Eliminating debt is my main FIRE goal

[rayvt]

Balderdash. The thing that makes margin dangerous is that it can be called at any time. And that it can (and will!) be called if the value of the stocks drop.

Neither of these is the case for a mortgage.

 

[rayvt]

You don't include your home in your calculations. That is not irrational. But it also is not irrational for people to include their home.

But I think it is irrational. Sure, it does increase your net worth figure, but that's rather meaningless.

IMHO, your house is a consumption item, just like the food in your freezer and pantry. You don't count those in your net worth, because those are consumption items. You have to live somewhere. Whereever that is, you are using up the benefit by simply living in it. Unless you are planning to sell your house and move into a cardboard box under a bridge, that is.

 

[rayvt]

Not true - you could own a home free and clear, but if you fail to pay your property taxes then the gubmint can get a tax lien and foreclose on the house.

Do you have any other hairs you need split?

There is also the situation a financial advisor told us about. "Do you know how a retired couple can lose their fully paid-off house? Easy. one of them gets sick and they need a large chunk of money and/or a large ongoing payments. They have to sell their paid-off house to get the money they need."

This came true with my uncle a few years back. He had unexpected quintuple heart bypass surgery, little cash, and a free-and-clear house & land. Couldn't borrow against the house, couldn't get a HELOC.

 

[jdw_fire]

But I think it is irrational. Sure, it does increase your net worth figure, but that's rather meaningless.

IMHO, your house is a consumption item, just like the food in your freezer and pantry. You don't count those in your net worth, because those are consumption items. You have to live somewhere. Whereever that is, you are using up the benefit by simply living in it. Unless you are planning to sell your house and move into a cardboard box under a bridge, that is.

i can see that housing is a consumption item if you are paying rent. that is more like the food in your freezer because once you consume it (live for the month that your rent payment bought or ate the food in your freezer) it is gone with no value left. but when you are buying (or have bought) a home the easiest way to show it isnt a consumption item (but actually a financial asset) is to look at the situation when you have paid off the mortgage note on said house. at that time your monthly income requirement to cover living expenses drops by the amount of the P&I of your mortgage payment.

in an attempt to show my point that your house is a financial asset lets look at an example. assume while you have a mortgage payment the P&I = $1000/mo. when the mortgage is paid off there would be a drop in the required income to cover living expenses of $12,000 a year which using the 25x rule of thumb is equivilant to an additional $300,000 of portfolio value that would be required if you had to pay that $1000/mo out in rent to maintain an equivilant lifestyle in retirement if you didnt own said home. the nice thing about this (fantom) $300,000 of portfolio is that it is throwing off (a fantom) $12,000/yr that is both guaranteed and non taxable (which would actually make the value greater than $300,000)

 

[rayvt]

Well, I would say that, yes, your house is a financial asset. In essentially the same sense that your car, your clothes, and the food in your freezer are. You can either sell it to raise cash, or "consume" it by living in it. But you can't do both. You can't eat your cake and have it, too.

If you live in it (rather than sell it), then its value is immaterial. It could be worth $300K or $3M---doesn't matter. The value is locked away where you don't have access to it. Sure, in one sense it may have a (fantom) $300,000 of portfolio [value] is that it is throwing off (a fantom) $12,000/yr. But that's fantom, not real. It is non-taxable because it is not real. It's not income, it's just the absense of an expense.

Consider it this way. Suppose your paid-off house is worth $300K, throwing off a "phantom" non-taxable income of $1000/mo. Alternatively, suppose your house is worth $3M, throwing off a "phantom" non-taxable income of $10,000/mo. Is there any difference in your finacnial situation between these two scenarios? I say no. You can't spend that $1000, nor can you spend the $10,000.

Suppose you are retired with a fixed income of $1500/mo, and have lving expenses (food, gas, electricity, phone, etc.) of $1200/mo. Leaving $300/mo of excess income.

Can you afford either house? YES. No payments, regardless of house value.

Can you go on a $5000 cruiise with either house? NO, with either. The extra $9000 of phantom income is only phantom, not real. You can't spend it. You can only spend real money. And your real money is $300, not $10,300.

It's nice to have freed up $1000 of expenses by having a paid-up house, but that's all you have done. You've un-committed an expense, not added to your income.

 

[ERD50]

i can see that housing is a consumption item if you are paying rent. that is more like the food in your freezer because once you consume it (live for the month that your rent payment bought or ate the food in your freezer) it is gone with no value left. but when you are buying (or have bought) a home the easiest way to show it isnt a consumption item (but actually a financial asset) is to look at the situation when you have paid off the mortgage note on said house. at that time your monthly income requirement to cover living expenses drops by the amount of the P&I of your mortgage payment.

in an attempt to show my point that your house is a financial asset lets look at an example. assume while you have a mortgage payment the P&I = $1000/mo. when the mortgage is paid off there would be a drop in the required income to cover living expenses of $12,000 a year which using the 25x rule of thumb is equivilant to an additional $300,000 of portfolio value that would be required if you had to pay that $1000/mo out in rent to maintain an equivilant lifestyle in retirement if you didnt own said home. the nice thing about this (fantom) $300,000 of portfolio is that it is throwing off (a fantom) $12,000/yr that is both guaranteed and non taxable (which would actually make the value greater than $300,000)

jdw_fire, I agree with rayvt that it makes sense to not include your house in your net worth. An exception would be if you bought more house than you need/want in retirement, and plan to downsize at some point. In that case, the "excess value" (house value minus replacement cost) in your house could be added to your NW.

Your numbers are flawed though. The 25x rule of thumb is for an inflation adjusted level of spending. A mortgage is a fixed annual payment. I've done FIRECALC runs to evaluate the multiplier for my non-COLA'd pension, and I (as have others) come up with ~ 12-14x for portfolio equivalent. So let's try again:

$1,000/month is $12,000/annual. That is a 30 year, 5%, $187,000 mortgage.

$12,000 x 14 (using the upper end) = $168,000.

So, with the mortgage, you have an extra $187,000 in your portfolio, but you only need ~ $168,000 to pay the mortgage. Individual tax situations will affect this, and probably close the gap some (or entirely). But the numbers always seem to come out pretty close, and that is why I always suggest to run the numbers, or even just go with what "feels good", but I've never seen the numbers to justify that it makes a big difference either way.

-ERD50

 

[beowulf]

I don't agree that a fully paid for (or one with a lot of equity) house is a phantom asset. Even though there are many fees and it's not generally advisable, you can get a reverse mortgage on your home and receive monthly payments. I'm not saying this is a good thing to do, just that your home could generate income for you.

In addition, like a car, bat, plane, etc., it has actual cash value. If you don't consider these to have real value, you can say the same thing about coin or stamp collections, rare books, artwork, etc. As long as you own them they don't generate actual income, but they are real, not phantom assets. And they can increase or decrease in value.

Something does not have to generate income to be an asset. I bonds don't generate spendable income until you cash them - does that mean they are phantom assets since they don't throw off monthly income that can be spent?

We are not talking about assets like "good will" or "name brand" - houses, cars, etc., are actual things that exist and can be sold relatively easily (depending on how much you ask for them). I would definitely include them in my net worth - if not, why would you include other items that don't generate immediate income?

 

[RunningBum]

jdw_fire, I agree with rayvt that it makes sense to not include your house in your net worth. An exception would be if you bought more house than you need/want in retirement, and plan to downsize at some point. In that case, the "excess value" (house value minus replacement cost) in your house could be added to your NW.

Yes, it's that exception that some of us are counting on, or are using as a safety net.

In my case, I'm not planning to downsize, but if I can see on the horizon that I'm not going to make it, I will. And unless I have an unexpected large expense suddenly come up, I figure I'll see it coming in time to not have to do a fire sale.

And house size isn't necessarily what makes it valuable. I have a wonderful view. Others may be ocean front or lake front. Getting a similar house but without in a different location could net quite a bit. But in my case I would also downsize.

I have to live somewhere, but I can get quite a bit of money without having to switch to a cardboard box.

 

[IndependentlyPoor]

I never believed in counting my home's value as part of my net worth for all the reasons that have been discussed here. I still believe these things true in normal times, but the housing bubble forced big changes in our thinking. Our house tripled in value so that it became an unreasonable portion of our net worth. Before we sold it, our taxes were more than the original mortgage.

Selling our house allowed us to embark on a 5 year early-retirement adventure. We bought a 39 foot sailboat and lived on it, and the payments were less than the taxes on our house had been. The income from the proceeds of the house sale went a long way toward financing our retirement expenses.

The downside is that when we finally decided to settle down again we found that the housing market had continued to skyrocket and we were priced out of all the neighborhoods that we had assumed we might settle in. Now we are renting a tiny apartment and looking and waiting. The condo market here seems to be in an upheaval.

C'est la vie. We aren't complaining.

 

[nun]

I was just wishing that for the past 7 years I'd put my after tax savings into extra principal payments rather than equities. If I'd put the money towards paying off debt I would have paid off the mortgage and my current 20% loss from the peak of my after tax investments would be a far smaller absolute number, instead I still have $200k left on the house.

 

[ERD50]

I was just wishing that for the past 7 years I'd put my after tax savings into extra principal payments rather than equities. If I'd put the money towards paying off debt I would have paid off the mortgage and my current 20% loss from the peak of my after tax investments would be a far smaller absolute number, instead I still have $200k left on the house.

And I was just wishing that I would have mortgaged/sold everything and bought Google at the IPO 4.5x in 5 years....

My point it, this sort of "rear view mirror" analysis only seems to be useful in terms of helping you decide what to do moving forward. Another way to put that is, what kept you from paying down the mortgage the last 7 years?

So, looking forward, do you expect the long term return of a diversified investment from current levels to be less than current mortgage rates? If so, what are you invested in?

edit/add - actually, if you have been DCA'ing into the market all during the downturn, you might not do so bad at all, assuming we have reasonable returns going forward. You bought a lot of shares at what might turn out to be bargain prices (we hope!)

-ERD50

 

[jdw_fire]

Well, I would say that, yes, your house is a financial asset. In essentially the same sense that your car, your clothes, and the food in your freezer are. You can either sell it to raise cash, or "consume" it by living in it. But you can't do both. You can't eat your cake and have it, too.

i agree it is similar to your car and clothes but not food in your freezer. the reason is that you can rent living space, a car and even clothes (eg. rented tux) but not food. to consume food you must own it (unless you are willing to steal it). when you own the car, clothes or house (paid in full) you no longer have a rental payment for them.

It's not income, it's just the absense of an expense.

...

You've un-committed an expense, not added to your income.

but when you are looking to retire, uncommitting an expense is atleast as good as adding income (i submit it is better since it allows a lower income and thus lower income tax bracket). the point here is how much it costs to maintain the lifestyle you have chosen. if you choose to rent your house, car and clothes you will require alot higher income (and therefore alot larger portfolio) for any given lifestyle then if you own your house, car and clothes and all i am saying it that owning those things is a lifestyle equivilant to having a larger porfolio and renting them. therefore the things owned have a portfolio equivilant value. now not many people choose to rent a car instead of owning 1 (i am sure there are people who cant drive or live in a place where it makes sense not to) and fewer still are the people who rent clothes instead of owning them so these things arent often talked of in this sense, but if you think about my point using them as an example it really makes my point. what i was saying in my previous post was that if you hold lifestyle constant, owning your home reduces the size of portfolio you need and that difference in portfolio value required is the portfolio value of your home.

Consider it this way. Suppose your paid-off house is worth $300K, throwing off a "phantom" non-taxable income of $1000/mo. Alternatively, suppose your house is worth $3M, throwing off a "phantom" non-taxable income of $10,000/mo. Is there any difference in your finacnial situation between these two scenarios? I say no. You can't spend that $1000, nor can you spend the $10,000.

the problem with your example is that you havent kept lifestyle constant and therefore it is an invalid example in your attempt to refute my point.

 

[rayvt]

All our computations and models rely on historical data and I was with ERD50 for a long time. But we all know that time horizon and future market returns will change the results of such calculations, a few down years going into ER is always possible. So I will continue to take 50% of my gains and put it into the mortgage as insurance against years of negative returns.

I don't understand this thinking at all. Maybe I'm failing to understand something, but this seems to me to be an outright fallacy. Here's why:

When you make extra principal payments, you don't get any concrete benefit until decades later, when the mortgage is finally paid off. Your required monthly payment stays the same--it doesn't go down.

You still have to make the same required payment each and every month---you don't get to skip any payments. You can't call the bank and say, "Hey, remember all those extra payments I made last year? Well I want to skip a couple of payment now."

It's a one-way lockbox. You put (extra) money in but you can't get it back out. The pnly way to tap it is to take out a new borrowing--a HELOC, a cash-out refi, etc. But that's not taking your money back out---it's taking out a new loan. Even a new advance on an existing HELOC is just a new loan--it's not getting your own money back.

Your risk situation is NOT reduced when you make extra payments. In fact, your risk is a bit higher, since you've reduced your liquidity. If you get foreclosed, the bank takes your house and KEEPS all the extra money you've paid in. You can't say, "Hey, I gave you $10,000 extra that I wasn't required to, so now give it back."

Your net worth is no different, you've just shifted some of it from (liquid) cash to (illiquid) real-estate. You do have an unrealized gain from the interest that you've ducked. But it doesn't become realized until you finally pay the mortgage off completely.

There are only two conditions w/r/t a mortgage on your house. 1) You have a mortgage, and 2) you don't have a mortgage. There is no "you have a smaller mortgage balance than you otherwise would have." That's #1--you have a mortgage.

If you really and truly want to pay off your mortgage early, it seems the best way to do so is with a "Mortgage Freedom Account". Instead of paying extra on your mortgage, put that extra money into your MFA. When the MFA is larger than the mortgage balance, pay it off all at once. This MFA money is in your hands. If you get foreclosed, you keep the MFA---the bank doesn't take it as well as your mouse. Actually, you are LESS likely to get foreclosed. You can tap the MFA to make your mortgage payments. The bank is happy because they continue to get their monthly payment. You're happy because you are effectively skipping payments, since it doesn't come out-of-pocket but rather from the MFA.

The net cost of the MFA method is the difference between the mortgage interest rate and the MFA earning rate. Think of this cost as an insurance premium. This "insurance" is protecting you from running out of liquidity before the mortgage is fully paid off.

 

[jdw_fire]

Your numbers are flawed though. The 25x rule of thumb is for an inflation adjusted level of spending. A mortgage is a fixed annual payment. I've done FIRECALC runs to evaluate the multiplier for my non-COLA'd pension, and I (as have others) come up with ~ 12-14x for portfolio equivalent. So let's try again:

$1,000/month is $12,000/annual. That is a 30 year, 5%, $187,000 mortgage.

$12,000 x 14 (using the upper end) = $168,000.

So, with the mortgage, you have an extra $187,000 in your portfolio, but you only need ~ $168,000 to pay the mortgage. Individual tax situations will affect this, and probably close the gap some (or entirely). But the numbers always seem to come out pretty close, and that is why I always suggest to run the numbers, or even just go with what "feels good", but I've never seen the numbers to justify that it makes a big difference either way.

-ERD50

my example using a mortgage was an attempt to get at what the rental value of said house might be so please forgive me. that being said i believe i am still correct when you use the rental value of the house in the example. i explained further in a previous post. and rent will need a cola to compensate.

 

[rayvt]

the problem with your example is that you havent kept lifestyle constant and therefore it is an invalid example in your attempt to refute my point.

The point I was trying to make is that it doesn't matter how much your house is worth. You are "using up" the entire value of your house by living in it. That's what I meant by saying a house is a consumption item. The only way to extract the value out is to sell it--but then you're not living in it anymore. Well, maybe you could extract some value by getting a roommate and renting half the house to them. But then you aren't using (consuming) the entire house, only half of it. But you are consuming 100% of your half.

Perhaps it's a fine point, perhaps we are just talking past one another, perhaps we are saying the same thing in different ways.

I have the same problem when people say "Paying extra on mortgage principal is the same as earning the same rate. If the mortgage is 6%, then I am earning 6% on the extra $1000 principal payment."

My response to that is, "Well then, I pay off my 20% interest rate credit card every month, so I'm earning 20% on that money. And 20% is more than 6%, so I'm doing a whole lot better than you."

The truth, of course, is that they are not earning 6% and I am not earning 20%. Both of us are just reducing the expense that we would otherwise be paying. It's no different from deciding to not buy a new car. I've avoided a $20,000 expense but that's not the same as earning $20,000.

 

[jdw_fire]

The point I was trying to make is that it doesn't matter how much your house is worth. You are "using up" the entire value of your house by living in it. That's what I meant by saying a house is a consumption item.

i am not sure what point you are making. if you are talking about value to a persons retirement i addressed that in my previous post (and there are other ways to view that value as pointed out by other posters). if you are talking about an absolute value then it is easy to see that you dont "use up the entire value" by looking at what happens when you die. the house is worth something at that point (even if it is just the land value).

I have the same problem when people say "Paying extra on mortgage principal is the same as earning the same rate. If the mortgage is 6%, then I am earning 6% on the extra $1000 principal payment."

My response to that is, "Well then, I pay off my 20% interest rate credit card every month, so I'm earning 20% on that money. And 20% is more than 6%, so I'm doing a whole lot better than you."

and you would be correct. if you dont pay off your credit card with $X then next month you will owe $X * (20%/12) more which is a larger number than the other person who wud have only avoided $X * (6%/12) in interest charges. thus you are better off.

The truth, of course, is that they are not earning 6% and I am not earning 20%. Both of us are just reducing the expense that we would otherwise be paying. It's no different from deciding to not buy a new car. I've avoided a $20,000 expense but that's not the same as earning $20,000.

you may not be actually "earning" 20% but by avoiding paying out that 20% financially you are equivilant to having earned it. (actually a little better off as again if you reduce the amount of income you require, you lower your taxes, provided you can also alter your income)

 

[harley]

Is there any way of linking this thread into a closed loop leading back to one of the other hundreds of other unresolved conversations on this same topic? The posters wouldn't even have to know the difference, and it would save dozens of electrons.

 

[REWahoo]

Is there any way of linking this thread into a closed loop leading back to one of the other hundreds of ther unresolved conversations on this same topic?

We could do that for this and a dozen other subjects. But once we did, what would we talk about?

 

[ERD50]

my example using a mortgage was an attempt to get at what the rental value of said house might be so please forgive me. that being said i believe i am still correct when you use the rental value of the house in the example. i explained further in a previous post. and rent will need a cola to compensate.

Now I'm really lost - did you just switch this to a rent-vs-buy discussion?

Rental value is whatever the market will bear - but that's a totally different discussion.

-ERD50

 

[Bestwifeever]

We could do that for this and a dozen other subjects. But once we did, what would we talk about?

Curvy women?

 

[jdw_fire]

Now I'm really lost - did you just switch this to a rent-vs-buy discussion?

Rental value is whatever the market will bear - but that's a totally different discussion.

-ERD50

no, i am not switching anything. the point i am making is that an owned home has an equivilant, non-zero portfolio value from a retirement perspective. if you are renting your house then the rent is a consumption expense as rayvt said but not if you own your home. i just should have used rent in my 1st example instead of a mortgage payment. my point is more easily made (explained, shown to be true) if you are comparing paying rent to a f&c house but it is still true even if you have a mortgage.

however if you can accurately determine the equivilant portfolio value of a stream of rent payments (as well as the maintenance costs) for the house you are interested in buying this thought could be used to help you make the rent vs buy decision.

 

[bbbamI]

We could do that for this and a dozen other subjects. But once we did, what would we talk about?

Hairy men?

 

[ERD50]

the point i am making is that an owned home has an equivilant, non-zero portfolio value from a retirement perspective. ...

OK, I see where you are coming from now (I think). So sure, equity in a house is certainly worth something. I don't think anyone is denying that. A retiree with $X portfolio and some home equity is certainly in better shape than a retiree with the same $X and *no* home equity.

But what some of us are saying is: Assume that your home represents some standard of living that you wish to maintain during your retirement. At that point, the $ value of it does not mean much. It is what it is, also assuming that any future moves would be a "sideways" move in cost (maybe trading square foot for location or other qualities, but at roughly the same cost). So, whether it goes up, down, or stays flat in value is of little consequence - it's all a wash.

Under those assumptions, let's say my home quadruples in value (along with all comparable properties). I am not in a position to increase my spending based on this higher Net Worth, because I didn't really "gain" anything - replacement homes are the same cost, and I said I was not going to downgrade. So why include it in a Net Worth calculation?

-ERD50

 

[rayvt]

Exactly right. That's what I was trying to get across when I said, "You have to live somewhere."

Or in the words of Buckaroo Banzai, "No matter where you go, there you are"

 

[nun]

But what some of us are saying is: Assume that your home represents some standard of living that you wish to maintain during your retirement.

My home also represents income as I rent out the downstairs apartment. It produces $18k a year and if I was to move downstairs myself and rent out the upstairs I'd get $30k. So once the mortgage is paid off the rent will cover a large portion of my expenses, that's part of my motivation to pay off the mortgage