UK mortgages: financial innovation run amok. Source: Google images.
In a never-ending saga, I’ve spent quite a lot of free time these past few weeks studying the UK mortgage market. In sum: crazy:
- Where I’m coming from: US mortgages. In particular, the fixed-rate 30-year mortgage guaranteed by Fannie Mae or Freddie Mac. When my wife and I bought a house in the US, the choices were pretty much either a 15-year or 30-year fixed rate mortgage. Simples.
- How about a 30-year fix in the UK? Nope, not available. If only Americans fully appreciated how sweet the government support of housing is in the US. No dice in the UK. BTW, for those wondering – mortgage interest is tax-deductible in the US, but not in the UK. But anyway.
- What do Britons do? Fix for 2 years. The standard mortgage here seems to be a 2-year fixed rate, which then reverts to a penal ‘Standard Variable Rate (SVR)’ charged by the bank. Given low rates, there are several offerings for 3-, 5- and 10-year fixes these days. In practice, the assumption is the mortgager refinances by the end of the fixed rate period – spending another £1,000 or so on fees for the privilege of keeping a discounted fixed rate. Or they move, or pay off the debt, or…
- How to take advantage of low rates? Variable/tracker mortgages. If you believe rates will continue to fall, there are mortgages which either reflect changes in that SVR (‘variable’) or changes in the Bank of England base rate (‘tracker’). Those smart cookies who successfully predicted the massive fall in BoE base rates entered a strange world of negative mortgage payments in 2008/9. With the base rate at 50bps, I’m guessing there isn’t much further to go.
- Extension: but what if I wanted to ‘fix’ my own 30-year mortgage? The SVR is completely at the discretion of the mortgagee – they can change at will, so very hard to hedge interest rate risk on a variable, or indeed 2-year fixed, mortgage. The tracker is more interesting – BoE interest rate decisions generally take place at meetings announced well in advance, so could in theory be hedged. I’m looking into solutions involving Short Sterling and/or UK gilt futures to achieve the fix.
- Brilliant UK innovation – offset mortgages. It’s well-known that paying off mortgage principal early is a good thing, to build equity and lower total interest paid. But what if you come across a load of cash (a bonus, perhaps), with a potential need for said cash in the future (early retirement, perhaps)? The offset mortgage allows your cash savings to offset the mortgage principal; you can still access your cash if needed, but otherwise you only pay interest on the net amount of principal outstanding. I like that feature, though it comes at the cost of higher interest expense.
- But wait – don’t you loathe the UK housing market? Hmm… yes, particularly in London area. Upon further research, housing in the Midlands and North of England (+ Scotland and N Ireland) isn’t as overpriced/undersupplied as the dreaded Southeast. This is reflected in gross rental yields: London yields are a joke (3% p.a. before fees/fixes? Happy to rent with that.), while yields elsewhere are much more reasonable. So maybe worth investigating a purchase further afield.
What fun, investigating financial products. Ah, to have a 3.8%, 30-year fixed mortgage with a tax credit to boot instead.
From the weekend reading, I learned about a few awesome blogs on the topic of (very) early retirement. There seem to be several folks out there making a go of living financially independent lives in their 30s. They generally have a few things in common:
- A high-paying job in their 20s (e.g. software engineer), usually in concert with a high-paid spouse.
- True dedication to savings – most are socking away 50-70% of income during working years. Experiences vary on how to achieve this – some are more ascetic than others.
- Good financial sense – just solid practices, such as maxing out retirement savings, sticking with cheap index funds, etc. Nothing particularly fancy, though some pretty sweet tax planning to be found.
In any case, here are the 3 new blogs on my list. I’ve already picked up a few tips to save on my taxes, so worth every penny of reading!
- Go Curry Cracker – a couple doing the early retirement thing in Mexico/US. Great transparency on their finances/expenses for how to make things work.
- Mad Fientist – brilliant resource for tax planning.
- Jim Collins – a resource for investing basics, particularly stock investing.
You said it. Source: Google images.
A quick read from this morning’s press turned up an interesting article – Determining the optimal U.S. tax rate for high earners. In brief, the author summarises existing economic literature which empirically estimates the top tax band (NB: the top tax rate in the US is currently 39.6%, compared with 45% in the UK). He finds the top rate can and should be substantially higher, using 3 elasticity approaches.
- Background: tax policy is especially important in the US, relative to other countries, in order to achieve income redistribution. Americans seem happier to use progressive taxation, rather than cash transfers, to help level the playing field. Here’s some OECD data, summarised by Greg Mankiw, on the topic of US versus other countries in measuring tax progressiveness.
- The issue: policy makers need to set top tax bands to achieve both needed revenue and a feeling from society that the rich are paying their fair share. The big concern is the substitution effect, which means the rich will work less as their effective (after-tax) pay is cut. The measure of this effect is called elasticity, which is measured in 3 ways by the research quoted in the article.
- The result: in all 3 cases, the optimal higher tax rate is far above the existing rate – between 57% and 83%. For history buffs, the latter is roughly where the top rate was in the 1930s-1950s.
- How can that be true? From the article, it seems high earners don’t care about their marginal tax rate – again spitting in the face of rational economic theory. Perhaps they’re working for other reasons than earning a lot, and/or still feel rich with high marginal rates.
- So what? Part of me reads the article and feels the usual cynicism, e.g. “like that’ll ever happen”. So worth asking why the US would raise the rates…maybe to squeeze just a bit more out of an already progressive tax system, in order to fund more progressive cash transfer system? Also worth wondering what the elasticity would be for leaving town – testing the common argument that high earners will quickly leave town if rates are increased (e.g. London hedge fundies moving to Geneva when the top rate was increased to 50%, only to regret it later). Finally, would hiking top tax rates actually raise additional revenue? The elasticities in the article would hint at ‘yes’, but other authors suggest otherwise.
In sum: let’s put these findings in the basket of “hollow arguments the rich make to frighten working/middle class voters into voting against their best interests”. Higher top tax rates may help raise revenue and social equality, with little effect on tax avoidance or decreased effort on behalf of high earners.
Ah, the good feelings of having been away for a couple weeks. Now it’s back to work.
Worth a read. Source: Amazon.com
Among the spires of York (great place to visit, by the way), I took the opportunity for some light holiday reading. As mentioned in my About page, the books I favour tend to favour financial history. This trip’s selection was Paper Promises: Money, Debt and the New World Order by Philip Coggan. Overall, a great read for folks like me: plenty of history, easy reading – bordering on ‘page turner’ material. Some thoughts:
- The author is a long-time financial journalist; most recently the Buttonwood columnist for The Economist. That was a big draw for me, as I’m a fan of the magazine’s writing style.
- An early focus for the book was the path of using precious metals for money over time.
- One strand I hadn’t considered before was the impact of the Industrial Revolution and rapid productivity gains on prices: there was a huge increased demand for money as more and more goods were produced and traded, which would’ve meant disastrous deflation unless more gold/silver arrived in Europe at about the same time (thanks to new mines, this is what happened).
- The gold standard, as many Americans think of the early 20th century, was actually an exercise in fiat money anyway: only a small proportion of the paper money supply was kept in gold. The repeal of the US gold standard in 1971 happened because the bluff was called, in a way!
- Early experiences with paper money (e.g. France in early 1700s) were pretty disastrous; I wonder what will happen in future, when the temptation to print to cover growing liabilities rises considerably…
- I really liked the narration around the 2007-2008 crisis, in particular answering the question “Where did all the money go?” Great exposition around the conundrum that perceived ‘value’ for things like housing and other assets assumes they can be sold without moving the market; if everyone wants to sell houses at the same time, the lost ‘value’ when selling at a discount never actually existed…it was merely an imagination of the person holding the house.
- The final part of the book reflects on post-crisis financials, particularly the intergenerational transfer of wealth that I’ve touched upon before. Things are not looking well for many governments’ finances.
- In sum: well worth reading, though the final part of the book is a bit dated already (so policy prescriptions might raise eyebrows). Loved the writing style and history.
Hello from holiday land – this time a budget-satisfying stay-cation in London.
From my holiday reading: I really hope this guy becomes a billionaire. I’ve written before about how incredible local power storage would be for a myriad of reasons, not least providing a crucial link to enabling full use of renewable energy. If it can’t be Elon Musk, let it be this guy.