Despite the many economic challenges facing the UK economy over the years, house prices have increased dramatically since the 1950s. Consequently, many of the so-called “baby boomers” of the 1950s have a significant element of their wealth tied up in property. However, once the family has flown the nest and homeowners are looking to downsize, some attractive options exist.

Background to downsizing

It is important to put into perspective the rise in house prices over the last 70 years or so. According to the land registry, the average property in 2022 is worth £281,161. This compares to £1891 in 1950, which, even after inflation, equates to just £69,042 in 2022. There’s also been a significant increase over the last ten years from £167,854 to the current level. For many, this creates the perfect background to downsize, reducing their living expenses and releasing equity from their property.

Case study

It is easier to demonstrate the process of downsizing with a practical case study. If we take the following scenario:-

Homeowner: Couple in their 60s

Property value: £500,000

Mortgage: Nil

Equity content: £500,000

In this scenario, the homeowners are looking to downsize to a property worth £300,000, but they have limited capital available. There are several options in this scenario:-

Combined sale and purchase

Once you have decided to sell your existing property and downsize to another property, the perfect scenario would be an identical sale and purchase settlement date. This means you would receive net sale proceeds on the same day that net purchase proceeds were due on your new home. Unfortunately, you may experience some issues that can very quickly unwind this perfect scenario:-

  • Delayed buyer chain

It is not inconceivable that the people buying your property will experience delays of their own or be caught up in a chain. While this may not necessarily scupper your sale, it could mean a delay in available funds, which could put your proposed purchase at risk. If the chain were to collapse, you would have committed to a new property purchase with no funds.

  • Delayed seller chain

If the owner of your next property was caught up in their own transaction chain, they could also be susceptible to delays or a collapse in the process. In some ways, this is the nightmare scenario, you have sold your existing home and have the funds available, but your preferred property is not yet available. In this situation, you may be forced to look towards rental accommodation in the short term or consider alternative properties.

Financials

Settlement dates: No delays

Funds received: £500,000

Funds required: £300,000

Surplus: £200,000

 

Settlement dates: Delay on buyer’s side

Funds received: £0

Funds required: £300,000

Surplus: (£300,000)

 

Settlement dates: Delay on seller’s side

Funds received: £500,000

Funds required: £0

Surplus: £500,000

 

Sale and rented accommodation

When the property market is “hot”, it can be tempting to take a profit on your home and look towards short-term rented accommodation. In theory, you would sell at the top of the market and then look to downsize when property prices have “cooled”. As the UK private rental market has grown significantly over the years, you should be able to find temporary accommodation with little difficulty. However, there are many potential issues to consider with this strategy:-

  • Property market continues to rise

It is almost impossible to buy at the bottom and sell at the top of any market, stocks and shares, property or other assets. If the market were to continue to rise, you would lose out on any potential increase in the value of your home. Unfortunately, the cost of your dream home would also likely rise, leaving you in a relatively worse financial situation. Even if the market was to fall eventually, this could take months or even years, and you would need to consider rental costs.

  • When do you buy back into the market?

Hindsight is beautiful, but once you have sold your property, when do you go back in to buy your dream home? In theory, this all sounds relatively straightforward, but getting back into the market can be a little more complicated.

  • Will you find a suitable property?

Even if the couple were to perfectly time the sale of their home and purchase of a cheaper property, would they be able to find a suitable home? If, as initially hoped, property prices were to fall significantly, then this could encourage more buyers at lower levels. Consequently, even if the market is under pressure, there may be competition which could increase the price.

 

Financials

Property market: Increase by 10% in a year

Property sold: £500,000

Relative loss: £50,000

Reinvestment: £300,000

Relative spending power: -10%

Rent: £1000 a month x 12

 

Market: Decrease by 10% in a year

Property sold: £500,000

Relative gain: £50,000

Reinvestment: £300,000

Relative spending power: +10%

Rent: £1000 a month x 12

In a perfect world, those looking to downsize would take advantage of a strong property market, sell their original home, wait until prices weaken and then buy back in. As we touched on above, there are several challenges to this strategy. The only certainty is property prices today because nobody can be sure what will happen tomorrow.

 

Bridging loans

The concept of bridging finance is relatively straightforward, bridging the gap between a potential sale and a potential property purchase. Numerous things need to be clarified regarding bridging finance, but many homeowners would do well to consider this option. The essential elements of any bridging loan are as follows:-

Capital: Dependent on security (potentially in the millions of pounds)

Interest rate: Circa 1% a month

Repayment date: Open or fixed

Loan to value (LTV) ratio: Up to 70%

We will now look at the specifics for a property sale where there is no mortgage and one where there is an outstanding mortgage.

 

Mortgage free property

If we look at the situation where the home is mortgage free, as you will see below, the homeowner can, in theory, borrow more than the value of the property they are looking to buy.

Value: £500,000

Maximum LTV: 70% of property value

Maximum bridging loan: £350,000

Security: £500,000 property

Loan required: £300,000

Monthly interest payment (1%): £3000

Capital repayment: £300,000

Bridging finance duration: 12 months

Even though the homeowner may already have a buyer for their property, they have decided to take out a 12-month bridging finance loan (which can be repaid early) to give them breathing space. If the agreed sale collapses, it gives them more time to find another buyer and realise the full market value. Once the property is sold:-

Funds received: £500,000

Bridging loan repayment: £300,000

There will be cases where the homeowner is not in a position to pay the monthly interest payments on the bridge loan. However, there is the option to roll up monthly interest payments, which are then repaid upon the sale of the property, together with the original bridging loan capital. Those choosing this option need to be aware of the impact of interest on interest. As each monthly interest charge is added to the original loan capital, next month, the interest will be calculated on a larger capital value, and so on.

 

Part equity/mortgage property

Bridging finance is still applicable for those who have a property with part equity and part mortgage. The only difference will be the LTV and security against the bridging finance.

  • LTV ratio

If we work on the maximum LTV ratio of 70%, in the above situation, this equates to a maximum loan of £350,000. However, if there were an outstanding mortgage of £100,000, this would be included in the maximum bridging calculation. Consequently, after deducting the £100,000 of mortgage liabilities, the maximum bridging finance loan would be £250,000.

  • Security

When looking to secure bridging finance, you will be asked to provide security. In the above example, the mortgage-free property worth £500,000 would be used as security against the £350,000 bridging finance. The bridging finance provider will take a first charge over the property where there is no mortgage. If there is an existing mortgage liability, the bridging finance company will take a second charge behind the mortgage company – assuming there is sufficient equity in the property to cover the bridging loan.

This means that in the event of default, the mortgage finance would be repaid, and any surplus would be used to repay the bridging finance. Any excess funds would be returned to the homeowner after the mortgage and bridging loan repayments.

The bridging company will look to include additional security if there is insufficient equity in the property for sale. This could be the property being purchased or any other assets held by the client. As with a straightforward bridging loan, the LTV against the combined net value of the assets would be at most 70%.

 

Conclusion

In principle, the idea of downsizing your property is relatively straightforward but as demonstrated above, there can sometimes be hurdles to overcome. In addition, the use of bridging finance is something that many people fail to consider, even though it has relatively strong merits. Consequently, when looking to downsize your property, it is essential to take professional financial advice.

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