Smart Money Mindset

I’ve heard these phrases so many times:

“My house is an asset”
“I’m not worried about my mortgage – I have lots of equity in my property”
“I can always sell if I get into trouble”

And I used to think the same way. That it was ok if I had a large mortgage, so long as I had equity in the property I was safe. I was wrong.

These phrases are based on some common misconceptions:

1) House prices will always go up
Maybe in the very long-run, but in the short-term they can fall and fall rapidly

2) All other circumstances will remain unchanged
The time when you get into trouble is usually the time when other people are getting into trouble, as well as the economy. This means just when you need to sell one or more of the following will be occuring: job losses; restrictions in mortgage lending; falling house prices; buyers holding back from the market; people restricting spending; interest rate increases (we have been lucky on this one but think back to the last recession); price inflation.

3) That you will be able to sell your home
Even at a discount, if economic circumstances have changed you will find it very difficult to sell and sell in a quick timeframe. As recent events have shown buyers can dry up, and even those still around will struggle to get mortgages at the level they need.

4) That things won’t spiral out of control
As you fall behind in mortgage payments charges will increase rapidly putting you in a even more difficult position financially. You will find it difficult to remortgage as your financial circumstances have changed, and your credit rating will be falling rapidly!

Here is a common sequence for repossession:

1. You get into trouble financially (job loss; injury; business collapse; personal or family member illness; divorce etc. – you only need one of these to occur)
2. You realise that your biggest financial outgoing is your home (mortgage, property taxes, insurance, electricity, gas etc)
3. You realise that you have no option but to sell your home and within 6 months or you will be repossessed
4. You need to sell quickly so you put it on with multiple estate agents at a small discount, hoping to get a good price
5. Viewers come, they are fussy (it’s a buyer’s market), even if they make an offer they cannot get mortgages, and cannot complete in the timeframe necessary
6. You become increasingly desperate and drop the price further, and further…
7. You run out of time. (By the way you still have plenty of equity in the property)
8. The bank repossesses the property, you lose your home, the bank adds multiple charges, sells your home at a discount at auction, allocates the remaining debt to you for the next 6 years, your credit rating is shot.

What you must realise is that cash flow is more important than equity when dealing with property, especially the home you live in. Here’s why: you can survive negative equity if you have the cash flow to service your debts (think of all the people who managed to keep their homes during the last recession), however you without cash flow it doesn’t matter how much equity you have in your home, you will be repossessed if you can’t pay your debts.

Even the tiniest debt, if unpayable, gives the lender the right to repossess.

In these ciricumstances it’s often professional property investors who are actually able to purchase and in the timeframe required. So even if you do manage to sell, and your equity saves you, you pay a heavy price.

The follow example is a deal a friend did recently:
Market Value: £300,000
Mortgage: £140,000
Purchase Price: £200,000

Now a £140,000 of debt on a £300,000 property isn’t much is it? But it is if you cannot service the debt.

The lesson here? Don’t rely on your equity to get you out of trouble. Pay constant attention to the cash flow position you are personally in.