Are you wondering what proportion of your savings should you offer as a house deposit as a first-time buyer?
Buyers often find themselves in this quandary, in part due to the high prices of properties in the UK.
Because the average price of a home in Britain is now £230,000 (2019), the deposit required to buy an ‘average home’ has risen to £33,000.
Buy-to-let investors, who are offered smaller mortgages than home-buyers, have found that they need to commit an ever-increasing chunk of their savings to acquire a single property.
This can be an uncomfortably large amount, leading to questions around what is the reasonable maximum amount we should invest in our first home?
Covering the property & portfolio basics:
This is a companion article to our ‘How to invest in property‘ ultimate guide. In the property article, I outline 8 different ways you can access the property asset class.
Property is just one of several common assets classes which investors use to construct a successful investment portfolio. Check out that portfolio article to learn about the essential principles you need to know about building a portfolio of investments, then head back here.
Property could work well in your portfolio if you received a profile of ‘Balanced’ or ‘Adventurous’ in my investment risk appetite questionnaire. It is also only appropriate if you have a time horizon of (i.e. can lock your money away for) 5 years or more.
I recommend that you check that article out before you read on as it covers a lot of common ground which this post will build upon.
How much of your savings should you spend on a first home?
Before investment properties are an option, we must buy a home to live in first.
The average age of a first-time buyer has risen to 33 (2019), and the average house deposit in the UK is estimated at £33,000.
So, does this mean you can buy a house once your savings reaches £33,000? Absolutely not. You need to hold back funds for the following reasons:
Firstly, you should always maintain a minimum level of emergency savings covering at least a few months of wages.
An emergency fund gives you a safety net to fall back on following loss of income due to redundancy or illness.
This is why 13% of my own portfolio is in cash.
Other transaction costs
Secondly, you will need to pay stamp duty and other professional fees to buy a home (which are not included in the deposit). These include legal fees and survey costs. Mortgage arrangement fees are also due but can usually be added onto the loan rather than paid upfront.
A house purchase is often a license to spend more money! Buyers will often edge their way into larger properties by buying ‘fixer-uppers’ – properties with tired or drab interiors that will benefit from home improvements.
With kitchen and bathroom upgrades running into the £10,000s you will need to hold back cash to pay for these (and other essential) projects once you’ve moved into your home. Beware of surprises – you don’t possess all the facts and will likely need to tackle some emergency work that you hadn’t foreseen in your first year.
After factoring in your emergency fund, fees and likely improvements, this will give a savings value which is your entire investable sum. You could invest this amount without running the risk of running out of cash in the short term.
Your investment portfolio
Finally, you should give consideration to whether you really want to convert your entire investable savings into a house.
While saving for your first home, you probably had a mixture of savings account, bonds and equities. This was a carefully balanced portfolio which matched your savings goal and your risk tolerance.
If you spent it all on a house – you are replacing it with a single, risky investment. That’s a dramatic shift in the way your assets are being utilised.
I believe that it’s the way you tie most of your net worth to a single property that makes buying a first home a very stressful experience.
In contrast, my portfolio best practise examples never show property being more than 20%, for the very purpose of minimising risk and stress.
Some investors simply ignore their residential home when calculating their portfolio – considering it a part of cost-of-living rather than an investment.
In that mindset, they haven’t converted their portfolio into 100% property, but rather they’ve simply used it to buy what they intended. It’s a reasonable view.
But I’m a firm believer in always having a portfolio of investments that can provide a passive income in the background. Are you happy reducing your investment portfolio to virtually nil, or would you feel happier if you left a ‘mini-portfolio’ in your stockbroker account ready for your next investing phase?
I would feel like my financial firepower had significantly reduced if I spent the maximum I could on a home. My options in life would shrink, and I would become fully dependent on my full-time job to be able to make mortgage payments.
Personally, I continued to save way past my first buying opportunity. This means that if I were to buy a house now, my deposit would represent <20% of my portfolio, and I would still enjoy significant dividend income from my remaining investments which could help cover my mortgage payments.
That’s simply my life choice, however. You might have a strong desire a home for aspirational or practical reasons which trumps passive income.
Summary: How much should a first-time buyer spend on a deposit?
In short, your deposit shouldn’t come close to 100% of your savings.
If you only leave a few thousand pounds, you will leave yourself vulnerable to nasty surprises from life or the property itself.
Work backwards from the other property costs to calculate what you’ll need to spend in addition to the deposit. Then reduce your spending pot further to provide yourself with a cash buffer that you can use in emergencies. This will give you a maximum investible sum for a deposit, which might be as low as 70% of your savings.
If you view your investments as a means to an end, i.e. a vehicle to use to buy a house, then you will be more comfortable using the maximum investible sum as a deposit limit.
If you view your investments as a growing source of financial stability throughout your life, you will see the advantage of delaying your home purchase. Instead, you will buy when the deposit will use an acceptably small fraction of your investment portfolio.
Due to the snowballing effect of compound interest – this won’t take as long as you think.