The ongoing coronavirus pandemic has radically altered young people's priorities. Some have relocated to the countryside while others have moved back to their family homes, either out of necessity or in order to save money.
This has had an effect on the UK housing market. According to a report by PWC, one in five people are now less likely to buy a property due to COVID-19, with 30% preferring to live in the suburbs or towns over city centres. Rents are falling fast in major cities across the UK as a result, and demand for properties from overseas workers, students, tourists and corporate travellers has plummeted.
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With the vaccine rollout underway and with 21st June in our sights, young people who are determined to buy a place of their own need to know how to increase their savings to house deposit territory.
In her new book, Own It! How Our Generation Can Invest Our Way to a Better Future, Iona Bain, financial expert and founder of the Young Money Blog, explores the routes young people can take when it comes to saving or investing for their first home. Ahead, she talks us through everything from injecting cash into ISAs to getting the best out of the stock market, so you can start to envision your financial future.
In years gone by, there was only one recommended route for wannabe buyers: that was to stick to saving – no ifs, no buts. That’s because it’s widely assumed that most first-time buyers are aiming – and able – to get those keys within five years. This surely rules out investing for your first home, right? Well, not necessarily. High rents and subdued wage growth have meant that many young people have needed to save for much longer than five years to get on the property ladder. In fact, that waiting game has typically been ten years across the UK, rising to 15 years in London, according to research from Hamptons International.
And something else has changed the rules of the game too. It’s called the Lifetime ISA (LISA).
ISA is an acronym, standing for Individual Savings Account. It’s a legal structure that was launched by the government in 1999 and it allows anyone to save into it, up to a certain amount, and hold any interest or investment returns they make within it tax-free. Everyone gets an ISA allowance each tax year, which begins on the 6 April, and right now it’s £20,000 a year (though this can change).
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You can put your allowance into one or a combination of ISAs: there are currently four available for those aged 18 and over. One has closed to new customers (Help to Buy ISA) and another can only be opened for someone under 18 (Junior ISA). Remember that the ISA itself is not a product but a tax-free "wrapper" for your cash or investments.
We’ll get to know the three other key members of the ISA family later. Let’s concentrate on the latest addition: the Lifetime ISA. Launched in 2017 by the government, it can only be opened by someone aged 18–40 and it can be used either for your retirement savings or to buy your first home. For now, we’ll focus on the latter.
The LISA is the first vehicle that provides a real incentive for young people to invest for their first home. That’s because there are two different versions of the LISA and both come with a bonus from the government. You can either put your LISA into cash or you can put it into investments through what is commonly described as a stocks and shares LISA.
Every £1 you put into the LISA will be topped up by 25p by the government. The maximum you can save into a LISA annually is £4,000 – so that means you could get up to £1,000 free cash towards your first home every year. If you saved the full whack allowed from the minimum age of 18 to the maximum age of 40, you could get £32,000 free from the government. Blimey!
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The cash version of the LISA offers interest in addition to the government bonus, which varies depending on the provider you choose. The rates haven’t been stellar – the best I have seen so far is 1.5% – but the government bonus is effectively a 25% interest rate anyway, making the cash LISA the most lucrative savings vehicle out there by a LONG way.
The stocks and shares LISA is, potentially, on another level. Equities do tend to outperform savings over longer periods. So, the possibility of much better returns may well tempt you to invest for your first home. But I’m about to slap some huge health warnings on this strategy.
Firstly, remember that the past really is no indicator of the future. Yes, research shows that investing in shares outperformed cash in most five- and ten-year periods historically. But will this happen again in the future?
Secondly, the performance of your stocks and shares LISA will depend on where and how it is invested. There isn’t one single investment you can buy that will magically do the job.
Which brings me on to my last, most important point. What happens if that stock market rollercoaster plummets and shows no sign of rising again for a good while? Uh-oh.
You might have to wait months or even years for your investments to regain their value. That’s the last thing you want when you’ve had your fill of renting, or you’ve found the right place at the right price, and you need to pony up the cash for your deposit straightaway.
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Young people who were on the cusp of converting their stocks and shares LISA into a first home deposit early in 2020 had to think again when stock markets crashed due to Covid-19. So that presents a conundrum. Should you open a stocks and shares LISA to invest for your first home? Here are the main questions you need to ask yourself.
Are you sure you want to buy?
The LISA is by far your best bet if you’re 100% certain you want to buy property. But if you change your mind, you’ll pay a 25% penalty on any withdrawals from the LISA, which claws back the government bonus and takes some of your money in the process too.
Note that this 25% penalty was temporarily cut to 20% following Covid-19. Many people were unable to access Universal Credit – the main benefit offered by the government – because their LISA savings counted against them. This penalty cut is still in place at the time of writing, with pressure from many advocates (including me) to maintain it after the crisis passes. But the current plan is to reinstate the 25% penalty at a later stage.
In the meantime, I recommend that you only take out a LISA if you can commit to it. Otherwise, you need to find other savings accounts that will pay an above-average rate of interest.
Are you confident that you will buy within five years?
If so, there is no point thinking about investing – stick to your cash LISA.
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How comfortable do you feel risking your home deposit?
This is a toughie. Yes, a stocks and shares LISA can and should be invested in a way that will reduce your risks, which is particularly important when you’re relying on this money to fund your first home. But ultimately, if you can’t stomach the idea of your money being at any kind of risk whatsoever, it’s best to play it safe.
When people are new to investing, they often overestimate how much risk they are willing to entertain because it’s tricky for them to accurately predict how they will react if markets fall. Of course, you can get a lot more comfortable with risk when you learn more about investing. But if you think there’s any chance that a fall in your investments would freak you out, and possibly provoke you to withdraw your money, it’s vital that you listen to that instinct and go with a cash LISA. Nobody knows your mind better than you.
Don’t hang your hopes on housing
Buying a home isn’t compulsory and neither is investing towards a home deposit. It’s totally fine to choose to save for your first home in a cash LISA, or even in a regular savings account, if you’re not sure. In fact, it might be the best thing to do if you’re looking to buy within five or ten years and you really don’t feel comfortable taking that extra risk.
Most crucially, you shouldn’t put all your faith in housing. Yes, it’s lovely to have a place you can call your own, but don’t get too comfortable in your new crib. Your financial journey is far from over.
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If you can achieve your home-buying dream, you have a fantastic opportunity to open new financial horizons. The temptation might be to sit back, hope that house prices will grow and rely on selling your property one day for big bucks, perhaps to fund your eventual retirement. After all, that seems to be what a lot of boomers are doing (or at least claiming to do…).
But that would be a big mistake. Personal and professional reasons should be behind your home-buying zeal as much as financial ones. Besides, property should only be one part of the plan to build your long-term wealth.
Iona Bain is the author of Own It! How Our Generation Can Invest Our Way to a Better Future, out now, published by Harriman House