at 3-4% over 20 years then the repayments would be the same in year 20 but not the same in real terms because of inflation.

Big difference between 2000 a month repayment today and 20 years ago.

air

Schnitzel Muncher wrote: »

You can choose whether the overpayment shortens the term or not.

Yes, I'm aware of that. The point I was making that while it can be psychologically attractive to shorten the term (i've x less years left to pay etc) it's better to reduce the repayment amount, leaving the term unchanged but continue to over pay on a monthly basis.
If you lose your job or just need cash for something else you can revert to the lower payments without even needing to think about the bank's approval.

Schnitzel Muncher wrote: »

My current mortgage interest rate is less than the net rate I get on most of my savings after DIRT, so no point in my overpaying for the moment, and I retain flexibility.

Good for you, no point in paying down a tracker unless you're worried about a Cyprus type event.

khards

Galego wrote: »

Ha ha, totally thought the same when I read it! :-)
He needs to bring those values to present time and then see what those extra 10k really cost in today's money.

I have just looked into the present value of what the €20,000 deposit would be at today poor interest rates of about 2%.

https://www.americancentury.com/calculator/time_value_calculator.jsp

There is another calculator above on a compunding interest of 2% your deposit would grow from €20,000 to €36,424.

khards

jester77 wrote: »

Would you not have to also take future inflation into account? If you were to fix your mortgage at 3-4% over 20 years then the repayments would be the same in year 20 but not the same in real terms because of inflation.

Big difference between 2000 a month repayment today and 20 years ago.

The inflation that you need to take into account is wage inflation minus cost of living inflation.
If your wage inflation is less than the inflation of your expenses (food, fuel, taxes etc.) then you get poorer and your repayments become more difficult.
So yes you are correct in a way, it could be more or less difficult to make payments in year 20.

Tombo2001

Bigcheeze wrote: »

You give us a finance "lesson" but you completely fail to comprehend the principles of the time value of money. :rolleyes:

What......you mean where inflation is running at zero per cent and interest rates at an ECB level may go negative this year?

Tombo2001

Another very important point that people just dont consider with mortgages.....

with a 30 year mortgage as per above......people think, oh i'll be paying back x per month, the size of the mortgage will go down........yes it will go down......but not in the first ten years of the mortgage.

If you borrow an extra €10k to buy a house.....thats an extra €670 per year......after ten years you'll have paid off €6700 on that €10'000......but you will still owe €8000 on it.....the longer your mortgage, the more your first few years are pure interest repayments.

Galego

khards wrote: »

Hi all,

I started this thread in the hope of educating a few of the boards readers.

Every week I encounter people who are hell bent of borrowing as much money as they can to outbid others.

Ok, I put these numbers now in excel and my calculations differ a bit from yours.

See below:

Purchase 200,000.00
Deposit 20,000.00
Loan 180,000.00
Term 30
Average % 6%
Total % Cost 208,508.00
Cost of House 408,508.00

Purchase 210,000.00
Deposit 210,000.00
Loan 190,000
Term 30
Average % 6%
Total % Cost 220,306.00
Cost of House 430,306.00

Difference 21,798.00

Now:
10K invested in a compounded average % of 3% over 30 years.

10K Savings + % = 24,272.62


Now bring both values to present time using a historical index inflation for Ireland of 4%

21k Diff in mortgage 6,720.73
24k Made in your 10K deposit 7,483.70
Sum of the two = 14,204.43

So you are 14k better off.

Let me know if these calculations make sense to you.

Note: assumptions have been made in order to calculate figures. Taxes have not been taken in account.

beeno67

khards wrote: »

I have just looked into the present value of what the €20,000 deposit would be at today poor interest rates of about 2%.

https://www.americancentury.com/calculator/time_value_calculator.jsp

There is another calculator above on a compunding interest of 2% your deposit would grow from €20,000 to €36,424.

You need to look at inflation rate and interest rate. Statements like "this will cost you X over the lifetime of the mortgage" are pretty meaningless unless you have a fixed interest rate for the entire mortgage and unless you know what house price inflation will be over the entire term of your mortgage.

Anyway, are you constantly seeing people bidding an extra €10,000 on a house? Really? Where? In Ireland?

beeno67

Galego wrote: »

Ok, I put these numbers now in excel and my calculations differ a bit from yours.

See below:

Purchase 200,000.00
Deposit 20,000.00
Loan 180,000.00
Term 30
Average % 6%
Total % Cost 208,508.00
Cost of House 408,508.00

Purchase 210,000.00
Deposit 210,000.00
Loan 190,000
Term 30
Average % 6%
Total % Cost 220,306.00
Cost of House 430,306.00

Difference 21,798.00

Now:
10K invested in a compounded average % of 3% over 30 years.

10K Savings + % = 24,272.62


Now bring both values to present time using a historical index inflation for Ireland of 4%

21k Diff in mortgage 6,720.73
24k Made in your 10K deposit 7,483.70
Sum of the two = 14,204.43

So you are 14k better off.

Let me know if these calculations make sense to you.

Note: assumptions have been made in order to calculate figures. Taxes have not been taken in account.

You are 14k better off in 30 years time. However €14k in 30 years time will be worth substantially less than 14k today. Saying 14k sounds like a substantial amount but in 30 years time it will not. 30 years ago 14k would have bought you a house (nearly) so you can imagine how much the value will fall in another 30 years

Galego

beeno67 wrote: »

You are 14k better off in 30 years time. However €14k in 30 years time will be worth substantially less than 14k today. Saying 14k sounds like a substantial amount but in 30 years time it will not. 30 years ago 14k would have bought you a house (nearly) so you can imagine how much the value will fall in another 30 years

No, that is 14k in today's money and assuming that you invest the extra 10k (which you do pay extra in bidding) in a 30 years compounded interest deposit.

beeno67

Galego wrote: »

No, that is 14k in today's money and assuming that you invest the extra 10k (which you do pay extra in bidding) in a 30 years compounded interest deposit.

No it is 14k in 30 years time not today. You haven't included inflation at all

PhilMcGee

beeno67 wrote: »

You are 14k better off in 30 years time. However €14k in 30 years time will be worth substantially less than 14k today. Saying 14k sounds like a substantial amount but in 30 years time it will not. 30 years ago 14k would have bought you a house (nearly) so you can imagine how much the value will fall in another 30 years

That 14k would have about the same value as 4k in 30 years.

4k in 2013 money = approx 14k in 2033 money

General rule of thumb is that money value halves every 20 years.