Investing for a house deposit with an ISA

Buying a house is likely to be the biggest purchase you make in your life. And given how much we glorify home ownership here in the UK, it’s not surprising that it’s also one of the things many investors aspire towards.

That’s why so many of them end up using a stocks and shares ISA as a means for securing a down payment on a home. 

But the idea of buying a home can feel daunting. Houses don’t come cheap, particularly in London and places close to the capital. For many that means it can feel like a Herculean task that isn’t worth embarking on.

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How much do you need for a house deposit?

Things don’t have to be that way though. Investing for a deposit does require time and discipline but it shouldn’t feel like it’s beyond your reach.

For one thing, the government is on your side. Currently first-time buyers have the ability to secure a mortgage with a 5% deposit for home purchases up to £600,000.

Minimum deposits were all over the place during the pandemic and you might still find banks cautiously bringing them down from around 15%. That’s why 5% can seem like a saving grace now especially.

Assuming you were buying a property at the average UK house price of £262,000, according to the latest Halifax House Price Index, that would equate to a little over £13,000 for a deposit. Maxing out that cap would mean putting down £30,000. These are not small sums but it’s certainly far less than paying the full amount up front.

Obviously this scheme could change in the future but most past UK governments have put in place various support schemes to help property purchasers, particularly those buying for the first time. So keep an eye on those as they are likely to play a role in your deposit.

Of course, that’s still likely to be a helping hand, as opposed to them doing all the work for you, so you do need to put in some investing work yourself. Thankfully this isn’t likely to be as tricky as it might seem.

Investing for a mortgage with an ISA

If you’re going to invest for a house deposit then a stocks and shares ISA is likely to be the best option for you.

The key benefit of a stocks and shares ISA is that you can purchase shares and have any capital gains remain tax free. Dividends paid on UK shares you invest in will also remain free of tax. 

It’s hard to think of a good alternative for this and if you are looking to build up a decent sized portfolio, even if it’s not for a house deposit, then a stocks and shares ISA could well be right for you.

“Ok,” you might say, “but then I only have a small amount to invest.” 

This is a fair point but it’s also where time and patience come into play. Investing small sums of cash regularly over a prolonged period of time can have the potential to net you a tidy sum. 

As an example of this, imagine you earn £32,000 per year — a little over the UK average. At current rates, each month you’ll be left with £2,118.52 after paying the taxman his due.

Now let’s say you’re paying £900 a month for a place to live and all your living expenses add up to £800. That leaves you with a little over £400 every month. You may want to keep another £100 of that for emergencies, entertainment or something else entirely. So you’re down to £300.

On a yearly basis that means you have £3,600 to invest. That may not sound like a lot but add this up over a 10 year period and factor in compounding and you could end up with enough for that house deposit. 

Assuming you averaged a 3% return each year on the £3,600 you invest annually, you’d end the decade with just over £41,700.

🤔 Deep dive: What is a stocks and shares ISA

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What should you invest in for a mortgage deposit?

Getting such a return would require you to invest in something. And given the paltry returns bonds and bank accounts currently offer, the likelihood is you’re going to head towards the stock market.

This can seem daunting but there are some simple methods you could use if you don’t want to spend time picking shares and learning the ins and outs of equity analysis.

Probably the simplest thing to do would be to invest in a mix of index-tracking ETFs. 

For example, an even split between the Xtrackers MSCI China, Invesco FTSE 100, Vanguard S&P 500 and iShares MSCI Europe would require very little effort and provide some solid geographical diversification to your ISA.

We’re using these ETFs purely as an illustration of one way to get a blend of countries into your portfolio. You could choose a completely different way to do that and none of the assets we mention should be taken as a recommendation to buy or sell any security.

Sharp-eyed readers will notice that these ETFs are all accumulating, meaning they reinvest dividends back into the fund. 

Distributing ETFs pay these out to you, which may be good if you want cash but, historically, has meant your total return is far lower than if they had been reinvested. As our goal is to build up a deposit, that means going for accumulating ETFs is likely to be the better option.

Another option for anyone who isn’t keen to spend time stock picking is to put money into investment trusts. Some popular ones on the Freetrade app include the Scottish Mortgage (SMT), Lindsell Train (LTI) and City of London (CTY) trusts.

There are a couple of things to be careful of with trusts. First are the fees, which are likely to be higher than those you pay on an index-tracking ETF.

The other is to make sure you’re actually aligned with what the trust managers are doing. For instance, the SMT has seen strong returns over the past couple of years but arguably takes on much more risk than other firms. You might be happy with that but may not if you don’t want to expose your house deposit to that type of strategy.

There’s also no guarantee having a human at the helm will mean you beat the average index tracker consistently.

Risks of investing for a house deposit

That points to a wider problem with investing for a house deposit. The example we gave above seems plausible but it could easily not happen.

Markets could crash, house prices may soar, mortgage rates might increase and the government may decide to scrap its support programmes. 

Similarly, things could move in your favour. You may get pay rises which mean you could easily deposit more than £300 a month or you could end up exceeding that average 3% annual return. House prices might also come down and make it much easier to secure a down payment.

That doesn’t mean we should do nothing. What we’ve described so far was designed to help provide you with an idea of how you could invest for a mortgage. 

Even if the descriptions don’t match exactly with your own circumstances, the principles imparted by them should give you some idea as to what you can do to get started on the road towards home ownership.

Looking beyond that goal, the positive is that, even if it seems as though you don’t have much to invest, regularly investing small sums of cash over a long period of time can leave you with a sizeable portfolio.

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Managed to pay a deposit already by using an ISA? Talk about any lessons you learned with other Freetrade customers on the community forum:

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Building your wealth over the long term should help you create a more stable financial future. Open an ISA account or transfer from another ISA provider and make the most of your £20,000 annual ISA allowance. Alternatively, start your personal pension early by regularly contributing to a SIPP or moving old pensions to a single SIPP pension pot. Find out how to choose between an ISA and a SIPP.

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