Author Topic: How to think about home equity in the 'stash  (Read 7655 times)

ultros1234

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How to think about home equity in the 'stash
« on: June 10, 2013, 11:27:50 AM »
Hi mustachians --

I'm not a homeowner, but would like to be eventually. I need you real estate gurus to help me understand how to think about home equity: How should I think about home equity in figuring the retirement 'stash?

A little background: My wife and I are several years at the very least from being able to afford a down payment on a home. We're paying off a load of student debt, but saving over $50k per year, so we could hypothetically be in a place to make a down payment in a few years if we made it a priority. Unfortunately, we also live in the nation's hottest housing market:
http://www.bizjournals.com/sanfrancisco/blog/real-estate/2013/06/where-home-prices-grew-most-in-bay-area.html
A down payment around here would be enough to buy a whole house in cash in other parts of the country, and we're not open to moving. Oakland's also a rent-controlled city, which means that our already-below-market apartment rent will get smaller and smaller in real terms the longer we stay in our current place. That's great for saving purposes, but it does make us feel a little trapped into renting for a looooooong time.

My question is, how do people understand the equity on their primary residence in their retirement calculations? It adds to your net worth, yes, but it's not money that can be easily tapped for groceries. I can see the advantage in eventually decreasing your monthly housing expenses, but a paid-off house doesn't generate passive income if you're living in it and not renting out rooms, right? So how do you get to count it as a part of your nest egg? Am I missing something? Because it seems to me that plunking down $100k of our 'stash on a down payment for a $500k home would wind up pushing FI many years further out.

arebelspy

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Re: How to think about home equity in the 'stash
« Reply #1 on: June 10, 2013, 11:44:53 AM »
You don't.  Most often, stache means your portfolio, that can generate income.

Add up all your expenses (this includes mortgage/rent).  You need ~25x that invested (assuming a 4% SWR).

If your house is paid off, then you'll have lower expenses (but also a lower stache, due to it being tied up in home equity).

In terms of plunking down money for a down payment for a house, it depends on whether buying or renting makes sense in your area.  It very well may be that owning may push your FI date out, or it may be that renting will.  You'll have to run the numbers specific to your area.  Being it is SF, I'd guess renting is much better for your FIRE date, but again, run the numbers.
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MorningCoffee

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Re: How to think about home equity in the 'stash
« Reply #2 on: June 10, 2013, 12:51:12 PM »
A down payment around here would be enough to buy a whole house in cash in other parts of the country, and we're not open to moving. Oakland's also a rent-controlled city, which means that our already-below-market apartment rent will get smaller and smaller in real terms the longer we stay in our current place. That's great for saving purposes, but it does make us feel a little trapped into renting for a looooooong time.

Sometimes, buying isn't the answer. If it cost less to rent, why buy? In some areas, buying a house is not a good "investment".

One way to get equity out of your home is to sell it and move to a cheaper cost of living area. You're not open to moving now, but what about once you retire?

aclarridge

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Re: How to think about home equity in the 'stash
« Reply #3 on: June 10, 2013, 01:31:26 PM »
I think if you really wanted to count it somehow, if you owned your house outright you could count it as giving you the difference between an equivalent rent and the taxes/maintenance house-owner related expenses.

Then your theoretical return on your house investment, say, your HouseBond, is equal to:
equivalent rent - taxes - maintenance - insurance - any other house-owning related expenses that renters don't need to pay

However, under this accounting methodology you'd have to count up your expenses as if you were renting your place, so that all the real-world numbers work out properly. That's a more fair picture of your true living expenses anyway - MMM's living expenses of ~25k have a big asterisk "with a paid off house". Anyway that's my thinking on what kind of monthly "return" i.e. reduction in monthly expenses, that you're achieving by buying a house.

Of course, the coupons and principal of a HouseBond are fluctuating a lot based on tons of different factors as you can see, but you could very loosely call it an inflation-linked bond over the long term I guess.

aj_yooper

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Re: How to think about home equity in the 'stash
« Reply #4 on: June 11, 2013, 06:58:39 PM »
Very good thread. 

ultros1234

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Re: How to think about home equity in the 'stash
« Reply #5 on: June 12, 2013, 09:29:43 AM »
Thanks all. Really helpful to get your feedback.

One conclusion of all this: I realized (playing with the rent-vs-buy calculators) that it would make more sense in our situation to have a longer mortgage and a smaller down payment (i.e., 30-year, 10% down), assuming the rate isn't radically different, partly due to the value of the mortgage interest deduction, and partly so that we're plowing cash into the 'stash rather than home equity.

aj_yooper

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Re: How to think about home equity in the 'stash
« Reply #6 on: June 12, 2013, 09:49:03 AM »
Is that taking into consideration the probable mortgage insurance fees at 10% down?

arebelspy

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Re: How to think about home equity in the 'stash
« Reply #7 on: June 12, 2013, 10:43:50 AM »
Thanks all. Really helpful to get your feedback.

One conclusion of all this: I realized (playing with the rent-vs-buy calculators) that it would make more sense in our situation to have a longer mortgage and a smaller down payment (i.e., 30-year, 10% down), assuming the rate isn't radically different, partly due to the value of the mortgage interest deduction, and partly so that we're plowing cash into the 'stash rather than home equity.

Absolutely, assuming you calculate PMI into it, as AJ points out.

If I could get a 0% down, 100 year, 4% mortgage, I'd take that all day.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

SnackDog

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Re: How to think about home equity in the 'stash
« Reply #8 on: June 12, 2013, 11:50:48 AM »
As has been pointed out, once the mortage is paid off you can reduce your forecast living expenses and potentially live longer off your savings.

In my retirement spreadsheet I can vary the sale of properties as required to fill out the later years.  For example, I would sell excess property at age 80 and sell our primary home at age 90.  The resulting windfall easily funds ten years of living expenses either renting an equivalent place (not likely needed), downsizing, or, confronting the spectre of assisted living.  In this sense, real estate holdings provide buffers to the tail end of life against any expense (medical, lawsuit) or investment (market collapse, war) surprises.

ultros1234

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Re: How to think about home equity in the 'stash
« Reply #9 on: June 12, 2013, 02:58:27 PM »
Really helpful, everyone! Thanks for all of your input!

DoubleDown

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Re: How to think about home equity in the 'stash
« Reply #10 on: June 12, 2013, 03:44:50 PM »
I would count home equity in terms of net worth unless you for some reason rule out ever selling the home. We live in a high cost of living area also, with significant equity built up in our primary residence. Obviously the equity in your home only counts in your net worth to the extent the house itself provides a roof over your head, or to the extent you can tap into it for cash flow. Since I'm not wedded to staying in this area forever and we'll one day move to a lower cost of living area, I generally count the equity. Since I'm willing to sell it at any time, I think if I didn't count it, I'd be artificially discounting a large sum of money.

To use an extreme example to make the point, if you owned a $2 million home that was fully paid off, and you were willing to sell it at any time to move somewhere less expensive (or rent forever), wouldn't it be silly not to count the equity? That equity by itself could provide a lavish retirement forever.

footenote

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Re: How to think about home equity in the 'stash
« Reply #11 on: June 12, 2013, 03:52:10 PM »
In my retirement spreadsheet I can vary the sale of properties as required to fill out the later years.  For example, I would sell excess property at age 80 and sell our primary home at age 90.  The resulting windfall easily funds ten years of living expenses either renting an equivalent place (not likely needed), downsizing, or, confronting the spectre of assisted living.  In this sense, real estate holdings provide buffers to the tail end of life against any expense (medical, lawsuit) or investment (market collapse, war) surprises.

+1 My projections get us through retirement without selling primary residence. The paid-for home will be the backstop in case one of us outlives our "best used by" date.

orpheus

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Re: How to think about home equity in the 'stash
« Reply #12 on: August 09, 2013, 08:38:11 PM »
Might be a dumb question here but:
If you had near 900k equity on three properties valued at 1.85m and they cost you nothing to hold and even produce extra.
And if you calculated a SWR of 4% $74000 and drew out say 50k per year as a line of credit. Couldn't you retire? You could increase rents when ever you could and refinance every 3 years or so.

So if the properties only increased by say 4% per year your not eating into your equity?

Again please sort out my line of thinking or give me a face punch if this is a stupid idea!
Or what would you do if it were you based on the above?

We could rent for 18k and live off the balance. So we would rent out the other three.

Thanks

« Last Edit: August 09, 2013, 08:46:50 PM by orpheus »

arebelspy

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Re: How to think about home equity in the 'stash
« Reply #13 on: August 10, 2013, 07:25:16 AM »
Might be a dumb question here but:
If you had near 900k equity on three properties valued at 1.85m and they cost you nothing to hold and even produce extra.
And if you calculated a SWR of 4% $74000 and drew out say 50k per year as a line of credit. Couldn't you retire? You could increase rents when ever you could and refinance every 3 years or so.

So if the properties only increased by say 4% per year your not eating into your equity?

Again please sort out my line of thinking or give me a face punch if this is a stupid idea!
Or what would you do if it were you based on the above?

We could rent for 18k and live off the balance. So we would rent out the other three.

Thanks

And when you rely on that plan and then something like 2008 happens and either: 1) home value drops so you don't have equity to do it with, or 2) you still have equity, but lending dries up and no one will refi you, and your HELOC gets reduced/shut down?

You're in a pretty rough spot.

What I'd personally do it leverage it up now, in today's low rates, and invest the difference.  You'll be in a much more secure position with those liquid funds..
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

slugsworth

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Re: How to think about home equity in the 'stash
« Reply #14 on: August 10, 2013, 07:34:49 PM »
In this example MMM includes home equity in the stash figure.

http://www.mrmoneymustache.com/2011/09/17/the-race-to-retirement-revisited/


expatartist

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Re: How to think about home equity in the 'stash
« Reply #15 on: August 10, 2013, 08:35:23 PM »
Excellent thread!

Our situation which may or may not be relevant to you:

Our 'retirement home' will be paid off, but unless we're renting part of it out, we won't include it in our net worth calculations. It will be in a much cheaper area than the places we live and work in now (major cities like Beijing, Hong Kong, maybe Manchester/London UK later). We currently own one fully paid for house (in the US we'd call it an apartment/condo) in inland Sicily, a region where land/house prices are quite low, but where there's a large holiday market for part of the year. So we rent the house out to holidaymakers now, and make about a 10% return, most of which is reinvested in improvements (so isn't a classic return I suppose).

We plan to buy up to a half-dozen little properties across Sicily, and eventually consolidate them once we've finalized where we want to live on the island. Then we'll manage several properties - or a block of flats/B&B - from our home base. All these properties will be bought with cash; this is how Italians have traditionally bought homes (aside from the coast and major cities), and a mortgage isn't an option unless we're willing to take a low-paying job there. We;re also looking at the UK as an option to buy leveraged properties, particularly in the commercial sector in my husband's hometown.

orpheus

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Re: How to think about home equity in the 'stash
« Reply #16 on: August 10, 2013, 10:57:35 PM »
Might be a dumb question here but:
If you had near 900k equity on three properties valued at 1.85m and they cost you nothing to hold and even produce extra.
And if you calculated a SWR of 4% $74000 and drew out say 50k per year as a line of credit. Couldn't you retire? You could increase rents when ever you could and refinance every 3 years or so.

So if the properties only increased by say 4% per year your not eating into your equity?

Again please sort out my line of thinking or give me a face punch if this is a stupid idea!
Or what would you do if it were you based on the above?

We could rent for 18k and live off the balance. So we would rent out the other three.

Thanks

And when you rely on that plan and then something like 2008 happens and either: 1) home value drops so you don't have equity to do it with, or 2) you still have equity, but lending dries up and no one will refi you, and your HELOC gets reduced/shut down?

You're in a pretty rough spot.

What I'd personally do it leverage it up now, in today's low rates, and invest the difference.  You'll be in a much more secure position with those liquid funds..



The only thing for me is if I leverage the equity out to buy index funds the best interest rate I can get is 5.4% variable or 5.99 fixed for 5 years. I know you guys in the states can get sub 5 so seems to make sense for you to borrow as much for as long as you can etc.
Do you think based on interest rates in n.z/ australa it's still a good strategy?
Other wise I can I can buy 2 to 3 more properties at 300k now BUT that would be 6 houses and not very diversified.

Thanks

Spork

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Re: How to think about home equity in the 'stash
« Reply #17 on: August 11, 2013, 07:49:03 AM »
I just compute it both ways.  I use the value of my house in my net worth AND I compute another value I call "financial assets" which does not include the house (or cars, etc).  I use the latter as an input for retirement calculations (firecalc, 25x expenses, etc).  I use the former as just a metric of net worth over time. 

arebelspy

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Re: How to think about home equity in the 'stash
« Reply #18 on: August 11, 2013, 08:13:14 AM »
The only thing for me is if I leverage the equity out to buy index funds the best interest rate I can get is 5.4% variable or 5.99 fixed for 5 years. I know you guys in the states can get sub 5 so seems to make sense for you to borrow as much for as long as you can etc.
Do you think based on interest rates in n.z/ australa it's still a good strategy?
Other wise I can I can buy 2 to 3 more properties at 300k now BUT that would be 6 houses and not very diversified.

Depends on a number of factors and the maths behind them (including your personal risk tolerance, as you'll see below).

My personal answer to the generic "should I get a mortgage at 6+%" question involves being a dirty market timer.

I'd open some HELOCs, let them sit, and if we have a 2008/9 type scenario be buying like crazy if the HELOCs aren't restricted/cancelled at that point.

That is, be fully invested at all times, but use them as "margin" in the case of a huge crash.

Obviously not a strategy for everyone.  But think through all your options and run the numbers and see which is the strategy for you.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

ender

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Re: How to think about home equity in the 'stash
« Reply #19 on: August 11, 2013, 02:32:13 PM »
From a FI perspective, a paid off $80k home provides similar utility to a paid off $500k home.

SIS

An 80k place even be better if it means you have a smaller place with lower utilities, taxes ;)

footenote

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Re: How to think about home equity in the 'stash
« Reply #20 on: August 11, 2013, 04:33:52 PM »
You don't.  Most often, stache means your portfolio, that can generate income.


Agreed, with one caveat. Our home is fairly expensive, and so while we don't consider it part of the stache, should we encounter a big problem in retirement (a need for long term care for example) we could sell the house, pocket the cash, and move someplace much cheaper.

So a paid off home can be a sort of "Plan B" if needed. But it's not like it's throwing off income while you live in it.  From a FI perspective, a paid off $80k home provides similar utility to a paid off $500k home.

SIS
Agree - and we will be doing just that proactively. (Probably in the 450k -> 165 neighborhood downsize.)

Zamboni

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Re: How to think about home equity in the 'stash
« Reply #21 on: August 11, 2013, 05:37:11 PM »
I also don't count home equity at all unless it's a rental property.