Personal home isn't income producing... or is it?

[Finallyunderstand]

I see on here often that people say to not count a home as income producing for part of net worth but I can't understand for the life of me why that is.  I also see people say don't count your home value as part of your net worth unless you plan to liquidate it.

Take for example two people:  Person A with a liquid/invested net worth of $1m but doesn't own a home and Person B with a liquid/invested net worth of $750k plus owns a $250k home outright.  Both are worth $1million on paper.

Can it truly be argued that that Person A has more income producing assets? 

If person A has a 4% ($40,000) withdrawal rate and still has to pay for housing it seems like they're in a significantly worse position than the person B who can withdraw 4% ($30,000) and use it all for whatever they please as opposed renting.  This is of course assuming they choose to live in similar style of lodgings.  Of course person A could rent a little studio apartment but if we compare apples to apples then it would seem that person B is significantly better off.

If you look at $250,000 financed over 30 years at 4.5% total P&I would be over $15k per year which would put person A $5k behind person B in regards to cash flow even though their net worth is the same dollar amount.  You're paying over $11k in interest alone in the first year.  I know mortgage interest is tax deductible but most people wouldn't be paying much in taxes anyway if they're living on investment returns. 

Am I missing something? 

[Khan]

A couple points:
-4% rule does not mean 4% returns. It means that over 30 years you can withdraw 4%, through market crashes, downturns, etc, and actually you're far more likely to end up 30 years later with more money then you started. You have ~95% confidence of surviving on 4%(in the US) and (in the US) if you reduced WR to 3.5%, or if you used one of the other withdrawal strategy rules, you'd survive the worst time period(~1960's through stagflation, poor sequence of returns at the start, I think ~1963/1964 were the only failing start years). You could also very likely survive on >4%, it all depends on the year.
-Average stock market returns over the last ~100 odd years of history is somewhere around 10%-11%/year, minus inflation of ~2-3%. Average real returns are thus ~7%. If you'd like, you can assume at this point returns going forward may average 6% due to high P/E compared to historical values for added conservatism. Point still stands.
-Many of us are locked in without PMI, and have locked rates down to 3% on 30 years possibly. I'm locked in at 3.25% without PMI(veteran)

One last note, for mustachians, it's possible that mortgage interest deduction may be a non-issue, because it's possible many of us will have such extremely low tax rates, as well as having less home then the Jones', which would be one less "positive" to home ownership.

[slugline]

See: Imputed Rent

[Finallyunderstand]

A couple points:
-4% rule does not mean 4% returns. It means that over 30 years you can withdraw 4%, through market crashes, downturns, etc, and actually you're far more likely to end up 30 years later with more money then you started. You have ~95% confidence of surviving on 4%(in the US) and (in the US) if you reduced WR to 3.5%, or if you used one of the other withdrawal strategy rules, you'd survive the worst time period(~1960's through stagflation, poor sequence of returns at the start, I think ~1963/1964 were the only failing start years). You could also very likely survive on >4%, it all depends on the year.
-Average stock market returns over the last ~100 odd years of history is somewhere around 10%-11%/year, minus inflation of ~2-3%. Average real returns are thus ~7%. If you'd like, you can assume at this point returns going forward may average 6% due to high P/E compared to historical values for added conservatism. Point still stands.
-Many of us are locked in without PMI, and have locked rates down to 3% on 30 years possibly. I'm locked in at 3.25% without PMI(veteran)

One last note, for mustachians, it's possible that mortgage interest deduction may be a non-issue, because it's possible many of us will have such extremely low tax rates, as well as having less home then the Jones', which would be one less "positive" to home ownership.

Wouldn't that just reinforce that owning your home outright is even more of a secure route since you are guaranteed to not have to use part of your return for housing?  If the housing market tanks you still would have a 2000sq ft house (or whatever size) regardless of the amount of your portfolio whereas if your investments falter you still need a place to live and would have to downsize or skimp elsewhere due to withdrawing 4% from a smaller portfolio. 

If you would withdraw an amount to net similar spending between person A and person B after taking into account housing costs then that amount in my situation above would be $25k.  This amounts to a 3.33% withdrawal rate for person B to live the same lifestyle of a 4%withdrawal rate from person A to cover housing and still have $25k leftover to spend.

I know interest rates can be locked in lower but right now they're not that low.  I had a 3.125% 15 year and still elected to pay it off early. 

[Khan]

It depends on your risk tolerance, and also on the specific numbers involved, as well as the time period compared. Over 20+ years, over 25+ years, you are far more likely to come out ahead with a mortgage and interest <5% and instead sinking that money into the "market" then you are having a paid off house. If you have 750k, then via the 4% rule you can receive 30k/year. If you had 1mil, via the 4% rule you can receive 40k/year. Part of a mortgage is simply a money changing endeavor, principle, which is money going from you to you. So you can back that out of home ownership costs.

So, 250k house financed at 4.5%, in the first year you would pay $15,200, however 4033 of that is principle. After 6 years however, the person who financed their house has their interest payments less than the 10k they were exceeding the person who owned the home outright, and again, the expected return of the stock market is around 10% a year on average. Again, the specific numbers involved here are important, as is the time period analyzed. For 3.25%, I can go out and buy any of a couple hundred dividend paying companies, which yield > my interest payment yield on my house.

At 4.5%, I would strongly consider paying off the mortgage, not because I dislike the expected return of investing my money, but because the guaranteed return of the mortgage is more attractive, however the PMI does go away <80%, so if that were a part of my 4.5% calculation, then i'd shoot for ending PMI first and removing that from the equation.

If you'd like to read further into paying off the mortgage vs. investing the difference, see the following two topics, where it was discussed until we mostly got burnt out on it.
https://forum.mrmoneymustache.com/welcome-to-the-forum/has-anyone-here-remortgaged-their-house-in-order-to-invest/
https://forum.mrmoneymustache.com/welcome-to-the-forum/mr-math-and-paying-off-your-mortgage/

[ROF Expat]

I think you're correct to observe that owning an appropriate home can be a good financial decision, but that doesn't make a house an income producing asset (unless you're renting out rooms or have a crystal meth lab in your basement). 

In your example of the two persons with a net worth of $1m, one of whom owns a $250k house and one who rents, both have the same net worth and there is no immediate advantage for the homeowner.  If there were, the renter could simply take $250K of his money and buy a house.  Similarly, the homeowner can sell his house and choose to rent. 

Historically, houses haven't been a great investment, certainly not as good as the stock market.   One can argue that it is better to rent and use your increased cashflow to invest.  That said, I think homeownership is still a good idea.  First, it stabilizes your housing cost.  Rent goes up unpredictably, and the costs of homeownership are more stable, although you have to be prepared for maintenance and repairs and property taxes.  Another good reason to own a home is that it helps diversify your assets.  When the stock market tanks, it will be nice to know that you don't have to draw on a shrinking asset to pay rent every month. 

I think another good argument against counting a house as an income producing asset is that many people allow their home equity to mislead them into thinking their financial situations are much better than they are.  Or, even worse, they delude themselves into buying far too much house because "it's an investment."  When the value of their house goes up (on paper) they convince themselves that they should take out some of their "profit" in the form of a home equity loan.  (This isn't too relevant on this forum, but I) saw a lot of people get burned this way when the housing bubble burst.)

Person B in your example, with a $250K home and $750 investable has about 25% of his net worth tied up in his house and is probably in pretty good financial shape.  Most Americans have a much smaller net worth and a far greater percentage of that net worth in their homes.  I think the median net worth of Americans approaching retirement age is under $200K and probably 70 or 80 percent of that is in their homes. 

Let's add two more examples to Persons A and B:  Person C who has a liquid/invested net worth of $250K and a $750K home.  He is also worth $1M on paper, and I would argue that he is in far worse shape than person A or B, particularly if he is retired and has to live off investment income.  And how about Person D who has a liquid/invested net worth of 130K, and $870k worth of equity in a 1.2 million dollar home and a $300K salary.  He has a net worth of $1M and probably looks richer than persons A,B, and C, but is in real trouble if he plans on retiring anytime soon. 

I think you are on the right track to think about the financial value of a house as its rental replacement, but only up to the point where the rental cost is still in some sort of balance with net worth.  Ironically, despite all my arguments above, I think homeownership is actually a big positive for most people.  I think that most people overspend on their housing.  But paying a mortgage is enforced savings/investment in a (mostly) appreciating asset.  If they didn't overspend on their housing, they probably wouldn't invest the money, they'd just lease a fancier car and buy more junk.  If they didn't have 80 percent of their net worth in their homes at retirement, their net worth would probably just be 80 percent lower. 

I think a house can be an important part of your financial plan, but it should generally be viewed as an expense that ties up your money in exchange for paying rent, unless you plan on downsizing or moving to a lower cost of living area.  I do think it should be considered part of net worth, though. 

[CheapScholar]

I feel we get too tied up in the definitions of things on this board sometimes.  I do count my home equity when tallying my Net Worth on my spreadsheet.  But, I would not include it in my goals related to Finanacial Independence or FIRE.  For those, I am looking for 600K in investments to consider my family minimally Financially Indpendent and 900K to FIRE.  I have those goals with the assumption I'll own my home outright by FIRE.

[Bucksandreds]

Totally should be counted in net worth. Not an income producing asset but imo, reduces risk of going broke over a long retirement. Not only is the cost not as effected by inflation as rent, it also greatly lowers your monthly expenses. Owning a paid off home is a very smart way to conservatively FIRE early.

[Finallyunderstand]

I ran the two very basic scenarios through FIREcalc and 30 year scenarios which would equal the full length of a mortgage with no extra payments.

Person A with $1 mil liquid net worth and 4% withdrawal rate would have a 94.9% chance of success with $15k in housing/renting expenses per year and $25k leftover to spend as they choose.

Person B with 3.33% withdrawal rate but paid for housing and therefore $25k to spend as they please which is equal to Person A would have 100% chance of success.

I know Person A is "paying themselves" with payment going towards principal but it is still a required payment for 30 years. 

Yes, Person A has scenarios that have them ending up with more money at the end of 30 years but they also have multiple scenarios of running out of money. 

It seems if someone gave me the 2 situations I would choose the sure thing over the chance of having a little more money at the end of 30 years but also a chance of being homeless and broke.

[Khan]

I ran the two very basic scenarios through FIREcalc and 30 year scenarios which would equal the full length of a mortgage with no extra payments.

Person A with $1 mil liquid net worth and 4% withdrawal rate would have a 94.9% chance of success with $15k in housing/renting expenses per year and $25k leftover to spend as they choose.

Person B with 3.33% withdrawal rate but paid for housing and therefore $25k to spend as they please which is equal to Person A would have 100% chance of success.

I know Person A is "paying themselves" with payment going towards principal but it is still a required payment for 30 years. 

Yes, Person A has scenarios that have them ending up with more money at the end of 30 years but they also have multiple scenarios of running out of money. 

It seems if someone gave me the 2 situations I would choose the sure thing over the chance of having a little more money at the end of 30 years but also a chance of being homeless and broke.

The 4% rule adjusts for inflation over time. Home mortgage payments do not.

[jim555]

People keep saying housing hasn't been a good investment.  I would say IT DEPENDS.  Timing is everything and sometimes housing is a great investment.  Having 25% of your assets in real estate is a good diversification away from stocks.  Also it has preferential capital gains treatment and you get to be in control of where you live which is an intangible to consider as well.

[undercover]

Housing is an expense. Whether you rent or buy, the goal for most here is to minimize that expense. Sometimes it makes sense to pay more even if the expense isn't totally minimized.

That said, I do consider money saved (over the long run) when purchasing something to be an "investment".

[Imma]

In my country, the home is considered to be an income producing asset for tax purposes. It could just be that they needed to find another excuse to increase the tax revenue ;-) but if you are a home owner, 0.75% of the value of your home is added to your taxable income. The government is basically saying "You are not paying rent, so your home is basically an income in kind".  It's not much, but it feels quite unfair. Our taxable income is about EUR 900 higher because of it.

[dandarc]

The 4% rule adjusts for inflation over time. Home mortgage payments do not.

Yep - this impacts the analysis.  Ran on C-Firesim with 25K spend inflation-adjusted, 15K non-inflating additional spend (Mortgage P&I) against a $1M starting portfolio.  Over 30 years, 100% success rate based on historical data.  And better average positions at the end of the 30 years compared to the 25K on $750K portfolio run.

As counter-intuitive as it may seem, the person with the mortgage in this case has a very good chance of coming out ahead in a significant way.  Does have a bit more exposure to sequence-of-return risk, due to needing 4% of portfolio at beginning rather than 3.33%.  Break-even is sequence-of-returns problems equivalent to about a 15% first-year loss on the portfolio (assuming 7% return in subsequent years, 3% inflation - with higher ROR), based on some back-of-the napkin type of spread-sheeting.  Note that the portfolio isn't necessarily doomed if you put in that 15% first-year loss - just the home-owner starts to come out ahead at that and worse sequence-of-return situations.

[nouveauRiche]

Historically, houses haven't been a great investment, certainly not as good as the stock market.   

I have to disagree with this.  It would be more accurate to say that houses are not as good an investment as stocks *if* you buy a house with cash and then let it sit empty.

However, you can borrow most of the cost of the house at a ridiculously low interest rate, you can live in the house or rent to roommates or rent out the whole house, part of your monthly payment goes toward your own equity, the interest part of the payment is tax-deductible, (in the US) you can avoid taxes on the first $250k of gains if you sell (if you've lived in the house 2 of the prior 5 years).  If you don't sell, you'll eventually own the house outright and have a very low-cost place to live in retirement.

[boarder42]

I ran the two very basic scenarios through FIREcalc and 30 year scenarios which would equal the full length of a mortgage with no extra payments.

Person A with $1 mil liquid net worth and 4% withdrawal rate would have a 94.9% chance of success with $15k in housing/renting expenses per year and $25k leftover to spend as they choose.

Person B with 3.33% withdrawal rate but paid for housing and therefore $25k to spend as they please which is equal to Person A would have 100% chance of success.

I know Person A is "paying themselves" with payment going towards principal but it is still a required payment for 30 years. 

Yes, Person A has scenarios that have them ending up with more money at the end of 30 years but they also have multiple scenarios of running out of money. 

It seems if someone gave me the 2 situations I would choose the sure thing over the chance of having a little more money at the end of 30 years but also a chance of being homeless and broke.

This math is wrong. Person 2 magically has more money than person 1 in your scenario.  money can either be invested in the house or the market and in most typical scenarios for mortgage vs invest, historically having a mortgage and investing the money makes fire safer than not. I suggest you run a 1.2MM with 40k spend and a mortgage that doesn't go up with inflation as an additional payment for 30 years then run 1MM and assume they have a paid off 200k house the mortgage holder is more likely to not fail.

[Finallyunderstand]

Historically, houses haven't been a great investment, certainly not as good as the stock market.   

I have to disagree with this.  It would be more accurate to say that houses are not as good an investment as stocks *if* you buy a house with cash and then let it sit empty.

However, you can borrow most of the cost of the house at a ridiculously low interest rate, you can live in the house or rent to roommates or rent out the whole house, part of your monthly payment goes toward your own equity, the interest part of the payment is tax-deductible, (in the US) you can avoid taxes on the first $250k of gains if you sell (if you've lived in the house 2 of the prior 5 years).  If you don't sell, you'll eventually own the house outright and have a very low-cost place to live in retirement.

Oh yes!  I wasn't even thinking about tax free gains from real estate.  That would make scenarios even harder to compare.  Plus double the exemption ($500,000) for couples. 

[Finallyunderstand]

I ran the two very basic scenarios through FIREcalc and 30 year scenarios which would equal the full length of a mortgage with no extra payments.

Person A with $1 mil liquid net worth and 4% withdrawal rate would have a 94.9% chance of success with $15k in housing/renting expenses per year and $25k leftover to spend as they choose.

Person B with 3.33% withdrawal rate but paid for housing and therefore $25k to spend as they please which is equal to Person A would have 100% chance of success.

I know Person A is "paying themselves" with payment going towards principal but it is still a required payment for 30 years. 

Yes, Person A has scenarios that have them ending up with more money at the end of 30 years but they also have multiple scenarios of running out of money. 

It seems if someone gave me the 2 situations I would choose the sure thing over the chance of having a little more money at the end of 30 years but also a chance of being homeless and broke.

The 4% rule adjusts for inflation over time. Home mortgage payments do not.

That's correct.  If Person A decided to rent instead of starting a mortgage then one can assume rentals rates are adjusting up with inflation too.

[dandarc]

So, to make it an apples-to-apples comparison, you've got to do it this way:

Person A owns the home but has a $250K mortgage.  (P&I is about $15000 / year, as you've pointed out)

Person B owns the home outright.

If Person A is renting and Person B owns, you're making a rent vs. own decision, which is not the same thing as a mortgage-vs-none decision once you've decided you're buying.  If rent is $15K on a $250K house, that's over 16 on the price-to-rent.  While not absurdly high, that's a "lean renting" situation.  If you're doing this this way, you've also left off some costs that the homeowner will pay that the renter will not - maintenance / repairs, higher insurance will come out of person B's pocket whereas that is included in Person A's $15K of rent - so Person B might be spending $28-30K each year vs the $25K net of rent Person A is spending, which pushes the analysis towards Person A.

[boarder42]

So, to make it an apples-to-apples comparison, you've got to do it this way:

Person A owns the home but has a $250K mortgage.  (P&I is about $15000 / year, as you've pointed out)

Person B owns the home outright.

If Person A is renting and Person B owns, you're making a rent vs. own decision, which is not the same thing as a mortgage-vs-none decision once you've decided you're buying.  If rent is $15K on a $250K house, that's over 16 on the price-to-rent.  While not absurdly high, that's a "lean renting" situation.  If you're doing this this way, you've also left off some costs that the homeowner will pay that the renter will not - maintenance / repairs, higher insurance will come out of person B's pocket whereas that is included in Person A's $15K of rent - so Person B might be spending $28-30K each year vs the $25K net of rent Person A is spending, which pushes the analysis towards Person A.

Property taxes as well

[ROF Expat]

Historically, houses haven't been a great investment, certainly not as good as the stock market.   

I have to disagree with this.  It would be more accurate to say that houses are not as good an investment as stocks *if* you buy a house with cash and then let it sit empty.

However, you can borrow most of the cost of the house at a ridiculously low interest rate, you can live in the house or rent to roommates or rent out the whole house, part of your monthly payment goes toward your own equity, the interest part of the payment is tax-deductible, (in the US) you can avoid taxes on the first $250k of gains if you sell (if you've lived in the house 2 of the prior 5 years).  If you don't sell, you'll eventually own the house outright and have a very low-cost place to live in retirement.

I agreed that homeownership can be an important and positive part of a financial plan, at least up to a certain percentage of net worth and size, but I don't agree that a house that you use as a personal residence is likely to be as good an "investment" as stocks.  Yes, government policies aimed at encouraging home ownership help, but every additional square foot of house beyond what I really need costs me money for utilities, maintenance, and repair.  And if the value of the home goes up, I pay more in property taxes long before I get any capital gains break.  Are you saying that I would be better off liquidating my stock portfolio and "investing" in a McMansion?   A lot of people who were upside down on their mortgages once thought that.  Rental real estate is a different issue, and I concede that getting a great deal on a house or just getting lucky and buying into the right market at the right time can outperform the stock market, but look up the long term performance of housing vs the S&P for yourself. 

This isn't just theoretical for me.  I love my (nearly paid off) house, but it is pretty non-Mustachian.  It is more house than I need and a greater percentage of my net worth than it should be.  I got a good deal and it has appreciated, but I could easily have bought a perfectly adequate house for half the price.  If I had done that and invested the difference, I'd be better off financially today.  Any financial advantage in owning the house only comes if I sell, and I don't want to do that.  Until that time, it is just higher expenses.  Fortunately, we were pretty close to FIRE when we bought the house and while it was not a financially optimal decision, we can afford it and it hasn't much affected our financial trajectory. 

[Finallyunderstand]

So, to make it an apples-to-apples comparison, you've got to do it this way:

Person A owns the home but has a $250K mortgage.  (P&I is about $15000 / year, as you've pointed out)

Person B owns the home outright.

If Person A is renting and Person B owns, you're making a rent vs. own decision, which is not the same thing as a mortgage-vs-none decision once you've decided you're buying.  If rent is $15K on a $250K house, that's over 16 on the price-to-rent.  While not absurdly high, that's a "lean renting" situation.  If you're doing this this way, you've also left off some costs that the homeowner will pay that the renter will not - maintenance / repairs, higher insurance will come out of person B's pocket whereas that is included in Person A's $15K of rent - so Person B might be spending $28-30K each year vs the $25K net of rent Person A is spending, which pushes the analysis towards Person A.

Yeah, this thread wasn't/isn't meant to be whether or not to have a mortgage. It appears mortgages vs not mortgages are most of the main discussions in the posts.   It was simply meant to compare someone who owns a home outright vs someone who doesn't own a home outright or who chooses to rent.  Basically someone who is still paying for housing one way or another vs someone who isn't. 

I have read a lot of the "pay off mortgage vs. not pay off mortgage" threads and this wasn't supposed to be another to continue to beat the dead horse. 

Where I live my home is worth about $200k.  I could rent it out for $1300-1400/m. 

I ran the two very basic scenarios through FIREcalc and 30 year scenarios which would equal the full length of a mortgage with no extra payments.

Person A with $1 mil liquid net worth and 4% withdrawal rate would have a 94.9% chance of success with $15k in housing/renting expenses per year and $25k leftover to spend as they choose.

Person B with 3.33% withdrawal rate but paid for housing and therefore $25k to spend as they please which is equal to Person A would have 100% chance of success.

I know Person A is "paying themselves" with payment going towards principal but it is still a required payment for 30 years. 

Yes, Person A has scenarios that have them ending up with more money at the end of 30 years but they also have multiple scenarios of running out of money. 

It seems if someone gave me the 2 situations I would choose the sure thing over the chance of having a little more money at the end of 30 years but also a chance of being homeless and broke.

This math is wrong. Person 2 magically has more money than person 1 in your scenario.  money can either be invested in the house or the market and in most typical scenarios for mortgage vs invest, historically having a mortgage and investing the money makes fire safer than not. I suggest you run a 1.2MM with 40k spend and a mortgage that doesn't go up with inflation as an additional payment for 30 years then run 1MM and assume they have a paid off 200k house the mortgage holder is more likely to not fail.

I don't see how the math is wrong?  I was trying to make it so each person had the same net spending available after covering housing costs.  Both have the same net worth on paper but allocated differently. 

Plus, as mentioned above, I didn't make this post to try to have it compare mortgage to no mortgage but more simply paid-for housing vs paying for housing in FIRE whether it be rent or taking out a new mortgage.  It did segway into mortgage arguments exclusively which wasn't the intent. 

[GenXbiker]

I think you're correct to observe that owning an appropriate home can be a good financial decision, but that doesn't make a house an income producing asset (unless you're renting out rooms or have a crystal meth lab in your basement). 

Exactly.  The subject of this thread and the question by OP, "Can it truly be argued that that Person A has more income producing assets?" refers to whether the house is an income producing asset, not whether it's better financially or not as he gives examples of.  Those are apples and oranges.

Here's another take on this.  In a very recent thread, someone said they owned a home and had $1,000,000 in net worth and was questioning whether that was enough to FIRE on.  I asked if they were including their home in that figure.  Because if they were including a $250,000 home as part of their $1,000,000 net worth, with $750,000 of it in their stache, that would be $30,000/yr at 4% WR.   If they were not including their home in their net worth figure, with a full million in stache, then they would have $40,000/yr at 4% WR.   Either way, they still have the house and same expenses, but depending on whether they included the house in their figure, and therefore, knowing what the actual stache was, would make a significant difference in the absolute dollars they can budget for based on the 4% WR.

[Finallyunderstand]

The title of the thread also wasn't meant to imply that your own home is literally producing income. More so it wasn't meant to state that if you own it outright then renting or paying a mortgage is TAKING your income (investment returns) in the opposite scenario. 

[jim555]

The homeowner who owns outright gets imputed rent on the equity.  Imputed rent is a way to have what amounts to tax free income.  This is a great way to lower your MAGI to get bigger ACA subsidies. 

[liberty53]

OP, it seems as if you asked a few different questions and are conflating some concepts - specifically around the 4% rule.

The 4% rule only compares survival of investments in stocks and bonds relative to a "need."

Your need by definition is everything you must use your investments to pay for.

This "need" includes rent if renting, or the cost of owning a home - whether paying for a mortgage or just home maintenance, insurance, and property taxes.

The renter may need $40K/year which includes rent.

The homeowner may only need $30k per year because the house is paid off.

To apply the 4% rule:

1. Find your annual need (all expenses for the year - including all taxes)

2. Determine your total assets in stocks/bonds and assume you can withdraw an inflation adjusted 4% from those assets every year.

3. See if the withdrawal from investments is greater than your need - if so - congratulations you are FI!

Of course this is simplified - you can use one of the calculators like cFIRESIM to include investments in cash, need reduction over time, anticipated windfalls, and liquidation of an asset like a house.

The 4% rule did not consider a house as an investment or income producing asset. Only stocks/bonds were considered.
 

[Bateaux]

I think home ownership makes sense if you're going to be there for a while.   If you move a lot or live single with very little stuff renting could be better.  We've owned for 25 years and it was the right choice.  It's an old house and takes lots of my free time and money, but it's still cheaper for the lifestyle we're living.   Our home and extra acerage would cost about $2000 a month to rent.  The latest assessment of value was $285,000 not including extra acerage and out buildings.  We didn't pay that much, but bought it a long time ago.  At the time of purchase it was the majority of our net worth.  If you save and invest over time your home will soon be a minor part of your net worth, ours with the home is over 2M now.  Our home is surrounded by some homes worth over a million now.  Most with a mortgage.  Who's better off, us with 1.75M liquid and 1/8 of our 2 million net worth in a home?  Is it the neighbor with a 1 million dollar home and owes 750k, has 250K in equity and 1 million liquid?

I'd rather my 1.75 million liquid working for me.  He has 1.0 million liquid working for him.  He's house poor.

[nouveauRiche]

<snip>

I agreed that homeownership can be an important and positive part of a financial plan, at least up to a certain percentage of net worth and size, but I don't agree that a house that you use as a personal residence is likely to be as good an "investment" as stocks.  Yes, government policies aimed at encouraging home ownership help, but every additional square foot of house beyond what I really need costs me money for utilities, maintenance, and repair.  And if the value of the home goes up, I pay more in property taxes long before I get any capital gains break.  Are you saying that I would be better off liquidating my stock portfolio and "investing" in a McMansion?   A lot of people who were upside down on their mortgages once thought that.  Rental real estate is a different issue, and I concede that getting a great deal on a house or just getting lucky and buying into the right market at the right time can outperform the stock market, but look up the long term performance of housing vs the S&P for yourself. 

You are putting a lot of words in my mouth.  I never mentioned the word "McMansion" or suggested liquidating one's stocks or said to buy more house than you need. 

You said

Historically, houses haven't been a great investment, certainly not as good as the stock market.

That's the statement with which I disagree, for the reasons I stated. 

I'll add (as others have pointed out) home ownership stabilizes your housing costs.  Houses in our HCOL area rent for about 2.5 X our current mortgage payment. 

Also owning real property can diversify your holdings (we have not liquidated our stock portfolios - we're invested in both real estate and in stocks).

If you do your homework and choose a property well, the rent can cover the mortgage, taxes, etc.  As the value goes up, the property taxes go up but, over time, the rents go up, too.  Eventually, you own the property and it continues to generate income. 

[nouveauRiche]

Sorry to double-post.

look up the long term performance of housing vs the S&P for yourself. 

You cannot make an "apples to apples" comparison between housing and the S & P like that (unless you intend to buy a house with 100% cash and then let it sit empty and go live elsewhere).

If you put $10,000 in the S & P and it goes up 10% per year, at the end of 2 years you have about 12,100.

If you put $10,000 down on a house that is worth $200,000 and it goes up at half the rate of the S & P (5% per year), at the end of two years you have more than $30,000 in equity. 

These are made-up numbers, obviously, but when you say "look up the long term performance of housing vs the S&P", you are overlooking virtually every relevant factor in the comparison.

[dandarc]

If you put $10,000 in the S & P and it goes up 10% per year, at the end of 2 years you have about 12,100.

If you put $10,000 down on a house that is worth $200,000 and it goes up at half the rate of the S & P (5% per year), at the end of two years you have more than $30,000 in equity. 

That's not really fair unless you have a 0 interest loan.  Just so the math is simple, I'm just going to assume this is an interest-only mortgage at 3% on the $190K, and ignore compounding since we're only talking 2 years.

While the house appreciates to $220K (5% for 2 years), you also paid $11,400 in interest on your $190K loan over 2 years to have the $30K of equity.  If you pay that $11,400 in to the S&P fund, at the end you've got $23,400 ($10K + 10% for 2 years on the $10K + the interest you otherwise would have had to send to the bank).  So buying more house wins as a use of this $10K, but by $6,600, not $18K.

Do the same, but your house only goes up 3% per year, and the house is worth $212K in 2 years.  So you have equity of $22K.  Nothing changes on the S&P side, so you've got $23,400 there.  Leverage cuts both ways.

So what to do comes down to how you expect your house to appreciate against the rate you can get on a loan.  Since rates are so low now, many are tempted to buy more house than they actually need to try and "cash-in" on the appreciation as you've noted.  But nation-wide, housing goes up at just about the rate of inflation - even at today's low rates of 3-4%, you're betting that your house will appreciate at a somewhat higher rate than history / national data would indicate.  That might be a good bet in certain markets, but in many it is probably not.

I think in most markets, the prudent approach is to make your rent vs. buy decision.  Then if you've decided to buy, buy as little house as makes sense given your situation, and take out a 30-year fixed and keep that till the end, possibly cash-out refinancing once in a while if rates remain good.

[nouveauRiche]

Well, we can beat this subject to death (and perhaps we will), but you're not counting the fact that if a person didn't own the house, s/he would presumably have to pay rent to live elsewhere.  That rent could be more or less than the interest s/he would pay.  Are we subtracting rent from the hypothetical stock market gains?

My main point was only this:  The blanket statement "a house is a worse investment than the stock market" is false. 

[Scandium]

No, a house is not income producing. Owning a home outright reduces your expenses. But at the cost of having paid it off rather than invest that money. But you would then have to have paid rent. So like people have said; it depends. IMO a mortgage is a reasonable way to get stable housing costs through future earnings and a government subsidized system, but the equity in the home will not produce any income.

You're also saying home value when I think you mean equity? My home's value is $400k+, but my equity is less than half that. I don't count either in my net worth, except if I consider selling the home and buying a cheaper one.

[ROF Expat]

Finallyunderstand,

I see where you're coming from, and maybe using your numbers as an example will help: 

Yeah, this thread wasn't/isn't meant to be whether or not to have a mortgage. It appears mortgages vs not mortgages are most of the main discussions in the posts.   It was simply meant to compare someone who owns a home outright vs someone who doesn't own a home outright or who chooses to rent.  Basically someone who is still paying for housing one way or another vs someone who isn't.  Where I live my home is worth about $200k.  I could rent it out for $1300-1400/m.


Let's skip the whole mortgage issue and pretend that you've just moved to the U.S. with a million dollars in cash and you intend to retire with that asset with no plan of earning more.  You could buy your current home in cash for $200K or rent it for $1300.  Which would be better? 

Renting: 
If your rent is 1300 per month, that's $15,600 per year.   Subtracted from your SWR of $40K  you have $24,400 for other expenses.  You should plan on your rent going up in the future.  Exactly when and how much is a question. 

Buying: 
If you take $200K out of your investments and buy the house, your safe withdrawal rate is $32K, but now you don't have to pay any rent.   But you do have to pay expenses associated with homeownership.  Let's say $1000 per year for insurance, $2000 per year for maintenance (assuming a 1% average), $2,000 per year for property tax, and $2,000 for HOA fees, if applicable.  These will likely increase in the future.  YMMV.  These are reasonable ballpark figures, but if something goes vastly wrong, like your roof needs to be replaced, you could be on the hook for tens of thousands of dollars.  Subtracting $7K from  your $32K SWR, we're now looking at $25K for other expenses. 

So cashflow at the end of the month looks fairly similar in the two scenarios.  The differences are likely to be in the specific details of your local taxes and local rental rates. 

With these kinds of numbers, I'd choose homeownership.  Committing the $200K to the house means annual housing cost will be $7K as opposed to $15,600.  That $8600 difference is sort of like locking in a 4.3% guaranteed return rate on the $200k that probably grows with inflation.  This is less than the 10% I'd hope for in the market, but I'd be ok with that, particularly because it stabilizes my housing cost and diversifies my portfolio.  Any increase in the value of the home would be ok, but can't really be harvested until you sell and would mean increased taxes and insurance in the meantime. 

[MrMoogle]

As others have said, owning a home can be better in the long run than renting, but it depends. 

But even if it's much better than renting, it is not producing income.  Those calculations are about expense savings, not incomes.  You can't withdraw 4% of it each year and own the home.  If you choose to include it, then one way to look at it is you are "spending" that 4% on shelter.  So if you include it, you also have to add in an expense to take it away, so you really aren't getting a net out of it. 

[SugarMountain]

No, a house is not income producing. Owning a home outright reduces your expenses. But at the cost of having paid it off rather than invest that money. But you would then have to have paid rent. So like people have said; it depends. IMO a mortgage is a reasonable way to get stable housing costs through future earnings and a government subsidized system, but the equity in the home will not produce any income.

Exactly.

The way I model it is home equity is included in my net worth but not in my investable assets when calculating the 4% rule.  Take it to the extreme and lets assume you have a home worth $1,000,000 that is paid off and that is your only asset.  Your expenses are $40k/year.  You can't really retire or consider yourself financially independent, partly due to the illiquidity of it.  You need that $40k to come from somewhere and it's not really going to come from the house.

What you can do with a paid off house, however is use it as a risk backstop.  Say I retire today at 49 and I run out of money when I'm 80, but have a $1,000,000 paid off house.  I could either a) sell it and start renting, which increases expenses, but the $1MM should be enough to cover it for the rest of my life or b) take a reverse mortgage and continue living their for free but my heirs get less when I kick the bucket.