In the ChooseFI community if someone posts a question about housing such as:
- should I buy or rent?
- should I pay off my mortgage early?
- is my house part of my net worth?
A long thread will begin with many great arguments on both sides of these questions. Posters have strong opinions on these topics. As the group is now Over 15000 members, if even 1% respond, that is over 150 posts.
This post will address whether to count your house as part of your net worth, especially as you get older and as the house is paid off.
My story: it took us 22 years to pay off our mortgage. With 5 years to go, we refinanced the last $87,000 on a five year balloon, amortized over a 30 year period, at 2.625%, with bi-weekly payments. This amounted to paying .0101% interest every two weeks. (Thirty year amortization means the payment is set to the equivalent of a 30 year mortgage. )
A balloon mortgage means that at the end of the balloon period, five years in this case, we would have to pay the balance of the mortgage off. This would normally be quite risky (if one made the minimum payments as if it were a 30 year loan) but in this case they had an out: for $200, one could get another 5 years at the rate current at that time.
I did some calculations and realized that if I kept my mortgage payment the same as it had been before refinancing, I could pay this off in the 5year window, which is what I wanted to do anyway, so I saw no downside. My old mortgage was a 10 year term at 4.75% and would have taken me a bit longer to pay off.
Worst case, if something happened to my income, I could have reverted to the minimum payments (which were very small) and taken the second 5 year term. This did not happen and we paid off our mortgage a couple months before I turned 60!
Back to the question – but is this part of your net worth? Financial advisors, who earn their living managing what they call your ‘investable assets’ do not count your home’s value. Not maligning them, but I think this is because they cannot make money off this asset – they often make their money from the assets you place under their control to invest. I can understand why they do not count it.
Another factor is liquidity. Stocks, bonds, mutual funds, CDs, and similar investments can all be converted to usable cash fairly quickly (within a few days at most). These are called liquid investments.
Real estate, whether it is your house or a rental property, cannot be sold and converted to cash quickly under normal circumstances. A property needs to be cleaned, fixed up and staged (made to look attractive for buyers). It needs to be advertised or otherwise promoted. The potential buyers need to be vetted and the title company will take time to arrange for the closing. Real estate is therefore deemed an illiquid investment.
But you can make money off your house. It plays an important part in your retirement strategy.
I recall watching a number of westerns that feature a widow who has turned her house into a boarding house in order to earn enough money to keep it after her husband has passed. The Shootist comes to mind. Today we call this house hacking. We have tools like airbnb to manage this.
Can I picture doing this in my own house? Not now. But if push came to shove, it is an option. (But, I suspect Mrs. TieDye wouldn’t approve.)
Another approach is to use the house like an ATM. Another topic that generates a long thread on the ChooseFI site (and other sites as well) is whether one should maintain an emergency fund. A counter argument to the emergency fund is to have all possible dollars invested. This line of reasoning posits that one could open a HELCO (Home Equity Line of Credit) and tap this for emergencies. Please note that interest rates on HELCOs are variable. Perhaps not a great idea in a time of rising rates.
Confession: we almost had our first house paid off in the mid-late 1980s. We had borrowed in the early 80s when interest rates were very high. In 1983 I had purchased two rental units for ‘no money down.’ This was not literally true, but it was close. Turns out that for a time they became cash flow negative. At the same time, interest rates were dropping. So I refinanced our house and paid off one of the rentals. Now I had about the same amount of mortgage debt, but at a much lower rate. I figured I could now use the positive cash flow from this rental to pay down my first mortgage. I also used a HELOC at some point in this process.
Be honest now, how many of you tapped the equity in your house to buy a new car or pay for a an expensive vacation or some other large purchase? Hopefully you learned that you were still making payments long after the asset had declined in value (or disappeared altogether) and determined that you wouldn’t do that again.
If you don’t mind risking losing your home to foreclosure, you can always tap the equity in retirement. (I hope you can tell by the way I wrote this sentence that I don’t really recommend this.) I did it when I was young and had time to recover should something have gone south. I don’t think I would ‘bet the farm’ in or approaching retirement.
So, If I we are ruling out house hacking and using your house as an ATM, why is it still part of your net worth? For 3 reasons:
1. Imputed rent – If we downsized our life we could in theory move to a two bedroom apartment (especially after my son moves out, which he asserts will happen this year). If we stayed in this area, we could end up paying $1800 – $2000 per month rent. Our utilities would be cheaper and we would not have property taxes. The net difference at the $2000 level would be around $1500 – 1600 per month (although no maintenance costs). That would be about $20,000 a year we would need in our budget or at least $500,000 more in net worth. So not renting (in this area) is worth about that much. As long as I am working we are bound to living in this area. Note that we would have the net from selling our house and moving, so that is a large chunk of that $500K, but not all of it. Oh, by the way, rents tend to go up over time!
Not to mention we’d have less privacy. We have a one-acre property, as do our neighbors. We are close enough that we see them and can visit if we want, but far enough to be just right. Apartments don’t quite offer the same level of privacy as a large backyard!. I like my neighbors, my neighborhood, and my trees. I cannot imagine living in an apartment complex if I did not need to.
So it seems fair to count my house in my net worth as it helps me avoid a large cash flow expense, in the same way that invested assets provide an income stream to pay for other cash flow expenses.
2. Geo-arbitrage – Some FI-ers who live in a high cost of living area (HCOL) are able to pay down their mortgage while they are earning the big bucks. At retirement they sell the expensive real estate and move to a LCOL area, buying a new house debt free and banking the difference. This is called geo-arbitrage, profiting from the difference in prices between two locations.
In our case, it may not be that easy. My wife and I are not very good at de-cluttering which is a pre-requisite for moving (in order to sell the house as mentioned earlier in this article).
For others though, it seems fair to count the house as part of one’s net worth if this strategy is a real possibility.
3. Reverse Mortgage – This is the last card to be played in the financial deck. Assume for sake of discussion you did the best you could to lower your expenses, you saved an amount you thought would be enough to see you through and you tried hard to live on 3-4% of your invested assets (plus pensions, social security, side hustles and any other source of income). Despite your best efforts, you reach your 80s and you realize you are going to outlive your assets. If it is unrealistic to sell your house and move to an LCOL area, or to rent in the same area, you could always get a reverse mortgage.
A reverse mortgage is somewhat misnamed – it is a mortgage like any other, except no monthly payments are required; the debt is settled when you die (or move permanently into a nursing home). The debt accrues interest according to the contract. At settlement time the lender may get fully repaid if the house appreciated faster than the loan, and/or you did not live too long. If you remain healthy and are able to stay in the house a long time, the lender may lose on the deal. Suffice it to say they can do the math better than you and will probably make a safe bet most of the time (or they will go out of business). They purchase insurance to cover themselves for their worst case outcome.
Because of the way the math works and their desire to stay in business, the lender will not lend near the full amount of the house. They have to preserve a margin for the interest to accrue so they will be able to collect. There are also larger fees for a reverse mortgage (that insurance I mentioned? Your fees are what’s really paying for the insurance, not them).
The upside of a reverse mortgage is that you do not have to make payments and you get to stay in your house until you can’t. The downside is that the mortgage costs more and in most cases there will be nothing to pass to your heirs – (your heirs will be offered first right of refusal to pay the mortgage off and retain the property, but they must do so in a short period of time).
While I characterize this as a last resort, it is still another reason you can count your house as part of your net worth.
As I See It: If you are young, not close to retirement, have extra money to invest, and have locked in a low interest mortgage, you may not be in a hurry to pay it off – it took us 22 years and the last 10 years were at a low interest rates (comparatively speaking). However, once paid off, your living expenses decrease, and the amount you need invested to support your retirement is less. There are ways to convert your house into money (although make no mistake, this is an illiquid investment). Therefore, it is appropriate to count this asset in your net worth.