# The Money Mustache Community

## Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: homeymomma on May 26, 2014, 07:34:42 AM

Post by: homeymomma on May 26, 2014, 07:34:42 AM
Just wondering if this is actually how it works. Assuming most people buy a house that's worth more than their own net worth at the time (I.e. 100K net worth, buy a home for 300k). Also assuming you plunk down only about 20%.

Does your net worth become negative until you pay off enough of your house and increase your own savings to offset the difference? Like, the 100K would suddenly become an actual net worth of -200K?

(My math)
100-60= 40 (remaining savings)
300-60= 240 (mortgage amount)
40-240 = 200 (savings - mortgage debt = net worth)

Or perhaps it would be -140K because you would include the 60K you put down as equity. Still, a negative number.

Is that how it works? If I want to buy a house but maintain a positive new worth, does that mean I have to amass a savings/investment total that is more than the cost of the house before buying? Do people just live with negative net worth for a while and that's normal?
Post by: matchewed on May 26, 2014, 07:41:00 AM
Your net worth is your assets minus liabilities. The house itself is an asset and can be counted as well in a guesstimate. It depends on the why you are calculating net worth.
Post by: BPA on May 26, 2014, 07:42:44 AM
I include the equity in my house as part of my net worth.

My whole savings/investment strategy for now is to pay down my mortgage.  I have a pension pending and a house worth more than twice what I owe on it.

I do not consider myself to have a negative net worth.
Post by: MelodysMustache on May 26, 2014, 07:44:41 AM
I include both the remaining amount of my mortgage and the current vale of my home in my net worth calculation.  But I think you are looking at it the wrong way.  Buying a house is not about what it does for your net worth the next day.  First it is about having a home you enjoy living in.  Second it is about your net worth in the long run.  Will you be better off 5, 10 or 20 years from the date of purchase.
Post by: frugaliknowit on May 26, 2014, 07:47:05 AM
Your net worth shrinks by the amount of your closing costs (several percent of the value of the house) for sure.  It will also shrink for all of the decorating, repairs, moving (believe me, this add up) and arguably furniture purchases.
Post by: chasesfish on May 26, 2014, 08:02:47 AM
This is always an interesting question.

Yes, buying a house shrinks your net worth, but primarily due to all the stuff you buy with it and the repairs/renovations you start doing.  Not to mention for you to sell it, you're usually going to eat 6% for a real estate commission or lower price doing it for sale by owner.

On the math piece, a home does count into your nest egg, but is not an income earning asset.  A paid off house is/should be slightly cheaper than renting (you still have to pay taxes, insurance, and repairs).

I look at having two numbers:  Total net worth as one number, then my early retirement number.  The early retirement number is total income earning assets and no debt.

I know for me to reach ER, the total amount I need is my target income earning assets, minus my current income earning assets, plus total debt.  (Target - Current Investments) + Debt.  That's the additional amount I need to stash away.
Post by: happy on May 26, 2014, 08:09:59 AM
Yes  using your figures you will have negative net worth until your equity in the house, or your investments increases above the size of your mortgage.  Some people here save up more than the house is worth before buying, so would never venture into negative net worth. If you can get a cheap accommodation arrangement then this is worth considering e.g. share household, because once you have a bit of a stash built, it will keep compounding and growing all by itself, whilst you then concentrate on a mortgage.  Unless your housing market has crazy good capital gains, provided you can get cheap rent its better to wait.  That said I think many of us get the mortgage before a good stash is built.

Edit. I can't believe I wrote this, must have been in lala land. I'm wrong - read ARS post below for the correct reply. Just shows not to believe everything you read on the internets.
Post by: arebelspy on May 26, 2014, 08:17:58 AM
No. Your net worth should go down the amount of your fees/closing costs.

Example:
NW of 100k (20k cash + 90k stocks - 10k student loans. those are your only assets/liabilities).  Buy a house for 300k, put 17k down. Pay 3k costs/fees. Get a mortgage for 283k (300-17 down).

Now your net worth is 97k (assets: no cash, 90 stocks, house worth 300.. Liabilities: 10k student loan, 283k mortgage).

It went down 3k due to the costs involved, but you transferred that 20k cash into 17k of equity, and the fees.. You didn't lose your whole down payment, nor is there not an offsetting asset for that large liability (the house offsets the mortgage).

So net worth should go down by the amount of the fees, assuming you bought at market price.  It may go up, if you got a deal (which very likely won't be the case if you bought off the MLS).

Hope that makes sense!

Post by: viper155 on May 26, 2014, 10:09:45 AM
Your net worth is your assets minus liabilities. The house itself is an asset and can be counted as well in a guesstimate. It depends on the why you are calculating net worth.

Your assessment is subjective. A house, rarely, is a true asset. If you have 100k in equity in a house that is worth 300k but you really pay 600k for the house after 30 years, this is not an asset. No way. So, to answer the original question....It depends who you ask. I say you are in the negative. MHO
Post by: Sonorous Epithet on May 26, 2014, 10:28:04 AM
Your net worth is your assets minus liabilities. The house itself is an asset and can be counted as well in a guesstimate. It depends on the why you are calculating net worth.

Your assessment is subjective. A house, rarely, is a true asset. If you have 100k in equity in a house that is worth 300k but you really pay 600k for the house after 30 years, this is not an asset. No way. So, to answer the original question....It depends who you ask. I say you are in the negative. MHO

You don't count the prevent value of future interest to be paid over the life of a mortgage in your net worth, only the principal remaining on the mortgage.

What if you decide to pay an extra \$500/mo? Then change it to an extra \$700/mo? What if you have an adjustable rate mortgage and the rate changes? What if you refinance to a better rate and a new term? What if you sell the house? What if you pay off the mortgage all at once?

In all of those situations, the total amount of interest you pay over the life of the mortgage will be different than what you'd calculate if you just paid the minimums for 30 years. (Hell, how often does anyone actually go a full 30 years paying only the minimum payments with none of the above situations happening?)

The interest you will be paying for any loan is not for the underlying asset that you're pledging as collateral. It's for the time you spend using someone else's capital (i.e., the money you borrowed to pay for the house). If the time has not passed yet, you don't owe it yet.

Knowing how much you will be paying in interest over the life of a loan is useful for planning how much cash you will need to pay out of pocket, but trying to capitalize interest is NOT useful for calculating net worth.
Post by: Pylortes on May 26, 2014, 11:01:29 AM
Your net worth is your assets minus liabilities. The house itself is an asset and can be counted as well in a guesstimate. It depends on the why you are calculating net worth.

Your assessment is subjective. A house, rarely, is a true asset. If you have 100k in equity in a house that is worth 300k but you really pay 600k for the house after 30 years, this is not an asset. No way. So, to answer the original question....It depends who you ask. I say you are in the negative. MHO

There seems to be a lot of misunderstnding on this issue. The OP poster asked about the effect on net worth.  Net worth is a calculation and there is nothing subjective about it.   When you purchase a house valued at \$300k, you an add an entry on you asset side for \$300k and entry on your liability side for the value of the loan.   You would also need to deduct out of pocket expenses like closing costs etc. as Areblspy went through.   Period.

The only subjetive part of this is the "value" of the house.  House values change all the time, but unlike stocks we don't receive a quote daily.  So it is harder to know until the time when you go to sell.  Personally, I have refinanced my house and during that process I was reuquired to get a new formal appraisal.  The only time I update my house value for purposes of net worth caluclations is when I have a new formal appraisal.  I ignore tax appraisals since they tend to be off from real market value.

So buying a house regardless of value \$8M house or a \$50k house will have no impact on your net worth at all, the only impact is the out of pocket expenses you paid for closing costs, furniture, prepaid insurance, etc.
Post by: SDREMNGR on May 26, 2014, 11:45:03 AM
What arebelspy said.  Your downpayment and principal pay downs go into your assets column.

But more importantly, many people misunderstand the purpose of a purchase of a primary residence.  It is two separate goals in one.  1st is that you are purchasing a consumer good, namely a place to live.  2nd is often the biggest financial investment of your life.  The two are separate things.

For example,  you may buy a huge house that is bigger than you need, in a nice neighborhood,  but you buy at a good price in 2009.  As a consumer purchase, you did bad and are paying for more house than you need, but as an investment, buying the bigger house allowed you to make greater appreciation if you were to sell today.  So you may have made the right decision overall.  It depends on your goals.

Sometimes people buy at wrong times, at too high a price for what they are buying for the market, etc.  So you can buy a small house but at a high price and lose money at sale.

Unlike stocks, real estate is most often purchased with leverage, a loan, so you will pretty much always make money if you "buy right" and hold it sufficiently long enough.  And by buying right, I mean that you buy it at 20+% below it's market price (at the time of purchase) and it's rental value will have positive cash flow for property on leveraged basis.

So when you buy the house of your dreams, figure out which dreams it satisfies.  Typically it satisfies your consumer purchase dreams not your investment dreams.  People don't typically say, I bought this house that isn't exactly where I want to live and the house is too small for us but we bought it so cheap and we have made 3 times our investment in 2 years.  They usually say, I bought our dream house with a chef's kitchen and charming garden and great location to my work, etc.  These are your personal consumption criteria, not financial investment ones.

Be crystal clear on why you are buying the house and be ready to pay for the consumption side of the equation.  Because it is a conscious or subconscious consumption decision.
Post by: Jamesqf on May 26, 2014, 12:10:26 PM
Your assessment is subjective. A house, rarely, is a true asset. If you have 100k in equity in a house that is worth 300k but you really pay 600k for the house after 30 years, this is not an asset. No way. So, to answer the original question....It depends who you ask. I say you are in the negative. MHO

But that also depends on how much you would pay to rent if you didn't buy a house.  Of course this is variable, just like buying a house is variable.  If you really want to save, you could live in a small apartment with several roommates, or even in a van.  But in my experience, at least, if you buy a dwelling place that is the same as you would rent, within a few years you will be paying less per year to buy.

For instance, my mortgage payment (including taxes & insurance) is about \$1100/month  (with something over \$400 going towards principal.)  .  Renting a similar place would run \$1500/month or more. So assuming I am going to maintain the same lifestyle, in 30 years I will have paid \$396K, and own a house, vs \$540K in rent with nothing to show for it but the need to come up with next month's rent :-)

Or you might look at it a different way, and ask why so many people here see owning rental property as a really good investment.  Just think of buying a house as owning a rental property that you rent to yourself :-)
Post by: data.Damnation on May 26, 2014, 12:15:57 PM
As others have mentioned, your net worth does not change, but your liquid net worth does goes down since your assets are now tied up in a non-liquid asset. You should always have some liquid net worth to cover for emergencies like a job loss or medical illness.
Post by: Cpa Cat on May 26, 2014, 12:49:37 PM
Your net worth is your assets minus liabilities. The house itself is an asset and can be counted as well in a guesstimate. It depends on the why you are calculating net worth.

Your assessment is subjective. A house, rarely, is a true asset. If you have 100k in equity in a house that is worth 300k but you really pay 600k for the house after 30 years, this is not an asset. No way. So, to answer the original question....It depends who you ask. I say you are in the negative. MHO

I think you're getting the asset and the liability mixed together. When you purchase the home, you own it. It's an asset. It's not a liquid asset, but it is worth \$300k. When you sell it, you will receive \$300k (minus selling costs). That's an asset.

The liability is the mortgage. You are not paying \$600k for the house. You are paying \$200k for the house (assuming \$100k out of pocket down payment). You are paying \$400k for interest. The interest is not a reflection of the value of your house, it's a reflection of the cost of borrowing money. And although you will pay that amount of interest over time, you could turn around tomorrow and pay that liability off with \$200k - thus it is a \$200k liability, not a \$600k liability.
Post by: arebelspy on May 26, 2014, 01:04:49 PM
Your net worth is your assets minus liabilities. The house itself is an asset and can be counted as well in a guesstimate. It depends on the why you are calculating net worth.

Your assessment is subjective. A house, rarely, is a true asset. If you have 100k in equity in a house that is worth 300k but you really pay 600k for the house after 30 years, this is not an asset. No way. So, to answer the original question....It depends who you ask. I say you are in the negative. MHO

I think you're getting the asset and the liability mixed together. When you purchase the home, you own it. It's an asset. It's not a liquid asset, but it is worth \$300k. When you sell it, you will receive \$300k (minus selling costs). That's an asset.

The liability is the mortgage. You are not paying \$600k for the house. You are paying \$200k for the house (assuming \$100k out of pocket down payment). You are paying \$400k for interest. The interest is not a reflection of the value of your house, it's a reflection of the cost of borrowing money. And although you will pay that amount of interest over time, you could turn around tomorrow and pay that liability off with \$200k - thus it is a \$200k liability, not a \$600k liability.

Kiyosaki fucked up bunch of people up by convincing them their house is not an asset, and trying to reframe asset as "something that puts money in your pocket" and liability as "something that takes money out of your pocket" and trying to call your house a liability.

It's fine to think of it that way for certain purposes, but that doesn't make it correct for a purpose like net worth.  The house is an asset offset by the mortgage liability.
Post by: Cpa Cat on May 26, 2014, 01:22:01 PM
Kiyosaki fucked up bunch of people up by convincing them their house is not an asset, and trying to reframe asset as "something that puts money in your pocket" and liability as "something that takes money out of your pocket" and trying to call your house a liability.

It's fine to think of it that way for certain purposes, but that doesn't make it correct for a purpose like net worth.  The house is an asset offset by the mortgage liability.

Ok. I get it. To be clear for everyone else, those aren't the definitions of an asset or a liability.

An asset is simply something that you own that has a value - it doesn't have to generate income, it doesn't have to be easily convertible to cash - it just has to be worth something.

A liability is simply something that you owe. A 0% loan from Grandma with no payment schedule is still a liability.

The definitions of assets and liabilities are only subjective in the Arthur Andersen school of Accounting. ;)

Post by: Jamesqf on May 26, 2014, 11:21:19 PM
The liability is the mortgage. You are not paying \$600k for the house. You are paying \$200k for the house (assuming \$100k out of pocket down payment). You are paying \$400k for interest. The interest is not a reflection of the value of your house, it's a reflection of the cost of borrowing money.

OTOH, if you rent a similar house, you are still paying that same interest, just on your landlord's behalf.

Quote
And although you will pay that amount of interest over time, you could turn around tomorrow and pay that liability off with \$200k - thus it is a \$200k liability, not a \$600k liability.

Good point!  Plus the \$200K liability declines a bit every month, as part of each payment reduces the principal owed.  That principal balance is your liability, since you can pay it off at any time.
Post by: fixer-upper on May 27, 2014, 01:19:19 AM
Just think of buying a house as owning a rental property that you rent to yourself :-)

My tenant is a jerk, but he's cheap labor for renovating the old shacks I put him in.

As a levered asset, houses tend to suck as an asset class.  Without leverage, it isn't too hard to get a ten percent annual ROI after figuring in rent savings, appreciation (better deal buying with cash), and a bit of sweat equity.

My current project house should net 15% ROI just in rent savings.  Add in the projected equity return from making it "lendable", and the annual ROI goes to 33% (tax free) with a three year holding period.