There's a debate raging whether one should include their primary home when calculating net worth or not. I think it's absolutely fine to include you primary residence as part of your net worth.
For example, in 2020, I put down $1 million to buy a larger home during the global pandemic. To then not include the equity of my primary residence as part of my net worth would be foolish.
I didn't suddenly just lose $1 million! In fact, I used my $1 million to take on leverage to boost wealth. Home prices are up between 15% – 20% in one year in San Francisco since I bought the home.
On the other hand, in my post, “The First Million Might Be The Easiest,” I exclude my primary residence in calculating my net worth figure at 28. I excluded it to be conservative.
The way to calculate your net worth is a personal preference. So long as you are netting out your liabilities from your assets you're on the right path.
Calculating the proper net worth is all about creating different scenarios that match your risk tolerance and financial goals as we've discussed in “How To Better Manage Your 401(k) For Retirement Success.”
It does seem strange to exclude what is likely our most valuable asset from our balance sheet. This post will argue why it's absolutely fine to include our primary residence when figuring out how much we are worth.
A RENTER'S PERSPECTIVE TO NET WORTH CALCULATION
To understand the fallacy of not including your primary home in a net worth calculation, we must first look at the perspective of the renter.
When a renter calculates his or her net worth s/he adds up assets such as:
- Cash
- CDs
- Stocks
- Bonds
- Company equity share
- Cars
- Jewelry
- Pet Bunny
- Other Valuable Assets
And subtracts liabilities such as:
- Credit Card Debt
- Student Loans
- Car Loans
- Personal Loans
- Gambling Debt
- Alimony Payments
- Secret Lover's Credit Card
- Outstanding Tax Liabilities
We do not include perpetual rent as a liability. If we wanted to do so we would simply “capitalize the expense of rent” by taking the annual rent and dividing it by current rental yield rates e.g. $24,000 a year in rent / 4% = $600,000.
In other words, if someone was renting a $2,000 a month one bedroom forever, his or her liability would equate to roughly $600,000 at today's rates. Sounds extreme, but we all know that the return on rent is alway -100% so there is truth to such calculation.
If we were to conduct this net worth exercise for renters, then we would be severely punishing the 20-34 year olds who are mostly renters given the average age for a first-time homebuyer in the US is around 35 years old.
Can you imagine if the average 20-34 year old's net worth was -$300,000, assuming there are $300,000 in assets to deflect the $600,000 liability? The US would be in full blown economic crisis mode with politicians and young protesters going crazy!
A HOMEOWNER'S PERSPECTIVE TO NET WORTH CALCULATION
Now that we see the fallacy in capitalizing a renter's rental expense in the form of a liability, we should be consistent with our thinking and not include the capitalized mortgage interest expense in a homeowner's net worth calculations either.
The only remaining variable between a renter and a homeowner is the homeowner's home equity which is simply calculated by taking the estimated value of your home minus your mortgage.
You can take a look at your home's rough estimate online. I check at least once a week for fun as their algorithm updates 3X a week.
It makes no sense to one day have $100,000 in cash as part of your net worth, and then take a $100,000 net worth hit because you put down 20% for a $500,000 home. This is simply accounting, which everyone needs to understand especially those who are afraid of debt.
Remember, the return on rent is always negative 100 percent. After 30 years, you build zero equity renting.
Leveraging Debt To Build Wealth
I think the best mortgage amount is $750,000 dollars on about $250,000 in income because of the tax benefits. Any larger mortgage or income amount and the benefits start getting phased out.
Some would balk at such a high debt figure, but that's because they either don't make a healthy amount of income, don't understand tax law, or do not have alternative investments worth $750,000 or more that are earning higher than the mortgage interest amount.
I've been doing my own taxes for over 10 years and meet such criteria. I strongly believe in such a ratio with the current tax regime and 10-year yield at roughly 1%.
Home equity can be extracted through a Home Equity Line Of Credit (HELOC), where interest on $100,000 can be deducted from your income if you use the HELOC “not to acquire, to construct, or substantially improve a qualified home” according to the IRS.
The language is purposefully vague by the IRS so the average person can view such language as a green light to pay for a new car, college tuition, a 100″ LED TV, a vacation property, or new gold plated undies.
Careful Borrowing Too Much
A bank's goal is to get you to borrow as much as possible in order to earn an interest rate spread. The HELOC amount is largely determined by a Loan-To-Value ratio that goes no higher than 80%. In other words, let's say you have a $1 million dollar home with a $500,000 mortgage.
Your LTV is 50%. You may be able to get a HELOC worth $300,000 to bring your LTV to 80% because it's $500,000 primary mortgage + $300,000 HELOC = $800,000 / $1 million. Banks pushed such HELOCs like crazy during the bubble and got burnt because many homeowners also went nuts and ended up not being able to pay back their debt.
If it was impossible to extract one's home equity, then it would be more prudent to keep one's home equity off the net worth calculation since it is not liquid. Better to be conservative and crystallize the value of your home after a sale then bake in lofty home equity figures which might not be therefore for draw down or investment purposes.
See: Follow The 30/30/3 Home Buying Guide
YOU'VE GOT TO LIVE SOMEWHERE ARGUMENT
The “you've got to live somewhere” argument is the main sticking point for why we should not include our primary residence in our net worth calculations. Yet, given we do not penalize a renter by adding the capitalized rent liability, why should we take away the home equity of a homeowner? This would be inconsistent math.
Homeowners have on average a 40X greater net worth than renters for several reasons. One reason is the inclusion of home equity as part of such studies, whereas much of the common man does not.
If you take out home equity and were able to “buy” a renter or a homeowner like a stock, you would obviously buy the homeowner all else being equal because you realize there is real value in home equity even though it is off balance sheet.
I will always bet on the long term wealth creation of a homeowner than a renter with the same amount of non-housing assets due to inflation. If you are always going to be a price taker, then you will always be paying more money over time. You've got to get on the right side of the equation by owning assets in an inflationary environment.
THE SOLUTION TO CALCULATING THE PROPER NET WORTH
Figuring out how to calculate your net worth is a personal choice. Maybe you're feeling a little depressed one day because you found out your friend from high school joined Facebook in 2005 and is now a multi-millionaire at the age of 30.
Go ahead and inflate the value of your 1952 Topps baseball collection which includes Mickey Mantle's $80,000 rookie card if it's in near mint condition. Add back your primary home equity as well.
Or maybe you're feeling like your managed stock portfolio is up an unsustainably absurd amount over the past several years, but you don't want to sell because timing the market is a long-term losing proposition.
Go ahead and remove your primary home equity in your net worth calculation to give yourself a buffer in case of a decline in stocks. It takes 30 seconds to come up with your home equity and add or subtract from your net worth dashboard on Personal Capital or in a spreadsheet.
The Chinese having a saying that if the direction is correct, sooner or later you will get there. The main purpose of tracking your net worth is to make sure you are focused and figure out ways in which you can optimize the various portions of your net worth.
Net Worth Calculation Flexibility
For example, with the 10-year bond yield rising, you might consider allocating more of your net worth towards bonds and less towards stocks which recently hit all time highs. The 60/40 portfolio looks very attractive now. You might also consider offloading some of your real estate as well given higher rates means a decline in demand at the margin.
The single family residence in San Francisco I purchased in 2004/2005 cost more than my main rental apartment. If I want to feel richer, I will do mental accounting and pretend my apartment is my primary and my primary house is my rental.
Instead, I just omit my existing primary residence from my net worth calculation to keep things conservative while keeping a second set of net worth calculations to include my primary home's equity.
The more conservative you are with your net worth calculations, the higher the likelihood you'll end up with more than you expected. No matter how poor or how rich you are everything is about expectations. If you can continuously underpromise and overdeliver, you are going to be one happy camper!
Here is my recommended net worth allocation mix by age. Also check out my latest Net Worth Targets By Age, Income, And Work Experience post.
Shop Around For A Mortgage
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Explore Real Estate Crowdsourcing Opportunities
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Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible.
For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you're looking for strictly investing income returns.
I'd also check out CrowdStreet if you are an accredited investor. CrowdStreet primarily focuses on real estate opportunities in 18-hour cities where valuations are lower and growth rates are higher. Thanks to technology, the spreading out of America is a long-term trend.
I've personally invested $810,000 in real estate crowdfunding to diversify and earn income 100% passively.
Manage Your Finances In One Place
One of the best way to become financially independent and protect yourself is to get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize your money.
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Ever since I started using the tools in 2012, I've been able to maximize my own net worth and see it grow tremendously.
Include Primary Home When Calculating Net Worth Or Not is a Financial Samurai original post.
Cash flow & Net worth need to be taken together to get a full financial picture.
Most things neatly fall into one or the other bucket, except for housing.
For homeowners, if you have decided that you are not planning on selling and moving (downsizing / moving to LCOL area), and if your plan is to retire in the house you own, then you should not consider the equity in the home as part of your net worth, since it is tied up capital that is not a liquid income producing asset. In this case the benefit is in the cash flow side when you retire, you do not have rent as a liability.
If you think you may not retire in your current home, then perhaps you could include home equity as part of your net worth, but then after retirement, you need to consider, as a liability, how much money will be needed for the new location you plan to move to. If the place you move into will have a new mortgage payment, then the mortgage payment will be a liability on cash flow side. If you decide to rent after the sale, then the situation will be the same as that for renters.
For renters, expected rent accounting for increases due to inflation in rents is a liability on cash flow side.
The only “legitimate” argument for not including your home equity as part of your net worth is because you want to psychologically manipulate yourself into not feeling complacent. But that’s not good logic or good arithmetic; it’s something different.
Here’s a scenario– and not an extreme one– that illustrates the absurdity of not counting a owner-occupied residence as part of one’s net worth. Suppose there are two identical houses side by side: one you live in and own, the other is owned by someone who rents it out. The one next door comes available and you decide to rent it from the owner, and then in turn rent yours out to a tenant. If we treat investment property as part of net worth but don’t treat primary residence as part of net worth, then the mere act of moving next door has just increased your net worth by the value of your equity. That of course is absurd. Whether the home you own is bringing in a cash return that allows you to pay rent next door, or is bringing in an “imputed” return by SPARING you from having to pay rent next door, you still own the freaking house.
(NB: thanks to tax regimes, there may actually be a financial payoff to making that move. But that’s a separate issue from the net worth question).
Let’s consider another scenario, an absurd one: Bill and Bob were born on the same day, earn exactly the same income, are married to twin sisters, and always, in every circumstance, even spend exactly the same amount of money. They watch the same TV programmes, they have TO THE PENNY the exact same amount of money in the bank, in their pockets, etc. They own the same stocks. There is literally ZERO difference in their financial lives– not even one penny. And both of them rent identical houses that are next door to each other.
And then tomorrow Bill learns that his landlord has died and, because he likes Bill so much, he has left him the house in his will. So suddenly Bill owns the house. Bob had no such good fortune, but, drumroll, Bob looked down and found a stray quarter on the ground, and picked it up.
Who is going to be idiot enough to say that although their net worths were absolutely identical yesterday, now Bob is 25 cents richer than Bill?
+1
I choose to include my equity in my net worth, but don’t include such things as the car, TV, computers, etc. I feel like they would be more or less a wash when it comes to taxes I would pay if/when I sell off my investments. Besides one car is a lease, anyway- it’s a Spark EV by the way, because I wanted to try out an all-electric car for various reasons. My “main” car, I bought when it was 2 1/2 years old, and paid in cash. Most of my personal belongings are depreciating assets.
I take a relatively conservative financial approach. I purchased a house in SF in 2010 with over 50% down. 75% of the down payment came from selling the previous house, and trading up. Similarly that house I sold in 2010 was “financed” from proceeds from the sale of a condo in 2000. So, arguably the equity in the previous homes contributed to my current net worth. Additionally, I pay extra in hopes to be mortgage free ASAP. In fact, what I choose to do is mix my investments, some conservative and some not so conservative. Then I will sell those more high risk stocks, and periodically apply that against mortgage. Eg buy 100 facebook and then sell it off a year later hopefully at a profit, but whatever it’s worth later minus taxes goes directly against the mortgage, and then buy 100 more for next cycle. That feels like a win/win because some people believe we should be mortgage free, and others insist on paying off as little as possible on the mortgage because it’s low interest. This feels like having your cake and eating it too.
In any event I have many situations where I will pump thousands of dollars of my “net worth” into my equity, and the closer I get to having the mortgage paid off, the more anxious I am, because the monthly mortgage payment goes from a relatively high amount to zero the instant equity hits 100%, and my cost of living suddenly will drop substantially. That’s the carrot at the end of the stick this donkey is after. I can’t possibly accept those extra payments as reductions in my net worth any more than I can having put down over 50% when I could have just paid 20%. Yes, I could have used 30% to buy Facebook stock, but hindsight is 20/20. Besides I’m buying stocks anyway, in moderation. I’m also buying (gambling with) crypto, but that’s a whole different topic.
Additionally, maybe it’s just my skeptical take on banks, I can’t imagine that it would be so bad to have a paid off mortgage because if it were, that means it is a bad idea for banks to loan us money. But then again, I’m not really a financial expert. Maybe they’re just diversifying, and our loans are just another revenue stream. My take is that I can’t retire with a mortgage. It’s more a psychological thing. If I would retire today, I’d have 2 choices: pay off the mortgage or trade down to be be mortgage free.
I guess the basic argument is that a renter who would choose to buy would suddenly dramatically reduce his net worth. Not in San Francisco over the past five years. Since 2012, the house I purchased in 2010 has pretty much doubled in value while I’ve paid 4% interest. Now that it’s practically paid off, I won’t have to swallow that tax write off as much with the new tax bill going into effect this year.
As a side note, I read a lot of your articles but never comment. I just happen to come across them, googling. Just read the hot tub one last week. When my house is paid for, I’m planning a remodel that will include a new hot tub. Your articles are very interesting and educational. Congratulations on retiring at such a young age. I couldn’t have achieved that at 34 and have chosen to work until they stop wanting me. I know I’m not needed, but it makes me feel like I have a purpose.
Does the Personal Capital tool calculate home value as part of net worth?
Yes it does, based on Zillow or something similar.
Completely agree with this article! You are absolutely right with regards to the inconsistency between how net worth is treated for renters vs home owners. For those that think you should exclude home equity, in that case a liability must be shown for the renter as was shown in the article. This is completely crazy! This flawed logic would have to be taken one step further with the because “I need food/water to live” argument. e.g. therefore, I have a liability of £10,000 for Chickens (or Cows or Pigs or whatever… point is I need to eat!) See how stupid this sounds?
Of course you’re absolutely right, and for all the reasons you gave. The “you have to live somewhere” argument is particularly silly, because it also applies to renters; those who make this argument seem to forget this very crucial point. A homeowner has the option to sell– at a loss, at a gain, whatever the market is doing– and then pay rent. A renter has the option to rent. So they’re both renters or potential renters, but one of them also has a property. So it is only common sense to count the equity of the primary residence– positive OR negative equity, mind you (let’s not forget our underwater brethren)– in the calculation.
I can illustrate this with my own situation. Personally, I own 3 properties, and have been living in one of them. But through a sudden bit of fortune, I have recently been given a part-time caretaker position that comes with free rent. This could last a year or it could, frankly, last 20 years. So suddenly I have been able to rent out my former primary residence. It would be absolutely absurd to pretend that my net worth has just increased from one day to the next by $500,000… but then if I lose or quit my caretaker position, and move back into one of my properties, that suddenly my net worth has fallen by the value of whichever property I move back into.
A person who owns a house– let’s say it’s owned outright, only because this is simpler; in reality, you can adjust by any remaining liabilities e.g. mortgages– has the option to sell the house and become a renter. The amount that he would realize on the sale is absolutely part of net worth. FULL STOP.
The person who owns the house also has the option to take a loan on the house. Let’s say that two people own outright houses worth $500,000; let’s say that tomorrow one of them takes out a $100,000 loan on his, and one of them takes out a $300,000 loan. It is absolutely indefensible to pretend that these actions are identical, but if you don’t count your primary residence as part of net worth, then there is no reasonable way to distinguish between the two of them– because if you aren’t counting the house, then it’s ridiculous to count the mortgage or HELOC.
The person who owns the house, who is old enough, also has the option to do a reverse mortgage, and create an income stream that the renter cannot create from the house that he rents. When the reverse mortgage-taker does this, and he takes some of that money to the grocery store to buy a gallon of milk, if the cashier fails to say “Sorry, we can’t accept this money because the house you live in doesn’t count”, then the remaining equity absolutely has to count as part of net worth.
Well, I suppose it all depends on why you’re calculating your net worth. If you’re simply trying to get an objective picture, then yes, count your residence, because objectively it is indeed worth something.
If you don’t count it, then you end up with a very weird result. Consider this hypothetical:
John and Steve both have exactly $100,000 in the bank, and exactly $0 debt; they both own no home but pay exactly the same $800 per month in rent. They have an identical net worth.
Then, one fine Tuesday morning, John “sees a penny, picks it up, and all the day he has good luck.” And Steve’s uncle dies and leaves him a house valued at $300,000, which Steve immediately decides to move in to, thereby sparing him the necessity of renting; but he also considers that if he doesn’t enjoy the house he will sell it and join John in once again paying rent.
If we don’t count one’s primary residence in net worth, then we have the bizarre situation in which we have to say that John has a greater net worth than Steve, because, after all, John found a whole penny and picked it up, whereas Steve merely owns a house. I.e., they used to have an identical net worth, but finding a penny adds to one’s net worth whereas getting a house doesn’t.
Aside from that, let’s look, pragmatically, at what it means to own a property in which one lives: 1. You have home equity that you can tap, in many cases without actually vacating your house. 2. You have an asset that you can bequeath to heirs who can sell it. If you didn’t have that property, you wouldn’t. That’s pretty cut and dry. 3. You have an asset you can sell, which will put you in EXACTLY the situation of the renter in that now you have to pay rent, but with the key difference that you have a chunk of cash in your pocket from having sold that asset that for some reason we’re asking whether it’s actually “worth” anything. 4. You have a place to live that spares you from having to rent a place to live. The savings on rent is putative income. That income, of course, is reduced by expenses, e.g., maintenance and property taxes. But since that income is only PUTATIVE income it is NOT reduced by income taxes. So, e.g., a monthly dividend income of $2000 that is subject to 25% in income tax (and so is really worth only $1500) is no different than owning outright a house that would cost you $2000 to rent, thereby freeing you from spending $2000, but costing you $500 per month on average in maintenance and property taxes. And certainly we would all consider stock ownership that paid out $2000 per month in dividends (before taxes) as part of one’s net worth; so we should, likewise, regard a house that spares you $2000 per month in rent (but on which you have to pay expenses) as part of net worth.
The most important caveat is that since we’re talking about NET worth, you actually have to deduct the value of any outstanding mortgage.
I tend to be conservative in my calculations or calc both ways and compare or split the middle. There are lots of businesses in SF that only accept cash. I wonder how many of them actually keep two sets of books or just use the “one”.
As alluded already, the question is premised quite heavily on economic geography. I live down the street from Microsoft. Despite a clubbed client business, it still has a healthy enterprise business for the foreseeable future. There is not a lot of available affordable rentals or housing nearby campus. Thus the free cash flow from renting my house is non-trivial.
Arbitrage that by renting a similar size apartment a few miles away from Microsoft to arrive at 30-50% delta. I would continue to garner tax and home equity benefits while living a comfortable non-corporate lifestyle. Moving really is an opportunity to downsize throwing out crap your family doesn’t need. And frankly local moves are not too terrible.
As for repairs, we will place suitable credit checks so as to secure a deposit for repairs 3-5 months of rent. As they start their Microsoft careers at whatever lifestage, one presumes they value their credit and would like to maintain a pristine report.
Of course, your results may vary.
There is definitely financial advantages to owning a home and I agree that if you are doing net worth for comparison purposes it should be included, however for my own tracking I count the debt but not the asset of my home.
To be honest, one of the major reasons I do this is that it results in a lower figure and prevents me becoming complacent. If I included my PPR I would have a positive net worth of around $90k, however by excluding it my net worth is $-340,000). Seeing a negative number keeps me hungry to make progress and reduce that figure.
I’d probably add my home back in if I was trying to compare my net worth to someone else’s, but at the end of the day what does that achieve? For me Net Worth is a way to track my progress, not to see if I’m ‘beating’ someone else.
Well I would include my residence (along with wedding rings, furniture, cars, etc.) if I calculated my net worth. After all net worth, by definition, is assets minus liabilities. But for me that’s a meaningless number – I’m not going to sell by house or my jewelry.
What I compute instead is what I call “investment worth.” It includes stocks, bonds, IRAs, rental houses (minus mortgage), vacation home, etc. For me that gives me a better view of the worth of things I would turn into cash and/or otherwise sell and buy different investment.
Sounds good to me. The activity of home equity is how much one saves not renting. Might not save anything in the beginning, but the savings starts becoming significant over time thanks to inflation and fixed rates.
But on the bright side, they got to walk away given CA is a non recourse state and live it up with fancy cars and all yeah? Long live America. They were the ones who hurt the rest of us who kept on paying our mortgages and buying what we could afford.
Uncanny, my most valuable asset is my pet bunny and I financed it via my secret lover’s credit card!
So, I’ll bet our neighbors up north sure would argue FOR including a primary residence in net worth calculations. Otherwise, Canadian’s net worth might not be better than the net worth of us “poor” US citizens after all! Just thought I’d make the connection since you highlighted the high net worth of those silly Canucks in a recent post.
Dang, what a coincidence! Don’t tell your honey.
Canadians are now all super wealthy in my eyes and I will always let them pay for drinks and dinner. Rock on!
My home does not have a mortgage, so I always include a conservative estimate of what it would sell for. I “update” that figure twice a year by going to MLS.ca and looking at comparable properties for sale in my neighbourhood. My place is finished quite luxuriously, so I know I can get at least the average neighbourhood price should I need to sell it in a pinch as few other places are finished as nicely. I feel not including all the equity I have in my home would be silly, as it’s purely an asset without a mortgage. I do try to be conservative with my estimate of how much it is worth.
Good practice. I have a feeling housing is going to stop appreciating or take a dip over the next 3-6 months due to rates rising. But who cares over the years.
I do the same as for my paid-off house. I enjoyed the discussion here, but I just figure my networth two ways: financial networth (without the house) and total networth (with home equity and net pension value). I do not include anything else (cars, etc.).
At the end of the day it’s just a spreadsheet calculation. You can run your portfolio with your real estate included and see what happens when you remove it. For me it shows that I’m too cash heavy and, being as conservative as I am, that suits me ok right now.
With real estate included:
42% real estate (SF condo 80%/Punta Cana condo 20%)
42% cash
8% total global stock fund
8% total bond fund
Without real estate:
72% cash
14% stocks
14% bonds
Is cash in a money market account or in a CD?
What are your plans for the cash?
Hi Sam – The cash is in money markets. Three accounts which all started yielding 1% and are now around .85%. CIT Bank (.85%), Ally (.84%) and Barclays (.9%). What’s up with account yields going down while interest rates are supposedly rising?
Not sure what to do with the cash. I’m thinking of buying another rental property although it seems I have enough real estate right now. Stocks seem over valued here. Looking for a way to invest in my X factor, tennis and music.
I used to include it when I was starting out. Everything changed when I saw so much equity in my home. It is one of the problems of living in California. Our home values are higher! I stopped because I felt it skewed my net worth. I wanted my net worth baseline to indicate my investing progress. I approach my investments conservatively and leave out my home equity, furniture and personal items. I even leave out collectibles and other valuables. I do not count my cars as assets nor include the loans as liabilities.
I have never heard of not including a house in a net worth calculation.
I have seen discussions about what it should be valued at – but to exclude never.
I have lived in my house for only 5 years but have paid off more than 50 percent of my original loan value – if I had a 30 year mortgage and paid at the regular amount I would have paid about 5 percent of the value – I’d I exclude the value of my house all the extra money a paid on my mortgage would be gone!
We need to get people to pay down there mortgages – we need to let people include it in there net worth!
Not to worry. Everybody is free to include if they wish and not feel guilty about it!
Thanks!
I just sent a check for $12,200 on Wednesday, I,was hoping I did not just decrease my net worth foolishly!!!
Yeah I feel you have to include it. Money used to pay for a property is going to something you own, whereas with rent it doesn’t (it goes to allowing you to live somewhere for a month). If paying 2k in a mortgage increases your equity by 2k, you should count that. Not counting it would be like putting a mortgage payment into an index fund, but not counting those shares as part of your net-worth — why would you do that?
The idea of “capitalizing the expense of rent” is a silly one. You wouldn’t “capitalize the expense of property tax” or “capitalize the expense of maintenance” for a homeowner.
The beauty of renting is that I do not have any large, non-geographically diverse, housing assests to worry about. Renting minimizes risk in that regard. If the neighborhood / county / state / country goes to pot, I can either move or pay less for rent. I have options that a homeowner does not. We could argue as to the value of those options, but I wouldn’t ever consider putting them in a net worth calculation.
A House is an Asset (although not my favorite kind of one), and a Mortgage is a Liability. Both should be included for Net Worth calculations. I think we can agree on that one. Whether or not home ownership is a worthwhile endeavor is another thing altogether.
Which is why it’s silly to remove home equity from a net worth calculation.
I definitely think you are right about renting. If North Korea successfully detonates a nuclear missile in your home down you have less risk.
The question is, how is your net worth at your age and what is your net worth invested in if you are willing to pay someone else’s mortgage?
I’m worried less about North Korea, and more about the unfunded government pensions in Illinois.
My net worth is inline with your recommendations (7 years of work and ~$300k). The vast majority of that is invested in S&P 500 index funds.
I’m willing to rent because an equivalent property in the same neighborhood is currently a financially poor decision. What I mean by that is under any realistic appreciation over a 10 year timeframe, the net present value of owning a house in my neighborhood is negative. I’d put my monthly rent at 0.5% of the home value. I think my landlord values a good tenant and consistent cash flow over rate of return.
Indeed.
If we don’t count one’s primary residence as part of one’s net worth, then we also couldn’t justifiably count the value of a mortgage as a liability against one’s net worth. And that would be absurd, of course.
Good article, makes me think. I the idea of of subtracting potential rent payments from net worth is interesting, though I can see why it’s not done.
But, when we truly get down to brass tacks, this argument demonstrates why net worth is nearly useless as any sort of measurement.
At best, it’s a ballpark number. At worst, it’s dangerous and can give a false sense of security. (Financial bubbles are all driven by speculations around net worth) We can’t even agree on how to calculate it!
It’s much better to look at passive cash flow over time. It’s very concrete and takes into account nearly everything that you need. An increase in passive cash flow will indicate a growing net worth, anyway.
Just my $0.02
True. Net worth might be more an ego fulfilling calculation. Calculating viable income streams that can last a long time is what counts.
At the same time, took my folks think a high income is a path to riches and forget to accumulate a nut. A high income can disappear in a nanosecond.
Primary should be counted especially for those who put a large down payment. You don’t lose it when you purchase the home. Also when budgeting you include the mortgage payment as a cost. I highly doubt those who argue against counting your home in your net worth would be willing to walk away from the equity.
Don’t think they would either. It’s just accounting to make people feel better.
I definitely include my mortgage in my calculation of net worth in order to get an accurate estimate of net worth. In my case, it’s a huge liability so my net worth would be way off if I didn’t include it.
I ‘feel’ that a $1m mortgage is too big for $250,000 in income. I have a $300,000 mortgage and about that income and with the extra money invest in income-producing assets (getting 10-30% yields). When it comes down to it, I just wouldn’t want the burden of that large of a mortgage on a personal residence, especially if your state does not have an anti-deficiency statute. I believe you that in terms of tax planning it makes sense, but when your mortgage is 2.4% on an FHA loan, the benefit seems minimal. I haven’t done the same analysis as you so maybe you can tell me I’m wrong then I can go buy a super fly house.
I agree with you that there is a strong case to include your house in your networth. Like you, I keep 2 calculations – the one that includes just investments (which excludes personal property and the house) is where I judge my progress.
B, pmfji, a rule-of-thumb for U.S. credit standards (pre and post 2005/6 bubble) is a 700+ credit score will qualify for a .28 income/mortgage ratio, and a .31 income/total debt ratio. The $1mm/$250K is a .25 ratio, a slam-dunk for obtaining a mortgage for a borrower with decent credit. Your feelings are to be respected, not long ago there were quite a few commenters on an FS blogpost that ‘explained’ why they defaulted on a mortgage; not one of the commenters admitted responsibility or considered that they may have taken on too much risk.
I am fortunate to have never been in a position to consider defaulted on a mortgage; however, I do not believe that a borrower has a moral obligation to continue avoid defaulting on a mortgage. Arizona, where I live, has an anti-deficiency chapter that protects borrower’s on a purchase money mortgage from liability for a deficiency (meaning the bank can’t sue the borrower for the difference between the amount owed on the note and the amount the bank collected in a foreclosure sale). Bank who do business in Arizona are fully aware of our anti-deficiency statute. In a sense, most mortgages in Arizona are l”non-recourse”. The bank took this risk knowingly. They have a qualified staff of underwriters and other employees who are paid to analyze risk. As such, banks are in a better position than 99% of borrowers to analyze and assume risk. If I were in the position that many of my friends were in, I would not feel like I violated a moral obligation if I elected to short sale my home. I would view it as a purely business decision. Sometimes reorganization is necessary. The anti-deficiency laws are drafted to protect consumers and they should not feel ashamed to use them.
It’s a personal preference. A $1 million dollar mortgage only costs $30,000 a year in interest that is fully deductible at 3%. If you are bringing home $20,000 a month gross, is 1/7th your income in deductible interest really a burden? $20,000 is about $14,000 after taxes a month. More than enough money for me in SF.
I think if you’re calculating net worth the equity you have in your home should be included. It’s value is non-negligible and can be tapped either through a HELOC or through a sale.
That said, I wouldn’t include your home equity in any calculations to see if/when you can retire or meet certain other financial goals. But as a general picture of your net worth, I don’t see why it wouldn’t be included.
Not sure though. If you can pay off your home, this act can really accelerate your retirement plans.
Your net worth is your total assets less liablities. If you have $1m in cash today you are a millionaire. However, the statement that if you buy a house tomorrow for $1m in cash, you are no longer a millionaire, seems a little ambiguous.
The flip side is, if you include a property, should you include your cars, antiques, pictures, jewelry? If you exclude your main residence, do you exclude your holiday home that you rent out and that you bought as an investment/second home. Some people buy pictures, antiques and jewelry as items that they make use of, but that can be liquidated in times of need, and hopefully at a profit.
It really boils down to who wants to know, your bank, your buddy, or the local friendly burglar.
I think you include everything that has value and assign a conservative value to it.
Well said on the last part. And to the IRS and property assessor’s office. Gotta look as poor as possible!
Your home should be included in the net worth calculation. If you run out of money, you can sell the place and get some cash right?
You just have to know that it’s not liquid and there’s probably better ways to make money than stashing it in your home.
I probably should be more conservative with my net worth calculation and deduct commission and tax…
Would love to read a post with the details! Cheers
Although fundamentally we disagree on having a mortgage if you have the cash vs. investing it to try and eek out that 3-4% difference, I think we agree that one should consider the value of their residence in their net worth calculations. If you put it in the context that you have a $1M paid for home in SF, that if you chose too out of economic necessity (not because you wanted to), you could sell that and live in a very nice $150k home in some town in TN/IA/wherever and live off the $850k. A home is a great hedge against inflation, and at the same time is one of the things that you spend money on that enriches your life (or is should at least).
I don’t consider it in my net worth though when considering retirement…only from the expense side.
Sometimes it can eek out a 30-50% difference if I’m lucky as demonstrated with the Chinese Internet stocks this summer. It’s a personal decision based on risk tolerance and goals.
I will always maximize my tax shield and take advantage of government subsidies so long as they exist for one day they may not. They’ve been thinking of removing or lowering the $1 million mortgage indebtedness for years now. If and when they do, I will adjust accordingly.
I hear you, there is no argument that your math is correct & that it does make financial by the numbers to have a mortgage when cash is this cheap. I guess I already have enough other investments deployed that for me it makes me sleep better that instead of a $1m mortgage, I’ve got a paid for asset that nobody can ever take away from me…unless I don’t pay my taxes that is!
Ha! Yes indeed, but actually don’t be so sure.
Lots of countries have confiscated property from their citizens before. By having a large more, you become LESS afraid of the government and don’t mind them taking away your property as you funnel your cash to off shore accounts in Switzerland! Why do you think I took a business trip there this summer? To learn more about their ways!
The way I define net worth is what I would have if I sold my assets and paid my debts. Since the sale of my house (and payoff of the mortgage) would result in significant money here, the house *has to* be part of this calculation.
My opinion is that if people say a home should not be part of your net worth, they aren’t looking at anywhere the same definition of net worth that I am. I’m not saying I’m right and they’re wrong in this case, but having studied economics and such for many years, I guess I’m pretty hardfast on where I stand.
I agree. It’s weird that every commenter seems to agree so far, yet so many advisors, magazines, and folks say to exclude the primary residence. Not sure where the disconnect is.
I include my home in calculating my net worth because a) This isn’t my “forever home”. Therefore, at some point in the next few years I will be selling. b) I believe I am currently underwater on my home. I want to keep track, since I could be selling soon, to know how that sell will overall affect my financial situation. I’ll likely owe money. But then again, if the market continues improving, I may walk away with a small amount of money. Either way, those situations will change my net worth (I don’t see immediately buying another home, but rather renting for a while), so I want to plan for them. Including my home, with negative equity, as part of my net worth allows me to see the entire picture, including how selling my home will impact my finances.
The underwater angle is something I did not think about, and another reason to include a primary home as part of one’s net worth. We need as realistic an assessment of our net worth picture as possible. The good and the bad because personal finance is a journey that is hopefully progressing most of the time.
Thanks for sharing!
We include ours in our net worth largely because it’s an asset that has a large liability against it. We wouldn’t be showing an honest picture if we showed one without the other and it seems quite irresponsible to omit our largest liability from the calculations.
On the other hand, we don’t consider it “edible”, and by this I mean it’s not equity that we ever foresee ourselves tapping. Our HELOC is extended against an investment property and we have a lot of other opportunities for credit without turning to our personal home.
Yep. Good way about looking at the hone’s liability as therefore a necessity in inclusion. You guys did a HELOC to buy one or two more rental props? If so, which do you plan to pay off first?
I’m in the process of finishing a post about this right now and we disagree.
However, I’m fully on-board with your attitude about being conservative with net worth calculations.
On a side note, I have family in SF and I love visiting, but it’s been many years now. They lived less than half a mile from Coit for a very long time, but have since moved.
There’s some information you didn’t ask for.
What exactly do we disagree on? I encourage folks to so both calculations as it takes two secs to take out the value of their primary.
Looking forward to your post!
A home is almost as liquid as your lending club loans. It would take a month or two to sell all of them and there are somewhat high costs associated with selling. I track sale cost of home (priced to sell within 1 month) minus a conservatively high estimate on selling/closing costs as part of my net worth because that is what I view as the liquid value.
The higher the cost of housing in the area you live, the more important it is to include home equity as part of the picture. It is a higher percentage of your net worth and moving to a lower cost of living area and investing the difference is also an option.
Also keeping track of your debt/networth, networth/expense, and networth/income ratios are very good indicators of your financial health and the risk you carry (and you need both home equity and home loan value to make these accurate).
Sounds good to me. Although, an expensive home could still be the same percentage of net worth as someone with an inexpensive home given income and savings levels needed to support such respective homes.
All those ratios are great to keep track of.