Read through the monthly Net Worth Updates and you’ll see one question pop up again and again.
Where is your home equity?
Put another way,
Why don’t you include the value of your house in your net worth updates?
For years, my standard answer to that question has been “because I don’t own a house!”
Technically, the house whose mortgage I split on isn’t in my name at all. Lady Money Wizard owns it – she bought it herself back in October 2017. (Here’s my full write up about that adventure. And some more tips about how we saved 20% despite a hot market.)
But the more I think about it, and more specifically, the closer I get to actually owning this house (we’re getting married in a few months) the more I realize something surprising:
I don’t plan on adding the home’s value to my net worth.
And I probably never will.
Here are the three main reasons why:
1. Most people use home equity as an excuse to ruin their financial lives.
I’ve seen it again and again. A smart young couple goes home shopping with a carefully crafted budget.
But then, somewhere along the way, either at the urging of their real estate agent or their well-intended but misinformed parents, they crank that budget to the moon.
What started as shopping for a $250,000 home somehow turns into a half-a-million dollar piece of luxury. No worries though, it’ll all go back into your net worth eventually…
And then they stress for the 30 years, strapped for cash and barely able to save any money for the future.
Make no mistake, this is absolutely one of the common ways people trip up on their financial journeys. Forget about the flu, the most common ailment in America seems to be house rich and cash poor.
The truth? Most people would be better off if they didn’t use their home’s value as an excuse to spend too much money. Instead, you should treat your home purchase like it is – an expense that will follow you for the rest of your life.
A too-expensive home destroys your ability to do the real heavy lifting needed to reach financial freedom, and it handcuffs you from being able to put money into the types of investments that actually help your goals. (More on that in point #2 below)
2. Your primary house isn’t an income producing asset
If you own a rental property, this doesn’t apply. But it’s 100% true for the place you lay your head every night.
Allow me to explain.
At the end of the day, I am tracking my net worth not because I’m some twisted personal finance geek obsessed with watching numbers go up on a screen. (Hey, that joke hit a little too close to home…) No, I’m tracking my net worth because it’s a pretty good proxy for when I can reach financial independence and quit my job.
(Or at least never have to worry about money ever again.)
When I set my $750K to $1 million net worth target, I chose that number because having that much cash invested into income producing assets should be enough to support my entire living expenses.
For example, using the four percent rule, a cool million bucks invested in the stock market generates $40,000 per year. Since I struggle to even spend $36,000 a year, having that amount of money invested into income producing stocks and bonds should fund my entire living expenses, with $4,000 to spare for nightly bottle service and gold plated underwear. (Or more realistically… health insurance.)
Better yet, stocks are pretty liquid investments, meaning they’re easy to sell. With a couple clicks on a computer screen, I could sell sell $40,000 of Vanguard funds right now, and within 2-3 days, have an entire year’s worth of spending sitting in my checking account.
Even better, dividend producing stocks will literally send me a check in the mail, zero maintenance required on my end.
Each month that those index funds or dividend paying stocks increase in value, the amount of living expenses they can fund also increases in value. So any increase in portfolio value means I’m measurably closer to being able to sell some of it to fund my living expenses.
Compare this to home equity…
As I make my monthly mortgage payments or as my neighborhood increases in value, what’s the end goal? My house being worth more money (or my loan getting smaller) doesn’t actually impact when I could retire.
Sure, it increases my net worth, but it doesn’t directly speed up my path to financial independence.
Why?
Because that value is literally land locked. It’s stuck in my place of residence, not actually earning me any money or funding any expenses.
Say I want to go on an extended early retirement roadtrip that costs $3,000. It’s gonna cost $3,000, either way.
Whether my house is worth $250,000 or $300,000 won’t change my ability to pay for it.*
And at the end of the day, my definition of financial independence is having enough income producing assets to fund my lifestyle.
*Yes, I could take out a home equity loan or something similar. But if I’m early retired, how will I fund the interest payments on that loan? I can either use proceeds from the loan, which basically just kicks the can down the road and turns my finances into a weird sort of ponzi scheme, or… you guessed it, use real income producing assets. Like my stock portfolio.
3. You always have to live somewhere
Admittedly, the big hole in my “home value doesn’t actually help you retire” opinion is that if your house increases a lot in value, you DO have a valuable asset.
And if you wanted to, you could always sell that asset, cash in your big bucks, and be rich rich RICH.
But think this through…
If your house increased in value, what do you think happened to the other houses in your neighborhood?
Not surprisingly, real estate as a market is highly correlated to… the real estate market.
Individual homes rarely increase in a vacuum. They’re pretty much tied to all the other homes in a neighborhood, city, state, or even country.
Take these last few years. Our house in Minneapolis has skyrocketed in value, somewhere to the tune of 20%. Sounds amazing! Let’s cash out!
But where do we go?
- Every other home in Minneapolis has increased by 20%, too.
- If I want to go back to my homeland of Texas, general housing prices have increased even faster there.
- Same story if I wanted to head back to Denver.
- Maybe I want to go ski-bum it up in the western mountains? Whoops, modern day urban flight means all that land has gone up, too.
If I was planning on selling the house at age 35 to go live in a van or live on a houseboat, maybe it would make sense to count my home’s value as part of the master retirement plan. But that’s not in the picture for now, so the house value will stay out of the net worth calculations.
But don’t fret! Your home’s value isn’t worthless!
After all this home equity bashing, you might be thinking the house is worthless.
Far from it!
Home equity is awesome, because there is one HUGE benefit of owning a house. (It just has nothing to do with net worth and everything to do with cashflow.)
Done right, owning a home is an amazing expense reducer.
By owning a house, your monthly mortgage payments are locked in for the next few decades.
No longer are you at the mercy of your landlord’s rent increases or your economy’s inflation. (Which is looking scarier by the day.) A mortgage payment today from a 25-year old loan is going to be laughably small, since you’re basically paying rent prices from 25 years ago.
And once you pay off the house, you’ve basically just cut your living expenses in half. (Sadly, those living expenses don’t reduce to zero because non-mortgage related expenses like insurance, taxes, maintenance, etc. usually make up half of your monthly home expenses. They definitely do for me.)
This seemingly subtle distinction highlights the importance of tracking two numbers towards your financial freedom:
- Overall net worth
- Monthly cash flow
As I’ve laid out, for someone monitoring their progress to financial freedom, I don’t think a home does anything meaningful to your overall net worth.
But if you buy a good house that fits well within your budget, owning a home can have a seriously positive impact on your monthly cash flow.
And arguably, that’s the even more important metric for reaching financial freedom, anyway.
What do you think?
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Hi Money Wizard, just wondering if you are taking into account taxes on your $40,000 income from the million dollars?
Not in that hypothetical example, just because it’s less of a factor than you might think. Long term capital gains tax rate is 0% for married couples filing jointly up to $80,800 right now. For fun, here’s my article about how to earn $101,200 a year and pay no taxes. I doubt I’ll ever be able to take full advantage of that, but the point is clear – taxes have a smaller impact when you’re living off your investments than when you’re working for a living.
Of course, all this can change with politics, which is another reason why I’ll probably always do something fun to earn income.
is it different for Pension income??
Yes, I’m pretty sure pensions usually get taxed at your ordinary income rate. My article was all about taking advantage of long term capital gains tax rates. I’m no expert on pensions though.
Great blog, as always. I’m a renter and probably will be for a long time. I’m single and just like the flexibility to move every 12-18 months if a better job opportunity opens up, predictability of rent payments without expensive repairs, and peace of mind of not having all of my assets locked up in one place #diversification. Although not having a rent/mortgage payments sounds nice, you’re right, you’re always going to have repairs/maintenance/property tax expenses. I pay $1,000/mo for a 1BR apartment. Even if I had a $200,000 condo which is comparable to what I have now, I’d still have ~$500/mo in R&M/taxes.
Yep that was my same mindset, at least until the golden rule of rent vs. buy tipped for me.
If you value flexibility more, then it makes sense your personal golden rule would be something like “Not interested in buying a house unless the all in payments are 20% cheaper than renting.”
I respect your reasoning, and I totally get it. if anything it does give you a false sense of security in your overall net worth.
But with that said the reason why I keep it in there is because we put enough equity down that it is important factor in our financial picture.
If we needed to draw on some of that money or leverage it to make an all cash offer on an investment property, we could go and get a HELOC.
In 15 years or so when my kids are grown up and out of the house we would likely downsize, thus freeing up a portion of equity to go to investments.
And even though I do count it I also look exclusively at my allocations of my liquid net worth.
So I figure no reason to not count it, but also try to be realistic about its true value to us right now.
Makes total sense for you.
For us, the only way we could downsize would be to move into a shoebox, so it’s less of a factor. If I was planning on downsizing I’d probably count the house, or at least the portion that I planned to downsize.
My wife has been telling me not to track our home value in networth, and over time I’m agreeing with her. The question I’m stuck with is since you aren’t tracking home value in net worth, do you also not track your mortgage as debt? What do you do about mortgage?
Correct. I just count the full mortgage principal + interest as a “rent” expense.
Can you make an blog on your withdrawal strategy once you hit early retirement? Where do you think your account values will be in five years? How much will you pull from each account? Do you plan on converting pre-tax assets to ROTH? I think we as a community spend a lot of time talking about the asset accumulation phase but not much on the withdrawal part. Since your so transparent, it would be interesting to show your projections using your real numbers as an example for folks.
I did a little bit here:
My new life plan to “retire” at 35 and still hit $4 million dollars in net worth.
But I agree it’s something I need to dive into more.
There are many articles out there on paying off your mortgage ASAP and adding the large amount you pay in interest to your net worth. Are you planning to do this? Pros and cons?
Personally, no. With interest rates so low (3-4%) the expected return from the stock market is higher (5-10%) especially since I’ve still got 20-30 years ahead of me.
Plus in an inflationary environment, I think low interest rate debt is no sweat. IMO it’s better to invest into assets (like stocks) that can increase with inflation
I guess I dated myself with my post, We paid our houses off early when we were paying 7.5% interest on our loans.
Ah yes, in that environment it definitely seems like a tougher decision. I’d probably do the same.
I don’t count it either but in our case it only represents a single digit percentage of our net worth anyway, so its kind of a moot point. But I agree with your reasoning. Unless you have a firm geoarbitrage plan in mind its hard to see how you can recoup that equity while you are still breathing. If you use Personal Capital or some other aggregator it is easy to see both liquid and total net worth. They are both valid numbers but its risky counting home equity as real money unless you have a real plan to extract it that works.
Love that last sentence. “They are both valid numbers”
Just goes to show personal finance is about more than a single number. Always gotta consider the whole picture.
I think you should include it in your net worth! However, of course we understand and respect that it’s completely your choice at the end of it.
I remember talking with my parents who say that my net worth is artificially high because I include my car value as part of my net worth. I wholeheartedly disagreed and said that not including it would be completely illogical.
Who’s right? No one knows. However, I will always include it in my net worth and depreciate accordingly every year!
Props to you for making those depreciation adjustments!
Just curious, do you include any other high ticket items?
Thanks for this, validated why I’m not in a rush to buy when we can afford to invest over 50% of our income into financial assets because our rent i so dang cheap (and hasn’t gone up in over 6 years and counting). It’s tough when people brag about how much equity they have in their home (when they also bought that equity with big remodels too) to make us feel inferior.
Most people brag about home equity because it’s the only asset they have.
Ignore them. It’s better for everyone’s sanity.
Net Worth is an accounting term that has a specific meaning. It includes all assets and all liabilities. If everyone invents their own definition for a word, then it ceases to be useful in communicating an idea. The measure that you’re talking about may be total invested assets or net liquid assets, but it’s not net worth.
Yes, my accounting professors would be rolling over in their graves at my bastardized version of the term. But such is the joy of writing a blog not a textbook.
Good article. I wanted to mention that, in our families, we have seen that the paid off home was an asset for our mothers and grandmothers to help pay for their nursing home care at the end of their lives. So that is how we are handling the home equity: no HELOC, no reverse mortgage, or things like that. It will be an asset for the remaining spouse to sell when it makes sense for him/her. I see you are younger than me, so maybe this is something you hadn’t thought of, that is why I wanted to mention.
Thanks, Chris. Definitely a good point.
Good article. I track 2 numbers, total net worth and liquid net worth (without home value and mortgage debt). I keep them side by side to keep me realistic.
Dave Mc
I like this approach, too.
My wife and I are in the market for a house right now, but we’ve set a 2+ year horizon so that we don’t feel rushed. Ending up “house rich and cash poor” is the worst case scenario for us here!
I really like the point about liquidity. I’ve had a few discussions with a friend about whether or not your primary residence is a good investment. Thanks for giving me some more fuel! Before moving in with Mrs. Money Wizard, did you consider house hacking at all?
Yes we did, just never found something we liked in the part of town we wanted. House hacking is definitely one of the fastest way to financial independence though… highly recommended if you can swing it.
I was looking forward to this article, not for the article itself because I totally already knew what you were going to say, haha, but for the discussion in the comments section. I don’t think you should start including your house in your net worth in this blog, as it would artificially boost it suddenly. And I agree with all the points you made, and appreciate you stating good reasons why people should include it depending on their circumstances. And all that said, if you were to sell your home, you could just approach that like a windfall at the time.
I’m actually doing my twice-annual official net worth statement today and include a number of things like this – my car (depreciating appropriately each statement – it could be useful if I was to move to a city where I didn’t need a car and decided to sell it, for instance), my eBike, my security deposit and last month’s rent held on my apartment (not liquid, but money we’ll get back eventually), and around $9,000 of original paintings my wealthy former boss gave me (hahaha!). [Side note, I’d love to hear your thoughts on art – as a store of value, and investing in something like Masterworks.] I plan to track my home equity when the time comes since it’s useful to know (and more fun to have a higher net worth, haha), but I absolutely think it’s foolish to include any of these in any kind of financial independence number (of which I also track separately and give much more weight to), but the way I see it – these things do have value and can give you options and are useful to keep track of for that reason.
Thanks Mike, you really summed up what’s going on here, I think.
As much as I call this blog a net worth tracker, it’s really tracking what could more accurately be described as my “financial independence number.”
For me, that doesn’t include the house. For others, it might.
There are arguments to include your primary house and not top include your primary house. But the fact that it does not generate income should not be one of them. If I invest in gold it does not produce income but it would be included in my net worth calculation.
Fair catch. Instead of “doesn’t generate income” the more accurate description would be “isn’t liquid enough.” I was trying to simplify the idea of a liquid asset. Gold can easily be sold to generate temporary income to live. Can’t really do that with a house unless you go into debt or uproot your life.
I think its a balance for me personally. I count my Roth & 401k in my net worth despite not being close to 59.5 to use it without loop holes. I do count the estimated house value in my net worth because I live here to commute to work. I would ideally live in a lower COL area once retired. As the when is TBD, the cost of that ‘new to me house’ is TBD, but sale of my current residence would go towards that.
Things in my life have changed so much in the last 5-10 years, I’m working on saving and I’ll reevaluate as I get closer to retirement.
Love that approach. Focus on what’s most important – stacking money – and worry about the details later! Perfect.
Honestly, I’m the same. The only time it makes sense to consider your home as net worth is in estate planning, leaving things behind for children, etc. But I’m a far far way away from that.
Obviously this is a niche comment:
My wife and I bought a 2 family in 2010, lived in half, rent half. Bought a single family in 2012, converted the unit we moved from in a rental. Then moved again in 2016, into another, nicer duplex, so it resulted in adding 2 more rental units, since we now rented the single family, the new 1/2 duplex, plus the original 2 family.
So my house, at least presently, is an income producing asset (or at least a portion is)
We’ve also liberally opened up HELOCs and can genuinely “consume” our equity if we want.
I currently have an application for something I haven’t seen…a 100% LTV HELOC, with a variable rate of prime minus .25%, meaning the rate is 3%. So that’s a lot of low interest equity, at least for now.
Intetest at that rate is much less costly than taxes of selling assets (if you are above the 0% long term gain rates) or earning money at work
Like you said above, personal finance is….personal!