The Money Mustache Community
General Discussion => Welcome and General Discussion => Topic started by: Ferrisbueller on October 05, 2014, 03:34:52 PM
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Hi all
For me it's saving as it's contributing to the equity in a substantial asset that can be traded down in future). So in calculating my savings rate I include the mortgage.
We have a large mortgage 500k over 25 years on a house around $950k-$1m value and mrs ferrisbueller and me really love our house. House is around 1500sqft in case anyone thinks it's a 3,000sqft McMansion.
But, I can see counter arguments;
- family home is not an investment (some say it's the opposite!)
- we could choose a much smaller house with small/no mortgage
- a huge amount of interest is paid on 20+ terms especially
- opportunity cost of putting the money to better (investment) use
What do you think and why?
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I count the mortgage payments towards my savings, simply because those payments would otherwise be going to savings. Of course, in my case, I "invested" in property in a declining area, so every time I pay a chunk off the mortgage, the value of the house goes down by more or less the same amount...
(I'm underwater on three houses, if that helps.)
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Only the principal, not the interest or escrow.
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F-yeah! (Principal, extra principal payments only)
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Only the principal, not the interest or escrow.
This is how I view it. Unfortunately, it is a low-yielding investment. Wait, that just means I hardly pay any interest! After tax, after inflation, the money is pretty close to free.
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I don't count any of it as savings. Reasons why:
-Extremely illiquid. Hard to get $ back out and usually takes either a large transaction cost (selling costs) or turning around and paying interest again on the money you just 'saved' (HELOC).
-You aren't really 'saving', you are paying down a liability. It doesn't seem any more like saving than paying down a car loan, even though paying down a car note also involves a sizable 'principal' portion in the payment. The fact that a house is supposedly an appreciating asset as opposed to a car doesn't change my view on this.
-The equity resulting from the note you are paying down can disappear at the whim of the local property market with no guarantee of returning. I suppose the same could be true of savings that are invested into stocks, but the difference is I don't view my primary residence as an investment, nor does it provide any return if the value remains stagnant (at least stocks spin off 2-3% in dividends).
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I don't count any of it as savings. Reasons why:
-Extremely illiquid. Hard to get $ back out and usually takes either a large transaction cost (selling costs) or turning around and paying interest again on the money you just 'saved' (HELOC).
-You aren't really 'saving', you are paying down a liability. It doesn't seem any more like saving than paying down a car loan, even though paying down a car note also involves a sizable 'principal' portion in the payment. The fact that a house is supposedly an appreciating asset as opposed to a car doesn't change my view on this.
-The equity resulting from the note you are paying down can disappear at the whim of the local property market with no guarantee of returning. I suppose the same could be true of savings that are invested into stocks, but the difference is I don't view my primary residence as an investment, nor does it provide any return if the value remains stagnant (at least stocks spin off 2-3% in dividends).
This. And also, money paid towards my mortgage is my expense for shelter. I think of it in the same vein as paying rent. I need a roof over my head, and there are two ways to get one, buy a house or rent one. Paying interest on a mortgage is paying for rent, and paying down the principle is how I reduce my future housing costs. But it's not savings, IMO.
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No it's not saving! It's just paying off a debt.
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No it's not saving! It's just paying off a debt.
Although if you think of your household as having a balance sheet, reducing your liabilities is really no different from increasing your assets. It is true, though, as mentioned above, that this is a very illiquid form of savings.
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I absolutely consider it a form of savings. Whether or not those savings are liquid or illiquid is beside the point and a different topic of discussions (i.e. How much liquid capital should you have available?).
Consider, some folks like us use a portion of our income to prepay our mortgage rather than putting that excess cash in a different investment vehicle. IMO if you are storing rather than consuming, whether liquid or illiquid, it is a form of savings. When the house is eventually sold the savings are released from behind their dam.
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Sure, it increases your net worth and lowers future expenses eventually.
It's just a really poor return on investment.
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I count my principal when I figure out my savings rate. I rationalize it by saying that my principal payment is like buying a long term CD, while my interest and escrow payments are like paying rent. My income is relatively small, so it makes me feel like I'm cheating when I do this, but I also like that it puts my savings rate closer to "mustachian" levels.
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Remember some of that payment sticks around when you get rid of the loan - taxes and insurance still suck. Make sure not to count that stuff.
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I have a cash flow spreadsheet that has my paychecks and expenses going a year into the future.
On that same sheet, I list my assets and liabilities and also calculate how many months expenses I have in savings.
I list house payments only in my cash flow section, and don't even list the house as an asset. I'm less sophisticated than most people here in a number of areas.
However, on the wall, I have an amortization schedule for the house showing the extra principal payments ($1,125/mo) and total loan outstanding. My goal is to keep up this extra payment until at least the end of 2016. If I can keep it up, the house will be paid off in 2019. If after 2016, I have to revert to normal payments, I'll still have the house paid off by the time I'm 62. I don't want a job loss in my 50's to result in making payments into my mid-60's.
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The reason why I think liquidity matters when considering if something is savings (my personal viewpoint):
To take a contrarian angle on the view that paying down a mortgage is storing equity in a house that can be released at a future point (I agree with this in theory), but as a devil's advocate...what if it can't? Selling a house requires finding a specific buyer at the right price, sometimes this is very easy to accomplish and sometimes it's not, and sometimes houses are extremely difficult or impossible to sell. At the very least, even in a recession or down market, you know exactly how much you can sell something like an index ETF for, and there is the market liquidity to sell it instantly and retrieve it's current fair value in cash if you chose. I'm not trying to compare stocks to real estate as investments or say that nobody should buy houses, just explain part of why I don't view paying down mortgage debt as part of my savings rate...savings to me are things I can get at when I need or want to, maybe not instantly but in relatively short order (measured in days, not weeks/months/never).
I agree with Primm that a mortgage is the expense I pay for housing, and the reason I have one is because after running the numbers it cost less to buy over the long term than to rent at the lifestyle level I want. While there is stored value there, IMO it's main benefit is that the lower lifetime housing cost from buying (circumstance specific and not the case for everybody) allows me to have extra money that gets saved/invested elsewhere.
Although if you think of your household as having a balance sheet, reducing your liabilities is really no different from increasing your assets. It is true, though, as mentioned above, that this is a very illiquid form of savings.
I suppose this is true from a purely balance sheet perspective. From a realistic perspective I would say having $100 in your hand is different than owing someone $100 less, in terms of utility.
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+1 for the 'not saving, but paying off a debt' camp.
One of the early posters noted he's underwater on three houses - taking that example to the extreme, one could pay every available cent to mortgages, and have a ridiculously high 'savings' rate when in reality, it's just servicing debt. I think net worth is the best indication of financial health, assuming mortgage = debt.
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The reason why I think liquidity matters when considering if something is savings (my personal viewpoint):
To take a contrarian angle on the view that paying down a mortgage is storing equity in a house that can be released at a future point (I agree with this in theory), but as a devil's advocate...what if it can't? Selling a house requires finding a specific buyer at the right price, sometimes this is very easy to accomplish and sometimes it's not, and sometimes houses are extremely difficult or impossible to sell. At the very least, even in a recession or down market, you know exactly how much you can sell something like an index ETF for, and there is the market liquidity to sell it instantly and retrieve it's current fair value in cash if you chose. I'm not trying to compare stocks to real estate as investments or say that nobody should buy houses, just explain part of why I don't view paying down mortgage debt as part of my savings rate...savings to me are things I can get at when I need or want to, maybe not instantly but in relatively short order (measured in days, not weeks/months/never).
I agree with Primm that a mortgage is the expense I pay for housing, and the reason I have one is because after running the numbers it cost less to buy over the long term than to rent at the lifestyle level I want. While there is stored value there, IMO it's main benefit is that the lower lifetime housing cost from buying (circumstance specific and not the case for everybody) allows me to have extra money that gets saved/invested elsewhere.
Although if you think of your household as having a balance sheet, reducing your liabilities is really no different from increasing your assets. It is true, though, as mentioned above, that this is a very illiquid form of savings.
I suppose this is true from a purely balance sheet perspective. From a realistic perspective I would say having $100 in your hand is different than owing someone $100 less, in terms of utility.
+1 As for Net Worth, yes. As for my Investments No.
We plan to live in this house for many years. This property or any change in the future will probably be passed on to heirs.
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Only the principal, not the interest or escrow.
Samesies, brosef!
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+1 for the 'not saving, but paying off a debt' camp.
One of the early posters noted he's underwater on three houses - taking that example to the extreme, one could pay every available cent to mortgages, and have a ridiculously high 'savings' rate when in reality, it's just servicing debt. I think net worth is the best indication of financial health, assuming mortgage = debt.
People in this forum use savings rate as a form of measurement to determine things like how little they are consuming, how quickly they can FIRE, etc. In both of those cases money not being consumed is going to the positive side of the balance sheet in one way or another. In your example with the houses it really makes no difference what the home is worth, retiring debt is improving the balance sheet no matter what the principal balance (underwater or three months from completely paid off), and the balance sheet is all that ultimately matters.
Cash flow issues are a big part of the overall discussion of course, but I don't think they apply to this discussion.
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I think of savings as what I don't spend. I include the principal portion of our mortgage in our savings rate.
I don't use my savings rate now to figure out my years to retirement from MMM's chart. It assumes that your expenses will stay the same in retirement. But, I won't have mortgage interest expense in retirement. It also assumes a higher rate of return than my mortgage pays me.
So for now I use my own calculations. Once the house is paid off and I'm investing the money instead, I can use MMM's chart for a rough guide.
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Like many, I count the payment towards principle as "savings" when figuring out savings rate and other such things and count all other payments including interest/property tax/insurance as an expense.
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I consider my house a savings vehicle, because I'm only paying 2.75% interest on it so the average yearly increase in property value easily exceeds the cost beyond principal. Plus, I am putting this money into equity rather than giving it to a landlord to put into his bank account instead. When I am old and move to a warm weather state without state income taxes, I'll sell the house and add the money to my 'stache.
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I don't... and here's why.
I consider savings to be (oversimplifying here) : Income - expenses
I consider net worth to be: Assets - Liabilities
Mortgage payments are (again oversimplifying):
insurance (an expense)
interest (an expense)
principal (a reduction in liability) -- NOT an expense
In other words: the big chunk you would call savings isn't an expense. At this point we're really talking about asset transfer. You have an asset (money in your checking account) that you're transferring to another asset (your home equity) by reducing Liability.
TL;DR:
Income/expense: relates to savings
Assets/Liabilities: relates to net worth
Yes, they're related, but they're not the same thing.
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I don't count any of it as savings. Reasons why:
-Extremely illiquid. Hard to get $ back out and usually takes either a large transaction cost (selling costs) or turning around and paying interest again on the money you just 'saved' (HELOC).
-You aren't really 'saving', you are paying down a liability. It doesn't seem any more like saving than paying down a car loan, even though paying down a car note also involves a sizable 'principal' portion in the payment. The fact that a house is supposedly an appreciating asset as opposed to a car doesn't change my view on this.
-The equity resulting from the note you are paying down can disappear at the whim of the local property market with no guarantee of returning. I suppose the same could be true of savings that are invested into stocks, but the difference is I don't view my primary residence as an investment, nor does it provide any return if the value remains stagnant (at least stocks spin off 2-3% in dividends).
This. And also, money paid towards my mortgage is my expense for shelter. I think of it in the same vein as paying rent. I need a roof over my head, and there are two ways to get one, buy a house or rent one. Paying interest on a mortgage is paying for rent, and paying down the principle is how I reduce my future housing costs. But it's not savings, IMO.
I also would consider it an expense for shelter. I would only consider it savings (or a return on my investment) if and when it were sold and I made a profit BEYOND the complete costs of owning the homes. So basicly what's left after I deduct all the principal, interest, property taxes, insurance, additional utilities, maintenance, repairs and my time to do them (based on my hourly wage), as well as the cost to buy the place (loan fees, points, appraisal, inspections, etc..), and the cost to sell the place (often a huge amount of money in realtor fees alone, capital gains taxes, etc...). Then, once it's converted to cash, I would consider anything that remained (if any - could be zero, could even be negative) beyond all those other expenses to be the amount I saved.
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absolutely not
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I don't count any of it as savings. Reasons why:
-Extremely illiquid. Hard to get $ back out and usually takes either a large transaction cost (selling costs) or turning around and paying interest again on the money you just 'saved' (HELOC).
-You aren't really 'saving', you are paying down a liability. It doesn't seem any more like saving than paying down a car loan, even though paying down a car note also involves a sizable 'principal' portion in the payment. The fact that a house is supposedly an appreciating asset as opposed to a car doesn't change my view on this.
-The equity resulting from the note you are paying down can disappear at the whim of the local property market with no guarantee of returning. I suppose the same could be true of savings that are invested into stocks, but the difference is I don't view my primary residence as an investment, nor does it provide any return if the value remains stagnant (at least stocks spin off 2-3% in dividends).
This. And also, money paid towards my mortgage is my expense for shelter. I think of it in the same vein as paying rent. I need a roof over my head, and there are two ways to get one, buy a house or rent one. Paying interest on a mortgage is paying for rent, and paying down the principle is how I reduce my future housing costs. But it's not savings, IMO.
I also would consider it an expense for shelter. I would only consider it savings (or a return on my investment) if and when it were sold and I made a profit BEYOND the complete costs of owning the homes. So basicly what's left after I deduct all the principal, interest, property taxes, insurance, additional utilities, maintenance, repairs and my time to do them (based on my hourly wage), as well as the cost to buy the place (loan fees, points, appraisal, inspections, etc..), and the cost to sell the place (often a huge amount of money in realtor fees alone, capital gains taxes, etc...). Then, once it's converted to cash, I would consider anything that remained (if any - could be zero, could even be negative) beyond all those other expenses to be the amount I saved.
Exactly!
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In my networth calculation, yes.
In my savings rate, yes (principle only).
In my FIRE number, no, because we plan to continue to live in this house. While it does not make sense, we will be paying off the house as a requirement to FIRE.
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Do we include our car payments as savings too? That's basically the same thing. Maybe your car depreciates faster than your home, but there's no guarantee. My car maintenance costs are proportionally similar to my home on any given year. About the only thing a home has going for it as a savings vehicle is the land it's sitting on since that can't be destroyed, but it can go down in value as well, and you do have to pay taxes on it.
Case study...we bought our home for $620k in 2004. Peak of the bubble it was valued at $750k (2006). Our family members were all gushing about how the home was basically our retirement vehicle...my inlaws even suggested that we could cut back our 401k contributions because the house value was what was going to make us wealthy.
Fast forward to today - ten years later - the home is worth $485k on zillow and $520k to the tax man. TEN years, -20% return, AND that's ignoring the interest costs and refinance costs that we've done in the meantime. Savings my ass. And oh yeah, there was recently a $6k HVAC cost due to failed heat pump, several thousand worth of water damage due to faulty plumbing by builder, not to mention all the modifications we've done for more livability that we won't get a full return on if we ever sell (landscaping, deck and patio, finishing the basement).
Another five years or so and the roof will need to be watched for replacement! Oops there's another $15k. In ten years it'll be all new windows...another $20k out the door!
Whoever thinks of a home as savings and not a speculative investment is full of shit IMO. It's a place to live and a liability. Period.
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Whoever thinks of a home as savings and not a speculative investment is full of shit IMO. It's a place to live and a liability. Period.
Meh, it doesn't need to be guaranteed to go up to be savings. While houses historically haven't been a great investment, they still traditionally go up at roughly the rate of inflation. If someone makes 100k after tax and puts 50k against their mortgage and only 10k into "investments" is their savings rate really only 10%? I don't think that makes any sense. The fact you had a bad experience doesn't really matter, investments are not guaranteed to go up either.
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Suppose you borrow $50K and invest in an ETF. the repayments are savings. Either pay 50K and invest, if you have the money, or borrow $50k and invest and pay off later.
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Whoever thinks of a home as savings and not a speculative investment is full of shit IMO. It's a place to live and a liability. Period.
Meh, it doesn't need to be guaranteed to go up to be savings. While houses historically haven't been a great investment, they still traditionally go up at roughly the rate of inflation. If someone makes 100k after tax and puts 50k against their mortgage and only 10k into "investments" is their savings rate really only 10%? I don't think that makes any sense. The fact you had a bad experience doesn't really matter, investments are not guaranteed to go up either.
Yep, good example. To Big Owl, a car is eventually going to depreciate to zero and a house is not, so you are talking apples and oranges. So no, I don't consider paying off a car (which is just a tool) savings. If and when a home is paid off it has significant value, that value will be liquidated at some point in the future. It matters not if the house depreciates instead of appreciates over that time period, the owner will still have significant wealth trapped in that home.
The very real fact that real estate has depreciated since 2008 has made wealth disappear, and of course the housing boom created fleeting (but very real at a snapshot in time) wealth.
I'll give my example. We moved in July 2008, six weeks before the crash. Our old home sold for way more than it is worth today. For sake of example, let's say we decided to rent from that point forward. Did we in fact have "savings" (equity) in the house that was released upon its sale? Of course we did! That equity was created by a combination of paying down the note and the housing boom, not just one or the other.
We moved into a different home and used a large chunk of that previously trapped equity as the down payment for our next home. Had we paid the bare minimum down payment we would now be in a home that would be break even after six years at best after several expensive upgrades, because it has lost 20% of its value since we bought it. That sure doesn't sound like savings to me either! But it is. Say we had one of those screwy pre-2008 loans where the owner of a property only pays interest on the loan, nothing else. Where would we be? We would be underwater in our home, our home purchase turned out to be costlier than renting.
So yes, there are no guarantees when it comes to home ownership and there are in fact people who go underwater and never come back up. Historically, however, that isn't the case. My mother lived in her home for 35 years and recently moved to an apartment for health reasons. Her home is now for sale, and even though she has spent quite a bit on it over the years the very real value of the property - whatever that eventual sale price turns out to be - is about to be released from behind its dam.
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I agree with Big Owl. A house does not appreciate, IMO. The land it sits on does (or 'can'...in some markets that is also untrue). Really even the land in many areas isn't so much appreciating as roughly keeping pace with inflation.
The only thing keeping the actual house from depreciating to almost nothing just like a car is the constant and usually large influx of money that it constantly takes to replace and maintain everything (hvac/roof/siding/painting/deck replacement/water heaters, softeners/appliances/misc plumbing repairs/etc etc etc...mandatory maintenance items, not 'upgrades').
After 30 years of maintenance and replacements, ESPECIALLY if you are paying for labor as well, it would not surprise me if the 'dam of money' that is released when selling it is not all that much more than the true opportunity cost of all those items, if you were to have invested that money systematically for all of those years.
This doesn't mean nobody should buy a house...I own one. But that's why I view it as a lifestyle and housing expense.
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I had never included my mortgage principal in savings calculations prior to reading this discussion. Now I am reconsidering.
When I estimate my net worth I include the balance in my Vanguard accounts, and also include an estimate of the equity in my home (less transaction costs). Paying down my principal increases the home equity line of my balance sheet, like purchasing additional shares of a Vanguard fund would increase my Vanguard balances. While the mechanics of those investments are different, both have the potential to gain and lose value with the their respective markets, and both increase my net worth.
Off to recalculate my savings rate...
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I had never included my mortgage principal in savings calculations prior to reading this discussion. Now I am reconsidering.
When I estimate my net worth I include the balance in my Vanguard accounts, and also include an estimate of the equity in my home (less transaction costs). Paying down my principal increases the home equity line of my balance sheet, like purchasing additional shares of a Vanguard fund would increase my Vanguard balances. While the mechanics of those investments are different, both have the potential to gain and lose value with the their respective markets, and both increase my net worth.
Off to recalculate my savings rate...
This is actually an example of how principal *isn't* savings, but is net worth.
Buying vanguard shares is not "savings". You have $100 in your checking account. You can:
* buy groceries. (0 savings)
* do absolutely nothing ($100 savings)
* buy $100 worth of vanguard ($100 savings)
In other words: buying shares isn't savings any more than sitting there and doing nothing. Not spending it is savings. Moving an asset from one asset class to another is a good move... but it isn't savings.
In the same regard: when the share price of a purchased stock changes -- it isn't savings. It's only savings if you sell it (and receive income) and don't spend it. I.e: Income - Expense = savings
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Nope. My savings rate includes contributions to my brokerage account and retirement accounts.
I do count my home equity in my net worth calculations.
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I count the principal in my mortgage payment as "savings". But I calculate two different numbers for net worth.
- Net Worth = Assets - Liabilities
- Stash = Net Worth - Home Value
I use Stash for my FI calculations, because those calculations also assume I will not have a mortgage or rent (though I will have property tax and insurance). Note that the mortgage is included in both. It's a debt I owe, no matter the eventual value of the home. So money I send to reduce that debt (as opposed to spending on video games or somesuch) increases my Stash, and is savings.
Investment returns are not savings to me, even if I'm cashing them out. Once I'm retired and living off my savings, I won't be producing new savings - by definition. Savings requires income - money that was not part of my net worth before.
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I agree with Big Owl. A house does not appreciate, IMO.
I think where people are getting tripped up is the notion that your primary residence is an investment vehicle. If so, it is surely one of the lousiest available. That does not mean you don't have stored value in it all the same. Most folks are generally getting the benefit of a roof over their head and some, hopefully a lot of, money back when they eventually sell. But there are no guarantees.
Consider this. I have two mortgages, one is my primary residence and the other a rental home. We are aggressively retiring the debt on the rental home. Yes, the rental home will always come with expenses (taxes, insurance, repairs, HOA fee). We are actively throwing available cash into our investment instead of the bank (or stocks, etc.). Do savings need to be in a savings account to qualify as savings? Suppose we were having this conversation in July 2008, I was using my savings to buy stocks and in March 2009 my stocks have plunged a full 50%. The point being, the return on the investment is a completely different conversation from how the investment is funded. The investment is funded with savings. Ergo, reducing principal on a house that could go up or down in value is still a form of savings.
When people here are talking about their savings rate, they generally mean the money they did not spend on consumption of some sort.
If folks consider saving as just putting the money in the bank, all well and good, but it is not the metric most folks on this site use.
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I had never included my mortgage principal in savings calculations prior to reading this discussion. Now I am reconsidering.
When I estimate my net worth I include the balance in my Vanguard accounts, and also include an estimate of the equity in my home (less transaction costs). Paying down my principal increases the home equity line of my balance sheet, like purchasing additional shares of a Vanguard fund would increase my Vanguard balances. While the mechanics of those investments are different, both have the potential to gain and lose value with the their respective markets, and both increase my net worth.
Off to recalculate my savings rate...
This is actually an example of how principal *isn't* savings, but is net worth.
Buying vanguard shares is not "savings". You have $100 in your checking account. You can:
* buy groceries. (0 savings)
* do absolutely nothing ($100 savings)
* buy $100 worth of vanguard ($100 savings)
In other words: buying shares isn't savings any more than sitting there and doing nothing. Not spending it is savings. Moving an asset from one asset class to another is a good move... but it isn't savings.
In the same regard: when the share price of a purchased stock changes -- it isn't savings. It's only savings if you sell it (and receive income) and don't spend it. I.e: Income - Expense = savings
OK, I'm with you, but how do you grow your net worth? Either through asset appreciation or by applying your savings to the purchase of additional assets. If my expenses are less than my income I save. If some of that amount goes into paying down principal vs buying vanguard shares, is there really a difference?
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I had never included my mortgage principal in savings calculations prior to reading this discussion. Now I am reconsidering.
When I estimate my net worth I include the balance in my Vanguard accounts, and also include an estimate of the equity in my home (less transaction costs). Paying down my principal increases the home equity line of my balance sheet, like purchasing additional shares of a Vanguard fund would increase my Vanguard balances. While the mechanics of those investments are different, both have the potential to gain and lose value with the their respective markets, and both increase my net worth.
Off to recalculate my savings rate...
This is actually an example of how principal *isn't* savings, but is net worth.
Buying vanguard shares is not "savings". You have $100 in your checking account. You can:
* buy groceries. (0 savings)
* do absolutely nothing ($100 savings)
* buy $100 worth of vanguard ($100 savings)
In other words: buying shares isn't savings any more than sitting there and doing nothing. Not spending it is savings. Moving an asset from one asset class to another is a good move... but it isn't savings.
In the same regard: when the share price of a purchased stock changes -- it isn't savings. It's only savings if you sell it (and receive income) and don't spend it. I.e: Income - Expense = savings
OK, I'm with you, but how do you grow your net worth? Either through asset appreciation or by applying your savings to the purchase of additional assets. If my expenses are less than my income I save. If some of that amount goes into paying down principal vs buying vanguard shares, is there really a difference?
Maybe I'm being anal and arguing a technicality.... but it is really common for folks to juggle assets and income; expenses and liabilities. And accounting just doesn't work that way.
In a round about way, yes, paying principle is savings... as it ends up "not being spent" when you move the asset (checking account) to pay down the liability (the loan). But I'm skeptical in general if someone is using principal in their computations ... that they're really computing it correctly. I'll guess they're not fully categorizing their expenses and income. ...but I've been wrong before oh so many times...
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OK, I'm with you, but how do you grow your net worth? Either through asset appreciation or by applying your savings to the purchase of additional assets. If my expenses are less than my income I save. If some of that amount goes into paying down principal vs buying vanguard shares, is there really a difference?
Maybe I'm being anal and arguing a technicality.... but it is really common for folks to juggle assets and income; expenses and liabilities. And accounting just doesn't work that way.
In a round about way, yes, paying principle is savings... as it ends up "not being spent" when you move the asset (checking account) to pay down the liability (the loan). But I'm skeptical in general if someone is using principal in their computations ... that they're really computing it correctly. I'll guess they're not fully categorizing their expenses and income. ...but I've been wrong before oh so many times...
Meh, I think you are overcomplicating it. If money is put towards an area that is calculated in your net worth, it is savings. If it is put towards something that is not tracked in net worth it is an expense.
School loan principal? Savings.
School loan interest? Expense
Mortgage principal? Savings
Replacing the roof on your house? Expense
Buying ETFs with Vanguard? Savings
I don't know if there are special accounting thought processes related to this but if so I think you are overcomplicating it.
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OK, I'm with you, but how do you grow your net worth? Either through asset appreciation or by applying your savings to the purchase of additional assets. If my expenses are less than my income I save. If some of that amount goes into paying down principal vs buying vanguard shares, is there really a difference?
Maybe I'm being anal and arguing a technicality.... but it is really common for folks to juggle assets and income; expenses and liabilities. And accounting just doesn't work that way.
In a round about way, yes, paying principle is savings... as it ends up "not being spent" when you move the asset (checking account) to pay down the liability (the loan). But I'm skeptical in general if someone is using principal in their computations ... that they're really computing it correctly. I'll guess they're not fully categorizing their expenses and income. ...but I've been wrong before oh so many times...
Meh, I think you are overcomplicating it. If money is put towards an area that is calculated in your net worth, it is savings. If it is put towards something that is not tracked in net worth it is an expense.
I've seen some people include their cars in their net worth calculations.
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Meh, I think you are overcomplicating it. If money is put towards an area that is calculated in your net worth, it is savings. If it is put towards something that is not tracked in net worth it is an expense.
School loan principal? Savings.
School loan interest? Expense
Mortgage principal? Savings
Replacing the roof on your house? Expense
Buying ETFs with Vanguard? Savings
I don't know if there are special accounting thought processes related to this but if so I think you are overcomplicating it.
I can accept when people include the mortgage principal in the savings rate. I don't do it this way, but I understand the logic and it's reasonable. You can probably sell the house later and recover the equity that was paid down...okay.
In no way can I see how student loan principal payment would be considered savings. At all. It has about as much logic as as saying car payments are saving. Actually, even less so...at least you can sell the car to pay off some of the loan (before it becomes worthless). Student loans are a debt and not backed by any physical asset that can be sold (unlike a house..or even a car). You can't 'sell' your degree to pay off your student loan, unlike something like a house.
Some people might say you can 'sell' your increased earnings time to pay for it, but that is semantics. Plus if you can't work...the degree is financially worth nothing to you but an anchor, you still owe the money. Not saying taking loans to go to college is a bad choice but they are purely a liability...paying them off isn't savings. It technically increases your net worth by owing less, but it's not really increasing your assets.
Can't get behind the 'student loan principal payment is saving' idea.
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If folks consider saving as just putting the money in the bank, all well and good, but it is not the metric most folks on this site use.
I just can't see how it could be considered savings, even within the frame of MMM. I guess we'll just have to disagree on it. All a mortgage is in my mind is a big giant honking debt to the bank. Instead of a car or boat or motorcycle as collateral, you have a house. In my mind, savings is something that can be diverted to other uses if needed in an emergency. If I normally invest $3k/mo (what I would consider a "savings rate") and some shit goes bad then I can stop investing and use that money for something else. Savings is something that's not mandatory and is above-and-beyond existing financial obligations. I could sell investments if I had a huge medical expense in order to cover the bill and my life would not be impacted other than having depleted my "savings".
If I stop paying my mortgage to pay off those medical bills then I end up on the street - it's mandatory, it's a debt. I can't just sell my house to pay those medical bills - maybe if I was lucky enough to have enough equity and could find a buyer quick and for the price I needed...but then I'd be homeless on the street and needing to buy into another living arrangement anway!
Sorry, paying a mortgage off is just not the same as saving money.
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It depends on what you mean by "saving" and what you intend to do with it.
A couple things to note:
1. A house is extremely illiquid. Plenty of reasons in the posts above me.
2. A house is an investment. Yes, even the house that you live in yourself. It's supposed to appreciate in value, and that's why it's an investment. But it also has its own cost: insurance, fees, taxes, maintenance, etc. So after you subtract appreciation minus these costs, then it *might* be a decent ROI, might not be. But as with most investments, you're taking a risk. Notice that I did not include mortgage in the list of costs, that's because:
3. You have to decouple the money that you used to buy a house, and what you did with that money. Imagine two scenarios:
A: You bought a 1MM house with 300k down payment, so you have 700k mortgage with 4% interest rate
B: You borrowed 700k from a bank with 4% interest rate
These two scenarios are almost identical. The only difference is that in A, you put the 700k into an investment called "house" immediately, whereas in B, you might put it into a portfolio, or whatnot. The other differences are minor: peace of mind, the status of having your own house (even if not paid-off) versus renting, not having to move when your apt lease is not extendable etc.
So if you pay the principal of the mortgage, it is saving in the sense that it's income minus expense. It's a money that you could be throwing away (in exchange of nice clothes / car), but you chose to do something productive with it. So yes it's savings.
But is it always the most prudent thing to put it into mortgage? In scenario B above, would you rather start paying off the bank loan, or would you bolster your portfolio? The answer lies on whether you think your portfolio can gain 4% a year.
The term "home equity" is a myth imo, because once you consider the comparison between two scenarios above, all you're doing is that you're paying off a loan where you could be investing that money somewhere better.
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Well said, big owl. This is also how I look at it. Paying down debt (even into home equity), is still just paying debt. Rain or shine, ability to pay or not, it's due every month.
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OK, I'm with you, but how do you grow your net worth? Either through asset appreciation or by applying your savings to the purchase of additional assets. If my expenses are less than my income I save. If some of that amount goes into paying down principal vs buying vanguard shares, is there really a difference?
Maybe I'm being anal and arguing a technicality.... but it is really common for folks to juggle assets and income; expenses and liabilities. And accounting just doesn't work that way.
In a round about way, yes, paying principle is savings... as it ends up "not being spent" when you move the asset (checking account) to pay down the liability (the loan). But I'm skeptical in general if someone is using principal in their computations ... that they're really computing it correctly. I'll guess they're not fully categorizing their expenses and income. ...but I've been wrong before oh so many times...
Meh, I think you are overcomplicating it. If money is put towards an area that is calculated in your net worth, it is savings. If it is put towards something that is not tracked in net worth it is an expense.
I've seen some people include their cars in their net worth calculations.
I do. And I add a yearly depreciation expense as well. Although as a percentage of net worth, they're probably negligible. But having the car on the books gives me a place to apply the depreciation expense... and that's more what I am looking to track. It is a significant expense.
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It is interesting to see people's approaches. Mine is simply that I view something as saving if it increases my net worth. Spending money on a vacation does not, while prepaying mortgage principal does. I could leave the money in a savings account, or purchase a mutual fund, or prepay the mortgage. Each of those investments has its own return, risk, and liquidity properties.
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OK, I'm with you, but how do you grow your net worth? Either through asset appreciation or by applying your savings to the purchase of additional assets. If my expenses are less than my income I save. If some of that amount goes into paying down principal vs buying vanguard shares, is there really a difference?
Maybe I'm being anal and arguing a technicality.... but it is really common for folks to juggle assets and income; expenses and liabilities. And accounting just doesn't work that way.
In a round about way, yes, paying principle is savings... as it ends up "not being spent" when you move the asset (checking account) to pay down the liability (the loan). But I'm skeptical in general if someone is using principal in their computations ... that they're really computing it correctly. I'll guess they're not fully categorizing their expenses and income. ...but I've been wrong before oh so many times...
Meh, I think you are overcomplicating it. If money is put towards an area that is calculated in your net worth, it is savings. If it is put towards something that is not tracked in net worth it is an expense.
I've seen some people include their cars in their net worth calculations.
I do. And I add a yearly depreciation expense as well. Although as a percentage of net worth, they're probably negligible. But having the car on the books gives me a place to apply the depreciation expense... and that's more what I am looking to track. It is a significant expense.
I apologize for not being clear in my comment. I was responding to Vilgan's comment that "If money is put towards an area that is calculated in your net worth, it is savings."
Would you count car payments in your savings rate?
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The "simple math of early retirement" article is a back of the envelope world that has income, expenses, and assets. Sure, the composition of your balance sheet matters, but it matters at a level that's more complicated than a single metric of progress towards FI like savings rate can be.
If Bill has realized he has a hair of fire emergency and is starting from net worth of -5 times annual expenses, and at the end of a year has improved that to -3.7 times annual expenses, he's made some rocking progress out of his bad situation. Sure he's still in a hair on fire emergency, but something we call a rate should be a measure of progress rather than a measure of position. Depending on the composition of Bill's horrible balance sheet, it may have made a lot of sense to focus that 1.3 times annual expenses on paying down debt. Or maybe Bill is a medical resident with large but low interest student loans and it made sense to start building the stache anyway. Or maybe somewhere in between, pick up a 401k employer match and then put the rest towards debt reduction.
The composition of your balance sheet matters, liquidity matters, but if you want one number that says, how close am I to independence, you can do a lot worse than net worth to annual expenses. And if you want another number that says, how fast am I getting there, you can do a lot worse than change in net worth to annual expenses.
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OK, I'm with you, but how do you grow your net worth? Either through asset appreciation or by applying your savings to the purchase of additional assets. If my expenses are less than my income I save. If some of that amount goes into paying down principal vs buying vanguard shares, is there really a difference?
Maybe I'm being anal and arguing a technicality.... but it is really common for folks to juggle assets and income; expenses and liabilities. And accounting just doesn't work that way.
In a round about way, yes, paying principle is savings... as it ends up "not being spent" when you move the asset (checking account) to pay down the liability (the loan). But I'm skeptical in general if someone is using principal in their computations ... that they're really computing it correctly. I'll guess they're not fully categorizing their expenses and income. ...but I've been wrong before oh so many times...
Meh, I think you are overcomplicating it. If money is put towards an area that is calculated in your net worth, it is savings. If it is put towards something that is not tracked in net worth it is an expense.
I've seen some people include their cars in their net worth calculations.
Actually, I factor the lunch meat in my fridge right now into my net worth calculations. ;)
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If folks consider saving as just putting the money in the bank, all well and good, but it is not the metric most folks on this site use.
I just can't see how it could be considered savings, even within the frame of MMM. I guess we'll just have to disagree on it. All a mortgage is in my mind is a big giant honking debt to the bank. Instead of a car or boat or motorcycle as collateral, you have a house. In my mind, savings is something that can be diverted to other uses if needed in an emergency. If I normally invest $3k/mo (what I would consider a "savings rate") and some shit goes bad then I can stop investing and use that money for something else. Savings is something that's not mandatory and is above-and-beyond existing financial obligations. I could sell investments if I had a huge medical expense in order to cover the bill and my life would not be impacted other than having depleted my "savings".
If I stop paying my mortgage to pay off those medical bills then I end up on the street - it's mandatory, it's a debt. I can't just sell my house to pay those medical bills - maybe if I was lucky enough to have enough equity and could find a buyer quick and for the price I needed...but then I'd be homeless on the street and needing to buy into another living arrangement anway!
Sorry, paying a mortgage off is just not the same as saving money.
Ok so "savings" is an inherently subjective term and it depends on what you mean by it and what your goals are, I guess. I don't need to save for emergencies, I already have an emergency fund of liquid cash sufficient for my purposes. So tracking my savings rate based purely on what I could liquidate in an emergency would serve me no logical purpose. My goal is to determine my progress towards FI. So the most practical measurement of that is the % of my income that serves that purpose as opposed to being spent on expenses. So...does paying mortgage principal help me achieve FI?
I think an argument could be made for and against here. In my case I am targeting FI at age 50, which is when my son will be 18 and be leaving home (presumably). I plan to sell my house and subtantially downsize at that time. So a big part of my home equity could end up being part of my FI nest egg. I'm also going to relocate from Chicago (high COL) to a lower COL area, further reducing my housing costs. I think the argument could be made that including my principal payments is relevant. On the flip side I actually feel better being conservative and like calculating the number without
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You can do it either way, depending on when you realize your housing expense.
If you realize your home purchase as a one-time $XXXk expense, in year 1, then your principal payments in years 1-30 are savings.
If you don't include your home purchase as an expense in year 1, then your principal payments in years 1-30 are amortizing that $XXXk expense over 30 years.
Basically, it's cheating to say principal payments are savings AND at the same time ignore the purchase price of the house.
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I view any extra principal I pay per month as part of my savings rate. My minimum monthly mortgage payment (which includes whatever principal it amounts to as part of that payment in addition to interest and escrow) I have as an expense.
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You guys are either over or under thinking this. Principal paydown on real estate should absolutely 100%, no questions asked count towards savings if you want to be accurate about it in an accounting sense. If you have goals other than accuracy, such as jedi mind tricking yourself into saving more by not counting it towards your savings rate, fine, that's up to you. But really, if it's not a form of savings then why would anyone ever make an extra principal payment? Why the voluntary expense? Expenses are everything else, including interest (aka rent on the money you've borrowed), taxes, HOA, repairs, etc. As others have pointed out, the ROI is irrelevant to this discussion.
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Expenses are everything else, including interest (aka rent on the money you've borrowed), taxes, HOA, repairs, etc. As others have pointed out, the ROI is irrelevant to this discussion.
I see interest as 'rent'. The capital repayment I don't include in my savings rate as it is, for the moment, a necessary expense. The overpayments I make I count as 'savings' and overall the capital repayment and overpayments increase my assets and, more importantly, reduce my liabilities.
I don't subscribe fully to the 'your home is an asset' argument - FB's 'asset' would cost more to service than a smaller 'asset' so trying to add in a relevant liability to my asset hurts my brain too much, so I don't do it ;). However, in my case once the mortgage is paid off* I'll be FIRE. Notice handed in, house tenanted and off to the sunshine (where we have a home I don't count as an asset). So I do feel ok saying what is currently my 'home' is an asset.
*£22,600 to go. 11 months. Not that I'm counting.........
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I think of it like a business. You have your Income Statement and your Balance Sheet.
Your Income Statement is monthly earnings minus monthly expenses. Since 100% of your mortgage payment is required to be paid, I would count that as an expense. If you are paying more than the minimum payment, you consider any additional money to be savings.
Your monthly change in Net Worth is a Balance Sheet calculation, and it does include principal repayments.
For me, both numbers are relevant. I generally pay more attention to my monthly change in Net Worth, although this is also impacted by moves in the financial markets.
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Yes - principal + increased home value added each month.
By the way, when you get serious about retirement. You can take your 500K net from the home and retire nicely in my beautiful Ozark neighborhood.
It always amazes met that homes cost 1 million for 1500 sq ft when our McMansion is 220K for 3,000 sq ft.
By the way, IMHO, I would refi and take the cash and throw it in this highly overvalued stock market.
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Yes - principal + increased home value added each month.
By the way, when you get serious about retirement. You can take your 500K net from the home and retire nicely in my beautiful Ozark neighborhood.
It always amazes met that homes cost 1 million for 1500 sq ft when our McMansion is 220K for 3,000 sq ft.
By the way, IMHO, I would refi and take the cash and throw it in this highly overvalued stock market.
You would cash out to put money in an overvalued market? Just checking
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I think of it like a business. You have your Income Statement and your Balance Sheet.
Your Income Statement is monthly earnings minus monthly expenses. Since 100% of your mortgage payment is required to be paid, I would count that as an expense. If you are paying more than the minimum payment, you consider any additional money to be savings.
Your monthly change in Net Worth is a Balance Sheet calculation, and it does include principal repayments.
For me, both numbers are relevant. I generally pay more attention to my monthly change in Net Worth, although this is also impacted by moves in the financial markets.
NorCal, you're thinking along the right lines, but this isn't accurate. It can't be both. It's either balance sheet, or income statement. You can (and really should) split up the payment into separate line items and include some on the balance sheet (Principal) and some on the income statement (Interest, Taxes, Insurance).
From an accounting standpoint, cash used for the purchase of a house and payments on the principal portion of the house should never be considered an expense. They are a transfer of capital, not an expense. The only time an expense would be recorded (other than repairs, interest, taxes, insurance, closing costs, etc.) would be if you tracked the market value of your home and it gained or lost value. If you adjust the fair value of your house on the balance sheet, you would record a gain or loss for that adjustment on the income statement.
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I think of it like a business. You have your Income Statement and your Balance Sheet.
Your Income Statement is monthly earnings minus monthly expenses. Since 100% of your mortgage payment is required to be paid, I would count that as an expense. If you are paying more than the minimum payment, you consider any additional money to be savings.
Your monthly change in Net Worth is a Balance Sheet calculation, and it does include principal repayments.
For me, both numbers are relevant. I generally pay more attention to my monthly change in Net Worth, although this is also impacted by moves in the financial markets.
NorCal, you're thinking along the right lines, but this isn't accurate. It can't be both. It's either balance sheet, or income statement. You can (and really should) split up the payment into separate line items and include some on the balance sheet (Principal) and some on the income statement (Interest, Taxes, Insurance).
From an accounting standpoint, cash used for the purchase of a house and payments on the principal portion of the house should never be considered an expense. They are a transfer of capital, not an expense. The only time an expense would be recorded (other than repairs, interest, taxes, insurance, closing costs, etc.) would be if you tracked the market value of your home and it gained or lost value. If you adjust the fair value of your house on the balance sheet, you would record a gain or loss for that adjustment on the income statement.
Fair point. That is the true accounting way of looking at it. Just not how I think about it.
This is why I work in finance and not accounting. In finance, you can make up your own reporting structures and analyze the business however you like. In accounting, you have to follow all the (mostly) silly rules.
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I think of it like a business. You have your Income Statement and your Balance Sheet.
Your Income Statement is monthly earnings minus monthly expenses. Since 100% of your mortgage payment is required to be paid, I would count that as an expense. If you are paying more than the minimum payment, you consider any additional money to be savings.
Your monthly change in Net Worth is a Balance Sheet calculation, and it does include principal repayments.
For me, both numbers are relevant. I generally pay more attention to my monthly change in Net Worth, although this is also impacted by moves in the financial markets.
NorCal, you're thinking along the right lines, but this isn't accurate. It can't be both. It's either balance sheet, or income statement. You can (and really should) split up the payment into separate line items and include some on the balance sheet (Principal) and some on the income statement (Interest, Taxes, Insurance).
From an accounting standpoint, cash used for the purchase of a house and payments on the principal portion of the house should never be considered an expense. They are a transfer of capital, not an expense. The only time an expense would be recorded (other than repairs, interest, taxes, insurance, closing costs, etc.) would be if you tracked the market value of your home and it gained or lost value. If you adjust the fair value of your house on the balance sheet, you would record a gain or loss for that adjustment on the income statement.
Fair point. That is the true accounting way of looking at it. Just not how I think about it.
This is why I work in finance and not accounting. In finance, you can make up your own reporting structures and analyze the business however you like. In accounting, you have to follow all the (mostly) silly rules.
But wouldn't an accountant depreciate the structure? That's an expense, right?
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For the people who don't think paying down principal counts as saving, I am curious how you would answer these questions.
Bill has 240K 5% interest mortgage, which he pays $1,000/month
Joe has 240 5% fully amortized 30 year mortgage which he pay $1288.37. He also has untapped 5% HELOC.
Every month Bill put $295 in his money market/emergency fund
At the end of the year Bill has $3,541 in the account and $240,000 mortgage balance.
Joe has no additional saving, but $236,459 loan balance and untapped HELOC.
Would you call Bill's $3,541 savings?
How is Bill financial situation any different than Joes?
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I think of it like a business. You have your Income Statement and your Balance Sheet.
Your Income Statement is monthly earnings minus monthly expenses. Since 100% of your mortgage payment is required to be paid, I would count that as an expense. If you are paying more than the minimum payment, you consider any additional money to be savings.
Your monthly change in Net Worth is a Balance Sheet calculation, and it does include principal repayments.
For me, both numbers are relevant. I generally pay more attention to my monthly change in Net Worth, although this is also impacted by moves in the financial markets.
NorCal, you're thinking along the right lines, but this isn't accurate. It can't be both. It's either balance sheet, or income statement. You can (and really should) split up the payment into separate line items and include some on the balance sheet (Principal) and some on the income statement (Interest, Taxes, Insurance).
From an accounting standpoint, cash used for the purchase of a house and payments on the principal portion of the house should never be considered an expense. They are a transfer of capital, not an expense. The only time an expense would be recorded (other than repairs, interest, taxes, insurance, closing costs, etc.) would be if you tracked the market value of your home and it gained or lost value. If you adjust the fair value of your house on the balance sheet, you would record a gain or loss for that adjustment on the income statement.
Fair point. That is the true accounting way of looking at it. Just not how I think about it.
This is why I work in finance and not accounting. In finance, you can make up your own reporting structures and analyze the business however you like. In accounting, you have to follow all the (mostly) silly rules.
But wouldn't an accountant depreciate the structure? That's an expense, right?
Norcal, I like the sound of that. No rules, just do what you like. Sign me up.
Dragoncar, yes if it's a business use asset, no if it's not. So a personal residence is not really depreciable. Even in a business you wouldn't always depreciate a structure. I.E.-For a home builder houses are inventory and not depreciated, but it should be adjusted if the value decreases.
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Ok the accountants have convinced me again. I'm leaning towards considering it an expense in the amount of the NPV of the loan+payments. What interest rate do I use?
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Ok the accountants have convinced me again. I'm leaning towards considering it an expense in the amount of the NPV of the loan+payments. What interest rate do I use?
I don't understand what this means. What are you considering as an expense?