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.
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.
Unless you’re willing to move across the country or otherwise downsize, it’s nearly impossible to do anything with the increased value of your home.
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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