Help me understand how the property ladder works??

[Keke94LND]

Hey all, so I am an idiot and don't understand how the property ladder works at all.. please help me with the following scenario..

Thinking about purchasing a 2 bed garden flat in London that needs work, price is £425k, 15% deposit which is £63,750, so we would be borrowing £361,250. We would put in an initial £30k to do the flat up (replastering walls, re flooring, new kitchen, new bathroom, do up garden) over time we are also thinking we could add a home office at the end of the garden, we would make the house look nicer from the outside to increase its curb appeal etc etc etc.

Other similar 2 bed garden flats, that are already done up, on the same street have sold this year for between £500k and £550k, so we are thinking, if we put in £30k to do it up, we could instantly increase the value by double that?

We would likely stay in the flat for 5 years, the flat is in an area of London that has been growing over the last 10 years and is still growing (for reference its an area close to Balham that could become similar to Balham in years to come). We are thinking that by doing the flat up and with added inflation over 5 years, there is potential that the flat could be worth up to £600k by the time we come to sell (maybe we are being naive and overly optimistic in thinking this??)

This is where my main confusion comes from.. I don't want to live in a 2 bed flat forever, and would want to move into a house outside of London in say 5-7 years, but I am concerned about being 'stuck' and not being able to afford to move when that time comes, as i know stamp duty and fees etc are all very expensive.

So how exactly does it work? Am I right when I say the following:

We save over the 5 to 7 years to afford the fees and stamp duty
We still have out £60k deposit
We could have £175k equity (if we were lucky)
So we would then have £235,000 to put towards the next house, would this be our deposit? so we could possibly buy somewhere for maybe £550k? and our next mortgage would then be £315,000

Am I on the right path or am I way off?

Thank you!

Yes that is correct. You build up equity and thus have a bigger deposit for a bigger house.

Yes, that's how it works.
You can also leverage the accumulated equity in your home for other investments.

It's how the rich get richer...

You would also have paid off some of the mortgage (assuming you have a repayment mortgage) so you would actually have more equity.

There is no ladder, it’s a ponzi like system that requires new comers in order to bring more and more debt to support the ever increasing entry price to support the pyramide. No one knows if we are going to experience another decade of 8-10% price growth that was witnessed in London over the last 30 years. There are arguments for both sides, but by nature, it is unpredictable, people are just use to assume it is always going to go up as most have not experienced anything different over their adult life. Basically you could end up with 150k of equity but also see price reversal and be out of pocket. And even if you do, the next purchase would have also increased in the same proportion preventing you to trade up easily.

Property prices tend to go up so you would also increase your equity by having the sale price increase over your purchase price just by length of time you kept ownership of it.

We had a do upper, when we sold 5 years later the sale price was 20k above what it would have been on a modernized house of same type in same area when we bought it. We bought for much less due to it needing full reno. So we had equity of:
increase in value from reno
increase in value from 5 years worth of property price increasing in the area
equity from paying off mortgage

We used some equity to pay stamp duty and fees and moving costs, and some as deposit for new house.

Atm you are paying rent and have money for the deposit. Percentage on saving account is small so your savings don’t work in reality. With your own house you will pay percentages and mortgage itself to the bank so slowly will increase your part (beyond your deposit) .
You could also do your flat/ house and hopefully someone would agree to pay more for it because it would be bigger/ better and for the trouble. It will give you better deposit for the next purchase.
In the future you might have better paid job/ promotion so could borrow more or you might get inheritance - so bigger deposit.
All these will help you to get better house.
This is my intake on property ladder.

That is basically how it works.

For your scenario you are also adding in the 'moving out of London' factor whereby as soon as you start looking at properties outside of London you can buy a 5 bed for the price of a studio flat in London.

The idea is less that you have savings but more that you add value to the property, the property market rises anyway, as you pay off the mortgage you have more equity and as you get older you have better paid jobs. Obviously none of these are guaranteed and can all go horribly wrong.

Unless you expect to earn significantly more in the future, or inherit a significant amount, there is no ‘property ladder’.

In your example, you buy a flat for £425k, spend £30k on it plus stamp duty of £9k.

You might sell it for £500k, or £550k, based on sold prices in that road, but you can’t bank on it. You’d be very optimistic to anticipate prices rising to £600k when you sell.

Your problem is that all other houses and flats will also have risen in price. So when you want to move to a bigger house, you need to borrow more. You might come out with £95k equity (£550k sale price less the £455k you spent) but you’d also have spent £9k on stamp duty.

If your two bed flat went for £550k then a three bed house with a garden in the area you like might be £750k. You might have paid off £30k of capital on your mortgage after five years: interest is front loaded. So you’ve got equity of £95k plus the £30k equity in the flat.

£125k of equity isn’t going to get you very far towards a £750k house. You’d need to borrow £625k. The stamp duty would be more than £20k, and you can’t borrow that.

How do people ‘climb the ladder’? By borrowing more, over a longer period. 35 year mortgages are common now.

So adding in the 5 years for the flat, you’d be paying a big mortgage for 40 years. Forty! Lenders are the real winners here. The longer the term, the more interest they earn. Money is cheap at the moment. It won’t always be.

Meanwhile you pay a fortune in interest that might have gone into a pension, with tax relief, kidding yourself that you are climbing a property ladder. It’s a neat trick, no?

I would also add that if you can afford it you should overpay your mortgage, most lenders allow up to 10% per annum. This would give you greater equity when you sell.
By the way is there a reason you need to buy in London now?

I think it might work if you are moving to a cheaper area, but agree with the poster that said if your flat has increased in value , so will everything else around you .

@Iamthewombat is correct. Rising prices just make it harder to move up the ladder unless your salary has increased significantly or get money from elsewhere.

and I would not assume you will make lots of equity on what you are buying particularly on a flat. The best way of gaining equity these days is future proofing & reducing the "steps". Try & skip the flat stage & buy a smaller house further out.

My Mum ended up in 'negative equity' (house worth less than you paid for it so when you sell you can't pay the bank back for the loan) when prices crashed which made it very hard to move.

The notion of a property ladder depends on house prices rising consistently and quickly

Given the cost of moving and the now uncertain rate of growth, your best bet is to stretch yourself as far as you can in as few moves as you can.

Iamwombat is correct.

But it only matters if you actually stay in the house as a forever home (and thus pay off the mortgage).

If its a short term house while you jump up the ladder. Then you dont actually have to pay off the mortgage. Yes you are paying more interest in the short term - but in day to day life you are paying less - and as long as you save that difference for the stamp duty on the next house then why not take a 35 yr mortgage.

We remortgaged on a 1.25% fix for 5 years/35 yr - for us its a 5-10 year home, I did the math and its better for us.

When you do buy a forever home - thats when you need to consider the mortgage term carefully.

The main pro of buying a 'starter property' (hate that term but I don't know how else to explain a property that you don't intend to stay in for life) is that instead of paying rent or overstaying your welcome in your parents' house, you get to have a stable place to live in plus build equity for your future plans, whether its is to upgrade or retire early. Sure, you can save more for that perfect 3/4 bed 'forever home' but realistically if you buy in a good area in London/the Home Counties, you are looking at 600-800k which is quite a lot more money to save and would take many more years (+ more years of paying rent). Even if you buy in an affordable area in the Home Counties, its usually 'affordable' for a reason - long commute times (higher commuting fares which means less money for mortgage overpayments; not worth it if you don't have children yet ) or a less desirable area that you might not want to live in.

I was 27 when I bought my flat, i mainly bought because I had already stayed with family for 3 years and I didn't want to rent. I would like to stay in the area long term and am looking at large 3 bed flats (cos the jump isn't as big as from flat to house and London flat prices have flatlined due to the preference for gardens). Having said that, while it might be hard to move up, it probably wouldn't get easier to buy that first property. Even if prices drop, banks are not going to be more generous with lending and there are many landlords/investors out there with huge cash deposits and who need a negligible mortgage. At least if you buy soon, you can get a fixed rate mortgage and start working on building equity.

In theory, what you have said isn't wrong, except you have forgotten that, if your flat continues to rise in value, then all the terraced houses, or semis will also have increased at the same rate.

The advantage of being able to buy earlier on, is that you are paying down your own mortgage rather than your land lords. Rent is commonly more than a mortgage payment also.

However, most people get to 'move up' because they have got a new job / promotion at work, or originally bought as a single person then they meet a partner and are combining forces, or they get a lump sum from an inheritance or a competition win or Premium Bonds or lottery, not by "making money" on their first property - as any price rises in housing stock also mean the 'next step up' has also risen.

my MIL managed to move up the housing ladder because the property market crashed in the 1990s. Her own flat crashed in value but because she had built a lot of equity, she was able to sell it and upgrade to a terraced house. Which is why falling house prices are actually beneficial for FTB and second steppers alike.

@Iamthewombat and @paepoyrol offer very good advice.

The concept of the 'property ladder' is very much ingrained into the British mindset (which is alien to me as a European), so it is difficult to step away from that and follow a different path.

As @paepoyrol said, if you must follow that path, the key is to minimise steps on the ladder as each transaction can suck away thousands.

First and foremost you need a home. Owning one is usually more stable than renting one and over 25 years rent will increase relatively and a mortgage will decrease as a proportion of earnings. At the end of 25 years you also have something to show for your money. It's best looked at as a long game rooted in having a home. Gains along the way nudging you up the ladder are unpredictable and vicarious.

Yes that’s right. But it all depends on being able to sell the flat. There was a thread on here not so long ago with a woman who was unable to sell her beautiful London flat. So couldn’t move up the ladder. Lots of people thought it could be the pandemic affecting whether people wanted flats now. I also know someone who bought their first home just before the property crash years ago. They ended up with £20k negative equity so couldn’t sell. So it works if it works but can also go wrong.

There was a good article in the FT how one of the major issues with property is getting stuck on the ladder (pre covid), that's why the stamp duty cut caused a flurry of activity as people didn't have to find so much money. Even with that activity I don't think London has seen too much growth, the problem is the bottom rung is so high & now it's very hard to build equity because there aren't so many ftbs who can get on the ladder. I think London will see stagnation, and other areas will grow more. Most people I know who moved up the ladder left London or had help from family to move up. A few did it because they got on the ladder years ago. As others said it's better to skip stages these days.

Oh & I think london rents are now cheaper than mortgages.

@countrytown surely stagnation of London prices is good if you are moving from London flat to London house- there is less of a jump!

is moving from a 2 bed flat to a 3 bed flat considered moving up the ladder? I don't think so and I don't mind either way- what matters is usable floor space, that the property is well managed, has 3 bedrooms and it is my area in London. I noticed that expensive larger flats in London are gaining less value than entry level £400k flats; there was a Mumsnet thread about a London lady who only had offers for £750k for the Richmond flat that she bought for 900k, she also mentioned it was 1095 square feet which is the same size as a smaller Victorian terrace really minus the staircases. I think it's because these flats were the preserve of wealthier FTB, downsizers and continental/East Asian buyers (only in prime central London). The market of wealthier FTB has been hit as most people in our age group prefer to move to the Home Counties when young, esp richer people who have no problem paying the season ticket fares. I don't think it's just about skipping the steps on the property ladder, I just think living centrally has less appeal these days in the age of Instagram. You don't exactly need to live within walking distance of Highgate village to Instagram yourself in Highgate village but having a large and beautiful house is much more impressive on social media (plus no one knows if it's in the sticks). One of my husband's ex colleagues bought his first home in caversham at the same time as us- it was 340k for a 2 bed house as opposed to £392k for our 2 bed flat in zone 3 north London. Combined with £500 per month commute fares, he wasn't saving any money at that time as an extra 50k in mortgage equates to £217 per month on a 25 year 2.05% mortgage (our interest rate). But he said he was living in caversham for the lifestyle-closer to countryside, more sporting activities, nearer to Henley. He now has a cat and a dog. I think the Facebook group 'caversham gossip girls' are probably a younger crowd- could be wrong about that! But yeah I see this combined with remote work as a positive for Londoners hoping to get on the property ladder or move onto properties unappealing to higher budget buyers (who seem to be predominantly following the national trend of moving to the burbs/countryside).

@Oblahdeeoblahdoe

I would also add that if you can afford it you should overpay your mortgage, most lenders allow up to 10% per annum. This would give you greater equity when you sell. By the way is there a reason you need to buy in London now?

No particular urgent reason, we're currently just trying to find a balance between best thing to do financially and best thing to do for quality of life.. we've both been renting in London for 5 years now, over those 5 years we have spent £45k each on paying someone else's mortgage, I'm 27 and bf is 32 so we feel really ready to actually own our own place and we have managed to save up a good amount of a deposit. Our initial plan was that we would move out to the Home Counties and buy a house, but thinking about it recently, do we really want to have an hour and a half commute each way when we don't absolutely have to, I've done the commute before and it is pretty draining which is one of the reasons I moved into London in the first place haha, secondly, the cost of commuting is crazy, I currently pay about £120 a month from zone 3 and my bf cycles, so over 5 years in London, our commute cost would be £7,200, if we moved out, the commute cost goes up to about £350 per month, my boyfriend wouldn't be able to cycle so that would be £350 a month each, thats £42,000 over 5 years, so by staying in London for another 5 years we would be saving £34,800 on commuting, plus paying into a mortgage, plus more likely to gain more equity on a place in London that is already gentrifying, and we would be able to enjoy our lives a bit more without the dreaded long commute.. at the moment, in my head, this just makes the most sense.. which is crazy to me because a year ago I wouldn't have entertained the idea of staying in London haha