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
Credible offers some of the lowest refinance rates today because they have a large network of lenders competing for your business. If you’re looking to buy a new home, get a HELOC, or refinance your existing mortgage, consider using Credible to get multiple offer comparisons in a matter of minutes.
When banks compete, you win. Mortgage rates are still near all-time lows. Take advantage! Get a no-obligation quote from Credible today. I locked in a 7/1 ARM for 2.125%.
Explore Real Estate Crowdsourcing Opportunities
If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
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.
Finally, they recently launched their amazing Retirement Planning Calculator that pulls in your real data and runs a Monte Carlo simulation to give you deep insights into your financial future. Personal Capital is free, and less than one minute to sign up.
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.