The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: FrugalFisherman10 on April 11, 2014, 03:23:55 PM
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Hello,
First post here. My question that I would like your input on is whether paying off a mortgage should be considered part of your "saving" chunk, with regard to your saving vs. spending chunks and the shockingly simple math behind early retirement." http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/ (http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/)
For example, currently I am spending 50% of my income and saving 50% of my income, and part of my "spending" chunk is the rent on the house I'm renting with roommates. I consider that money as just going out the door. Because it is. However, when I go to buy a house one day, would I/should I consider paying off that mortgage as part of the "saving" chunk, since my money is actually going towards something in that case? Currently my rent goes right out the door, but in theory, when you pay money into a house you will be able to "recoup" some/all of that money (equity) (I know there's a huge caveat here given that we just witnessed the housing crisis in 2008-09.)
Basically, my goal is to continue to try and save 50% and spend 50%, but determining what belongs in which buckets can get a little fuzzy. With regard to the shockingly simple math behind early retirement, the money you put into the house acts more like saving than it does spending..kinda. Right?
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Savings is whatever increases your net worth.
If you buy a house with a mortgage, anything that goes towards principle increases your equity, and thus your net worth.
You need housing of some sort, however, so many people bracket out home equity when talking about their FIRE number or nest egg.
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There has been lots of discussion of this topic before.
Here's the first two links from a search I ran, but there was lots more:
https://forum.mrmoneymustache.com/ask-a-mustachian/categorizing-mortgage-payments-spending-or-savings/
https://forum.mrmoneymustache.com/welcome-to-the-forum/do-you-include-principal-portion-of-mortgage-in-expensesbudget-projections/
One thing I noted in the first thread:
The whole thing to me is spending. But many (including MMM, if that matters) counts only the interest as spending.
To me it comes down to this: Plan your expenses for ER. If you plan on paying off the whole mortgage before ER, don't count it at all (principal or interest), as it won't be an expense in ER. If you plan on having the mortgage in ER, count both parts as spending, as both P&I will need to be in your budget.
I'm in the latter camp.
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Hello,
First post here. My question that I would like your input on is whether paying off a mortgage should be considered part of your "saving" chunk, with regard to your saving vs. spending chunks and the shockingly simple math behind early retirement." http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/ (http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/)
For example, currently I am spending 50% of my income and saving 50% of my income, and part of my "spending" chunk is the rent on the house I'm renting with roommates. I consider that money as just going out the door. Because it is. However, when I go to buy a house one day, would I/should I consider paying off that mortgage as part of the "saving" chunk, since my money is actually going towards something in that case? Currently my rent goes right out the door, but in theory, when you pay money into a house you will be able to "recoup" some/all of that money (equity) (I know there's a huge caveat here given that we just witnessed the housing crisis in 2008-09.)
Basically, my goal is to continue to try and save 50% and spend 50%, but determining what belongs in which buckets can get a little fuzzy. With regard to the shockingly simple math behind early retirement, the money you put into the house acts more like saving than it does spending..kinda. Right?
You seem to have bought into the Realtor(tm) industry propaganda that renting is "throwing your money away" - which is a dramatic overstatement. There are plenty of threads here discussing the pitfalls of home ownership.
Yes, I do count the equity in my house as part of my net worth. However, for your standard 30-year loan - it's a tiny, tiny amount for the first decade. Likely overshadowed by maintenance costs - not to mention the transaction costs of buying/selling.
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I think the quote arebelspy posted makes sense. You could also try some combo of the 2 ideas, like make a schedule in a spreadsheet that shows your costs dropping when the mortgage is paid off, if you're into that kinda thing.
I don't count my principal payment as savings, I consider it a cushion. Although I plan to downshift rather than FIRE. Also, I ran some scenarios and am happy with the outcome even without counting my principal in the stash. Maybe I'll end up with too much money, but I can find some good charities or something else cool to do with it.
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I don't count my principal payment as savings, I consider it a cushion. Although I plan to downshift rather than FIRE. Also, I ran some scenarios and am happy with the outcome even without counting my principal in the stash. Maybe I'll end up with too much money, but I can find some good charities or something else cool to do with it.
Savings is a pretty good description. It's not really an investment, as your real return is rarely more than inflation (absent enough leverage, et cetera. Generally speaking here) - you can also consider it a hedge.
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*swoops in*
Double-entry accounting man to the rescue!
There are four types of account: assets (what you have), liabilities (what you owe), incomes (what you get), and expenses (what you lose). Net worth is defined as your total assets minus your total liabilities, and when we talk about "saving" rather than "spending", we mean putting income into assets or liabilities (increasing your net worth), rather than into an expense.
Your mortgage is a liability. Suppose you pay $500, and $200 goes to interest. There are two ways to deal with that:
1) Transfer $500 from your current account (asset) to your mortgage (liability). Transfer $200 from "interest" (expense) to your mortgage (liability).
2) Transfer $300 from your current account (asset) to your mortgage (liability). Transfer $200 from you current account (asset) to "interest" (expense).
The net result is the same: $300 saved, $200 spent. Either method is equivalent, but #1 seems more natural to me because interest is something that accrues independently of whether you make a payment.
Double-entry accounting man, away!
*swoops away*
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I use Gnucash (http://www.gnucash.org/) because it's free. There's lots of similar software.
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No, I don't think housing costs should be considered saving. You bought a house, you purchased an item, whether you paid cash or had a mortgage. You still HAVE ongoing housing costs, property taxes, maintenance, etc, they're just (usually) less than renting costs. Just because it's a particularly useful item that tends to appreciate in value doesn't necessarily make it savings. You can't spend your house if all goes to pot, and especially if there's been a downturn in the market you may not even recoup what you spent on it if you are forced to sell.
A house is an item you've purchased in hopes of lowering your future (and ultimately, lifetime) housing costs. Just like buying new windows to save on energy costs in the future isn't saving. Or buying a stove so you don't have to spend more on restaurant costs. You're buying an object, the use of which will help lower your future costs.
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I consider my principal payment as savings. This is partially because my lot is worth more than the structure and I'll eventually convert the house to a rental while I sit on the lot.
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A house is an item you've purchased in hopes of lowering your future (and ultimately, lifetime) housing costs. Just like buying new windows to save on energy costs in the future isn't saving. Or buying a stove so you don't have to spend more on restaurant costs. You're buying an object, the use of which will help lower your future costs.
I tend to agree with this, with the exception of rental property. On a personal residence, while I'd count my home in my assets for a financial planner, in my personal accounting I don't count any of my monthly payment towards the mortgage as savings. Even once it's paid off, I'll still be living there. Granted, it's great that my living costs will then be free (minus maintenance, insurance and taxes) but until you sell, you can't cash in on any of that savings, and unless you're dead you'll then need to figure out the next roof over your head. I might be more inclined to count the principal payment on a rental property as monthly savings, since you can sell the property and put the cash in the bank and not worry about figuring out a new living situation for anyone.
Of course none of this is to say that I think renting is better than owning. I can't wait for the savings that comes with owning a home debt free, and if you downsize and get to bank a portion of the assets when you sell your more expensive property, that'll be a really good savings day!
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A house is an item you've purchased in hopes of lowering your future (and ultimately, lifetime) housing costs. Just like buying new windows to save on energy costs in the future isn't saving. Or buying a stove so you don't have to spend more on restaurant costs. You're buying an object, the use of which will help lower your future costs.
This is an argument that your house isn't an asset. (I'd prefer to say that it is an asset, but not an investment (http://thezikomoletter.wordpress.com/2012/12/10/you-are-naturally-short-housing/).) However, your mortgage is still a liability, and we tend to count paying off debt as saving, because it has the same effect on net worth.
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I don't count my principal payment as savings, I consider it a cushion. Although I plan to downshift rather than FIRE. Also, I ran some scenarios and am happy with the outcome even without counting my principal in the stash. Maybe I'll end up with too much money, but I can find some good charities or something else cool to do with it.
Savings is a pretty good description. It's not really an investment, as your real return is rarely more than inflation (absent enough leverage, et cetera. Generally speaking here) - you can also consider it a hedge.
Yes, I agree. I probably should have used a different word. When people talk about a "savings" rate, I assume they are talking about the money they invest and apply the 3 or 4% rule to. Maybe we should call it the "investment" rate, or maybe I'm the only one who gets the words mixed up, haha.
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For the purposes of the Shockingly Simple Math (http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/), paying off debt is saving, and you should count the "years to FI" from when your net worth is zero.
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I don't think this is hard to understand.
First of all, net worth is largely meaningless when it comes ot financial independence. If I own a house free and clear and I intend to live in it (as opposed to sell it and downsize to a less expensive house or rent it), how much the house is worth does not help me be financially independent. That's because it doesn't make any revenue. I can't eat the deed.
Savings only counts if it provides a means of income to live off or reduces the expenses I'll otherwise have when financially independent.
Here's an example.
I have $5000 of disposable income, above and beyond my expenses. I could invest it in the stock market. This would provide income in the future.
Or, I could buy a bigger house that would consume $5000 in principal, interest, taxes and insurance.
Some of that $5000 - the portion that is principal - would increase my net worth. But if I don't sell or rent it out, it's not going to help me be financially independent because it doesn't provide an income to live off of.
Net worth does not equal passive income.
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Savings only counts if it provides a means of income to live off or reduces the expenses I'll otherwise have when financially independent.
In this case, your house definitely counts, because it enables you to live rent-free... no?
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Savings only counts if it provides a means of income to live off or reduces the expenses I'll otherwise have when financially independent.
In this case, your house definitely counts, because it enables you to live rent-free... no?
I love SwordGuy's definition, partly because it says the value of your home doesn't matter. Your equity is NOT savings because it's not a helpful calculation.
I could have a $500k house for retirement, all paid off. Let's say I have $200k in investments, and my FIRE number is $750k. You COULD say I have $700k, if it makes you feel good, but $500k of that doesn't count toward FIRE, so who cares?
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Your equity is NOT savings
Correct. However, whether or not you count your house as an asset, your mortgage is still a liability, and paying it off increases your net worth, so it is saving as opposed to spending.
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Savings only counts if it provides a means of income to live off or reduces the expenses I'll otherwise have when financially independent.
In this case, your house definitely counts, because it enables you to live rent-free... no?
I love SwordGuy's definition, partly because it says the value of your home doesn't matter. Your equity is NOT savings because it's not a helpful calculation.
I could have a $500k house for retirement, all paid off. Let's say I have $200k in investments, and my FIRE number is $750k. You COULD say I have $700k, if it makes you feel good, but $500k of that doesn't count toward FIRE, so who cares?
But it is savings in that it lowers the FIRE number you need since your housing costs are lower in retirement
If that's how your gut understands equity, then make it part of your calculation. Your FIRE number is (home equity + investments earning passive income). So in the example above, your number would be $1.25 million instead of $750k.