Why you might be one of Britain's secret tenants

Millions of people believe they are homeowners when, in reality, they are hush-hush renters!

Last week, I saw a survey from property website Zoopla which showed that it is cheaper to buy a home than to rent in 40 of the UK's 50 largest cities and towns.

Buying beats renting...

On average, Zoopla found that the cost of renting exceeds buying by almost a tenth (9.7%) across the country.

To produce this survey, Zoopla compared the average monthly rent for a two-bedroom flat with the monthly payments for a 100%, interest-only mortgage to buy the same property, using a mortgage rate of 5%.

The widest gap between the costs of renting and buying is in Milton Keynes, Buckinghamshire, where it costs 43% a year more to rent than buy. At the other end of this scale is Poole, Dorset, where renting is 27% cheaper than buying.

In the past 12 months, rents have risen while house prices and mortgage rates have remained broadly flat, helping buying to gain an extra edge over renting. What's more, despite sky-high house prices in London, buying is still 16% cheaper than renting in the capital, according to Zoopla.

...or does it?

Of course, as a leading residential-property website, Zoopla has a vested interest in talking up home-ownership and house prices. However, its latest research is just plain wrong, because it ignores the true costs and risks of owning a home.

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First, lenders are very reluctant to grant borrowers 100% interest-only mortgages, as these are seriously risky. In fact, not one mainstream UK mortgage lender is willing to offer 100% mortgages to new applicants, making Zoopla's entire calculation flawed.

Second, getting an interest-only mortgage is far harder these days. Lendedrs much prefer to lend on a repayment basis, as they know that these loans will be completely paid off at the end of, say, 25 years.

Third, getting a no-deposit loan at a mortgage rate of 5% a year is impossible. In actual fact, the average interest rate for a 90% mortgage is around 6%. Hence, given the high risks of lending to customers with no deposits, a yearly interest rate of perhaps 7%+ is more appropriate.

In summary, Zoopla's survey is fatally flawed and, therefore, wildly misleading. Don't be fooled by this hype!

The UK's secret renters

In the real world, buying a home using a 100%, interest-only mortgage means taking a huge risk. For sure, when house prices fall, this decision could easily turn out to be a terrible one.

In my view, someone in this position isn't a homeowner at all. Indeed, Vincent 'Vinny' Daniel -- a trader at a US hedge fund that made a fortune from betting on falling US house prices -- had this to say about these homeowners: "A home without equity is just a rental with debt."

In other words, homeowners with mortgages equalling the value of their homes aren't homeowners in any meaningful sense, financially speaking. For the record, I call these people secret renters because, in effect, they are renting from banks instead of private landlords.

Even worse are those homeowners who have interest-only mortgages and no concrete plans to repay these loans. Without the ability or desire to repay their mortgages as they go, these folk are most exposed to falling house prices.

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Of course, were house prices to fall a further 10% (something easily within the realms of possibility), then anyone with a mortgage loan-to-value (LTV) ratio of 90% would have their precious sliver of equity wiped out. Furthermore, a 10% drop in prices would put all homeowners with LTVs exceeding 90% into negative equity, burdened with home loans exceeding their properties' values.

The more you owe, the less you own

In effect, the higher your LTV ratio, the less of your home you genuinely own.

With an LTV of 95%, in effect, you own just 5% of your home and rent the remaining 95% from your bank. You may be fooling yourself that you're a homeowner, but the reality is that you own a mere twentieth of your bricks and mortar.

What's more, those with no equity in their home or negative equity have a real problem: they are stuck where they are. Unless they can bring down their mortgages below the value of their homes, then they are utterly unable to move. Thus, until they've created some equity, they can't move along or up the property ladder.

Interest-only loans are dying out

The good news is that interest-only mortgages are much scarcer than they once were. Prior to the credit crunch, around 30% to 35% of loans to first-time buyers were interest-only. However, in March 2011, only one in 25 first-time buyers (4%) took out an interest-only mortgage.

Nevertheless, the previous popularity of interest-only mortgages means that millions are still around today. According to the Council of Mortgage Lenders, there are at least 3.75 million mortgages with interest-only elements, out of a total of 11.3 million home loans.

In short, one in three mortgages (33%) is an interest-only loan, with total interest-only debts standing at £470 billion. To some degree or another, any homeowners with little equity and no clear plans to repay their mortgages are nothing more than secret renters.

House prices remain too high

Lastly, according to Zoopla, 750,000 first-time buyers have been prevented from getting on the property ladder in the past three years. This is largely because of the continuing 'mortgage famine' in the aftermath of the credit crunch which began in mid-2007.

However, to attract first-time buyers, we shouldn't return to the mortgage madness of old, where anyone with a pulse could borrow as much as s/he wanted to buy a home.

Instead, the easiest way to make home-ownership more attractive would be for house prices to fall by, say 20% to 30%. Though 17.5 million homeowners really won't want to hear this!

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