Mortgage principal and savings rate

Mr.Moai · Post by **Mr.Moai** » Mon May 13, 2013 10:53 pm

Hello Everyone,
I was just wondering if you include mortgage principal repayment in your savings rate calculation? In other words - do you consider principal repayment as savings for purposes of ERE?
At first I thought that mortgage on a house you live in is an expense and can't be therefore considered as savings. However if I would be saving and investing money to generate an income to cover my housing cost that would be obviously included in the savings rate. Both ways seem to be somewhat similar in a way because end result is to basically eliminate a cost (for simplicity sake).
Am I out of my mind thinking that principal repayment should be included in the savings rate?
Thanks.

secretwealth · Post by **secretwealth** » Mon May 13, 2013 10:59 pm

I don't, but you definitely can. It is certainly savings--you are investing money in an appreciating asset.

George the original one · Mon May 13, 2013 11:22 pm

Yeah, the principal can be counted in your savings rate. No problem to do so.

BennKar · Post by **BennKar** » Tue May 14, 2013 12:24 am

I always included the principal repayment as part of my savings. I never understood why you wouldn't include it. Sure, the value of the house can go down (or up), but you can say that of most assets you can acquire.

secretwealth · Post by **secretwealth** » Tue May 14, 2013 12:47 am

The only reason I don't is buffer. But you're right: it is definitely savings and should be treated as such.

spoonman · Post by **spoonman** » Tue May 14, 2013 2:36 am

I think you can definitely count it as part of your savings. I have a 15 year loan on my condo and roughly 50% of my mortgage payment goes toward the principal. That's a nice chunk of change that I hope to get back someday when I sell the place.

Post by **jacob** » Tue May 14, 2013 2:42 am

Theoretically yes. Practically, it's trickier. While modern finance will happily exchange any cash flow for any other cash flow, in practice that costs money and/or is inconvenient.
For example, someone who in principle has a 3% WR but has 100% of their assets in the roof over their head will have to take it out using a reverse mortgage. I have no idea what a safe withdrawal rate is in that case.. probably 0%.
So frankly, I don't really know. The acid test for FI is whether you can generate adequate cash flow in the long run. Not some n% number.---That is just a guideline, not a guarantee.

secretwealth · Post by **secretwealth** » Tue May 14, 2013 2:57 am

As far as I'm aware (I've been meaning to look into this), reverse mortgages work like annuities so your age is a factor. If you're too young, the payment you'll get will probably be too small--if you qualify.
We all need a place to live, and owning outright lowers (or may lower) housing costs. So home ownership is a way to cut down costs and minimize risk. In this sense, it's a hedge.
Calculating this equity buildup isn't too helpful if you plan on staying in the home and you're looking to build up a portfolio that provides a passive income.
This is a great article to read on the topic: http://thezikomoletter.com/2012/12/10/y ... t-housing/

Spartan_Warrior · Post by **Spartan_Warrior** » Tue May 14, 2013 3:17 am

I include equity in my overall net worth figure, so naturally I include it in my monthly/yearly savings rate calculations also. I do consider the equity just another asset, since I can sell the house to recoup the market value at any time. Like any asset, it has its associated risks, holding costs, and transaction fees. But it's not like the money is swallowed in an inaccessible hole.
That said, I do keep track of "ERE funds" separately, and I don't rely on the equity to finance my retirement since I personally don't plan on selling my house. (I do rely on the low-cost housing solution of owning a home free and clear.) If I no longer need the house myself, I'll rent for a profit.

jennypenny · Post by **jennypenny** » Tue May 14, 2013 3:42 am

I don't count principle payments as savings, and I don't include any home equity in our net worth. I view our home as a consumption item, not an investment. I think the equity is offset by the financial obligations that come with it (RE taxes, maintenance, utilities).

Mr.Moai · Post by **Mr.Moai** » Tue May 14, 2013 8:42 pm

@jacob: I agree that it's just a guideline, however it's a great moral boost to think that I'm saving over 75% instead of just 55%

@secretwealth: Great article. I think this sentence sums it up flawlesly:

"If you choose to buy a house, you are not going long the housing market. You are going flat the housing market using a fixed rate product to lock in your exposure."
@Spartan_Warrior: My thoughts exactly!
@jennypenny: Interesting approach. I agree that your home isn't an investment as you need to live somewhere and would have to either sell it or rent it to realise a profit (or loss

, well explained in the article posted by secretwealth; however I think it would be a mistake not to consider at least the monies spent on principal payments in your net worth (house equity may be a bit more tricky). Home related financial obligations shouldn't be anywhere near your home equity IMHO. It's probably heavily dependent on the market, but if you would be renting then RE taxes and maintenance are covered by your landlord but you still pay for it in the end + his profit. Utilities need to be paid either way.
Thanks everyone for your great insight. I'm first time poster but I've been lurking for almost a year and you guys are a great inspiration.

George the original one · Tue May 14, 2013 9:32 pm

@jennypenny - I count a house as a long term asset, like an IRA, in that it will be sold to fund living in a care facility when we reach that age.
Just say no to reverse mortgages. They're a crappy way to extract money from a house.

Tyler9000 · Post by **Tyler9000** » Tue May 14, 2013 11:38 pm

Paying principal on a mortgage is a neutral action, neither saving nor spending. You're simply transferring money from a liquid account into equity. If you were to pay off your mortgage in full tomorrow using your investment funds, you would not claim to have saved the value of your home in the process.
So it depends on what you're measuring. From a net worth perspective, -new- money you accumulate after expenses is savings whether it goes into your investments or into home equity. But from a withdrawal rate perspective, your principal is an expense every month because it's being removed from your investments.

celliott · Post by **celliott** » Wed May 15, 2013 12:49 pm

I don't believe it should be considered a neutral action.
You will ultimately receive a return on this "savings". Imputed rent should not be ignored. If you were to invest the same principal in the market and after 15 or 30 years were to take the dividends or withdrawl the monies to pay rent, would that be a neutral event?
No. A paid off house imputes an intangible return as imputed rent. You can (and I believe should) account for it. How you decide to do that is up to you. But there is value there.

Chad · Post by **Chad** » Wed May 15, 2013 2:06 pm

I kind of view it as Jennypenny and Tyler9000.
@celliott

True, but what if you could rent something significantly cheaper and invest the difference? Then would the more expensive mortgage still be savings or would it be an expense for a certain lifestyle?

secretwealth · Post by **secretwealth** » Wed May 15, 2013 2:54 pm

I realized that I do calculate the value of my real estate in two important ways:
I calculate equity in my total net worth, but at the price I paid, not at its current market value. After 2008, I don't want to depend on price appreciation. I don't even calculate a 3% yearly inflationary growth. The price I paid is the price I hope to get out when I sell.
I also calculate the net rental income after expenses as part of my total potential investment income. This way, the SWR metric isn't exactly fitting, but I do get to measure how much the shortfall is between what I spend and what I can get from not working, which helps me target investment goals in other holdings.
Also, thinking about it this way motivates me to pay off mortgages completely instead of just paying them down as much as possible.

RealPerson · Post by **RealPerson** » Wed May 15, 2013 3:27 pm

If you want to correctly account for the money you put in your house, you need to account for the opportunity cost of the paid mortgage. In other words, what would be a fairly guaranteed and predictable ROI for the paid mortgage principal. That is an expense since you are missing out on that income. The other expense is obviously the interest you are paying on the balance of the mortgage.
On the other hand, you are saving the expense of paying rent. That could be entered as "income" and should reflect the actual current rent for a similar residence in your area. If you enter both sides of the equation, you would know what your actual cost is for living in your home. Your other cash layouts such as insurance, maintenance and utilities are also obviously expenses.