Your home’s value and your net worth
July 18th, 2007 | by
mbhunter |
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Few people would argue that real estate appreciation was very kind to homeowners during the first part of this decade. It really was a pleasure to own a house in many parts of the country, especially the ones with appraisals that defied gravity.
I bought a house in 2001. (Well, actually, I signed an agreement to allow the bank to hold the deed to the house I live in until I’ve paid back the entirety of what I borrowed back in 2001, but that’s not the point here.) It was all of four hours between the time my fiancee (at the time) walked into a Century 21 and when we signed the purchase offer on a house that was on the market for over three months for the asking price. Translation: I fell for every trick the real estate agent threw at me, and went into the deal paying quite a bit more than I should have. I bought into that house really, really dumb.
Since then, my relatively naive purchase has rewarded me with an appreciation that is close to what I make in a year. Now, if my net worth reacted so positively and lovingly to an utterly stupid purchase like that, I’m sure many others smarter than myself on that purchase have profited like gangbusters. Basically, it was pretty tough not to do well by owning a house over the past few years. I didn’t earn a dime of that increase. The increase in my net worth is a gift from easy money policy and wild real estate speculation.
It’s for these reasons that I’m reluctant to pay any credence to my home’s value, and I usually ignore my home’s value when I figure out my net worth. Thinking I’m rich because of a once-in-a-lifetime real estate market, that I entered at just the right time pretty much by accident, is foolish. My net worth would be quite a bit higher, and my return quite a bit greater, if I would include it, but the last thing I want to do with my financial future is to assume that I’ll get there doing what I’m doing. It’s a good way to kill your retirement dreams.
This doesn’t mean that home equity necessarily has to be the biggest component of your net worth, though. Nickel posted year-by-year historical net worth numbers for his family over the past ten years. His family’s net worth saw a nice jump the year after he bought a house. I commented on this, and it turned out that, even though he did include the equity in his home in the net worth figures, the home appreciation was not the main component for the large gain he saw the following years. Instead, he saw his main gains by the more legitimate hallmarks of financial discipline: aggressive saving and increasing one’s income. Now that’s old school. 
Technically speaking, the difference of your home’s value and the mortgage owed against it is part of your net worth. Given what a large part of net worth it can be, psychologically it’s more prudent for most people to ignore it. Otherwise, there’s the temptation to think rich, and borrow against it. Then, when house prices go down, psychologically nothing is lost, because it wasn’t counted on in the first place.
How do you account for your home’s value in your net worth?
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12 Responses to “Your home’s value and your net worth”
By traineeinvestor on Jul 18, 2007 | Reply
While you make some good points about the risks of people thinking they are richer than they are or using an increase in home equity to fund spending I respectfully but very strongly disagree with the suggestion that home equity not be included in a person’s net worth calculation.
I will not repeat the reasons why home equity is part of net worth why it is relevant to retirement plans as this has been debated in a number of blogs already but to address three of the points you raise:
1.”I didn’t earn a dime of that increase.”. I disagree. You earned it when you risked your deposit (if there was one), your credit rating and your future income by buying the proprety and taking a mortgage.
2.”The increase in my net worth is a gift from easy money policy and wild real estate speculation.” Only partly true. There are other reasons why real estate prices rose dramatically in many places (planning restrictions and land supply have been shown to be more significant factors than easy credit). Also, the same can be said for many gains that people make from other investments. At least part of the gains people are making from investments in the stock market now are due to the same easy money policies and corporate buy outs (actual and speculated). What caused the gain does not alter the fact that a gain has been made. If you exclude gains in real estate because they are a partially by product of easy money and speculation, then logic dictates that gains in equities must also be excluded (either in whole or in part) as they are at least partially attributable to the same causes.
3.Uncertainty over valuation is not a reason for excluding an asset from your net worth, although it would certainly justify a conservative approach to your valuation.
By Jon @ TheMoneyMythos on Jul 18, 2007 | Reply
To be fair, I don’t own a home yet. But I do not plan on figuring that house into my net worth. To begin with, as I understand it, your net worth would actually plummet down to nearly four times the cost of the house with a standard 30 year fixed rate mortgage, taking into account the total amount including interest you own on the house.
More importantly though, I like to think of my net worth as a solid figure, money that I can rely on. This of course includes cash, my savings, my investments, etc. I also include my car because in a pinch, I could sell it for about its blue book value.
However, I would never sell my house in a pinch. Therefore adding it to my net worth would do nothing but inflate that number (and, possibly, my ego) into some intangible reference instead of what I would consider a more accurate figure.
The only time it seems a net worth that includes a house would be useful is during a lawsuit or bankruptcy, and I am hoping to avoid both of those
By KMC on Jul 18, 2007 | Reply
That’s an interesting take on why you shouldn’t include home equity in net worth - the wealth effect. However, I think that anyone who truly takes the time to calculate their net worth probably isn’t going to fall for that (but I could very well be wrong). On the other hand, people evidently feel the wealth effect even if they only get the ‘feeling’ they’re asset has appreciated. Though most Americans don’t own stocks and barely a majority own homes, economists attribute growth all the time to ‘wealth effect.’
For what it’s worth, I calculate our net worth both ways, just for the perspective.
By Kurt on Jul 18, 2007 | Reply
“To begin with, as I understand it, your net worth would actually plummet down to nearly four times the cost of the house with a standard 30 year fixed rate mortgage, taking into account the total amount including interest you own on the house.”
You don’t understand it correctly. You don’t include the future interest expense in the current value for two reasons: you can pay off the loan immediately and not pay that interest and (more importantly) if you were to do this with the other side of the balance sheet (assets), you would show billion and billions of dollars of interest from just a simple checking account. Yes, the dollar figure you pay in interest is high, but it’s not a liability today.
By Gaming the Credit System on Jul 18, 2007 | Reply
I usually consider what one might call my Liquid Net Worth. This does not include *any* non-liquid assets (car, personal property, real estate; or any loans collateralized by such assets, *unless* the loan amount is more than the amount of the asset) in my day-to-day net worth. Yes, sometimes it might be fun to add up all of my belongings and try to determine the “pie in the sky” net worth, but for the most part I don’t see the use.
By Lazy Man and Money on Jul 18, 2007 | Reply
I do my net worth in several ways. For the purpose of publishing on my site, I include the house. As I no longer live in it and rent it out, it’s transformed from my home to an investment property. It seems silly to suddenly add it due to that transition as I didn’t end up buying or selling, gaining or losing anything. Nickel also mentioned in his article that he’s looking to expand the home. That will incur a cost and if he doesn’t “realize” the gain of the asset will look like he just took a big vacation or blew his money on women and booze :-).
So I have separate items for real estate and possessions (cars, furniture, etc.). I know exactly how wealthy I am across the board.
By Lord on Jul 18, 2007 | Reply
As an asset I carry it at historical book value, but track the market value separately as part of net worth, but don’t consider myself any wealthier because it’s value increased. Any other place I buy would cost at least as much and any appreciation can’t be spent without consequences. While it raises my taxes, it does not provide a nicer place to live, so I consider it counterbalanced by an increase in rental equivalent.
By used vans girl on Jul 19, 2007 | Reply
I own a property(mortgaged) but have never considered it to be part of my net value. Its something that we wouldn’t sell unless in an absolute emergency otherwise we would have no where to live. So although our house value may be rising with house prices I wouldn’t consider myself to be richer as everything else has increased in price also. When we bought our house which is 3 bedroom, to buy a house in the same street with an extra room would have cost us an extra 10-20,000 now we would be looking more like having to spend 50,70,000 for the same house. So I would say if you bring property into the equation unless its a second property bought solely for investment purposed Property certainly doesn’t make you richer.
By mbhunter on Jul 23, 2007 | Reply
TraineeInvestor: Maybe “earn” wasn’t quite the right word. Perhaps “deserve” is a better word. I suppose if I decided to get out of real estate completely and rent for a while, then when I sell, I will have earned that increase. Bottom line is I don’t feel any richer because of the increase in my home’s value.
Lazy Man: Yes it’s a little strange but it’s exactly what to do, because your home is now an income-producing asset.
By Michael on Jul 24, 2007 | Reply
I have my net worth sheet broken down into four areas:
–Property - So, obviously, I do calculate my home equity. One thing to make sure is to subtract out expected selling costs of your house, as well as your mortgage payoff. I just sold a condo and so I can say that you should expect about 7-8% off the selling price to go to agents, transfer fees, home warranties, title insurance, etc. So, on the flip side, when you buy a house, know that it has to go up about 10% in order for you to even break even on it.
–Cars - Same deal, I calculate the current Kelly Blue Book price less any outstanding loan balance. I do this because I don’t want my cars to represent a large part of my total net worth since it’s a depreciating asset. I actually have gotten much more frugal with cars and kept cars a lot longer than I did before I started this tracking.
–Current Assets - Bank accounts, money markets, mutual funds, etc. Anything that I could easily turn into cash
–Retirement Assets - 401ks, IRAs, etc.
Adding these four categories together provides me an overall net worth summary, but by breaking it out, I can see how I’m doing in each area, and also track what percentage of net worth is allocated to each category.
By threadbndr on Jul 24, 2007 | Reply
I run my numbers both ways - with a (conservative) estimate of house value less mortgage balance when I had one (classic net worth) and without the primary residence (liquid net worth).
I actually cut my net worth a THIRD way - without house OR retirement (investment net worth aka the ‘go the &*!! fund’)
I think that tracking all three indicators plus cash flow over time gives you a pretty good handle on if you are trending in the right direction.