There’s a war that has been raging on in the FIRE community since the beginning. Every corner you turn, every FIRE forum you stumble upon, you’ll see people arguing for and against including your home in your FI calculations.
I’ve always been in the for camp, but I’ve never fully explored the notion. So, for my benefit as well as yours, let’s deep dive into this question - Should you include your house in your net worth?
There are some people who swear by investing in property, not just for their main homes, but as additional investments too. Financial Samurai is one of them, he wrote this article which explains why he believes that property investment is more desirable than stock investments .
Property investment in the UK has made some individuals very wealthy although, I believe that the time for this has long passed. Due to the recent legislation changes in second property stamp duty and increased personal income taxation on mortgage interest, a lot of landlords which I have spoken to have said that their costs are now greater than their income and that they’re counting on the house price going up significantly to make the investment worthwhile.
The increase in house prices means that a lot of the younger generation of FIRE pursuers may never even own their own home. Looking at the statistics for people who rent vs. people who own, the prices in the UK don’t seem to differ that much between ‘throwing money away on rent’ vs. ‘throwing money away on mortgage interest’. This seems to be due to the fact that a lot of people tend to borrow the maximum that their bank is willing to lend them. Meaning, people with a mortgage end up with the same, if not higher, monthly costs than renters. And that doesn’t even include costs such as home maintenance, home improvements and moving.
All of this makes the UK a very different playing field to the USA, where it seems a lot more people tend to not include their property in their net worth. So let’s consider this and explore the pathway of two individuals; one who is renting their way to financial independence and one who bought their own home. I’ll use blown up numbers so it’s easy to calculate and follow.
Path A - Renting
Timmy is your average 25-year-old and due to living on his own and in a very expensive part of the country, he’s decided that buying a home is not for him. He has a good job and is able to save 50% of his 40k per year income, but being able to move when and where he likes is very important to him, so renting is ideal.
Timmy’s Fact Sheet
- Income of 40k per year after tax
- Expenses of 20k per year, 10k of which is on rent
- Years to FI 16.6 years at 41.6 years old
So, Timmy is left with a pot of £530k after 16.6 years of saving. He has housing costs in his expenses, but that’s OK as his pot size is big enough to pay his 10k rent and additional 10k expenses; he’s covered!
Path B - Mortgage
Alex is the same age as Timmy but he’s fortunate enough to live in a cheaper part of the country and he loves where he lives, so he’s decided to buckle down and get a mortgage on a beautiful home. He has an outstanding mortgage of £300k, at a 2% interest rate, this is costing Alex £1272 per month, £493 of which is interest alone.
Alex’s Fact Sheet
- Income of 40k per year after tax
- Expenses of £25,264 per year, £15,264 of which is on mortgage repayments
- £9348 per year is going into house equity
- Years to FI 24 years at 49 years old
- 25-year mortgage
Even though Alex’s monthly expenses are greater than Timmy’s, there’s one big difference; Alex is also paying monthly into his mortgage equity. This means that even though Alex has the same income and almost similar expenses as Timmy, it’s taking him a lot longer to achieve financial independence, with his years to FI number being almost a decade greater than Timmy’s.
These figures don’t take into account the fact that Alex’s mortgage interest will get less and less over the 25 year period that he owns his home. It also doesn’t take into account that the house prices could go down (or up), and it also glosses over house maintenance costs. But forgetting about these things for the sake of simplicity (they may actually cancel each other out), it can be seen that Alex is getting a considerably worse deal than Timmy. This surely can’t be right?
Should You Never Buy a Home?
Hold your horses, don’t go selling up just yet! There’s one thing that Alex is doing which is skewing the numbers…He’s not including his house equity in his FI calculations.
As Alex has ignored the fact that he’s got a big pile of cash in home equity, he falsely believes that he’s not going to reach financial independent until he’s 49 years old. What will happen with Alex is, he’ll work until he’s 49, and think “Hurrah! I can now cover my £25,264 per year expenses! I’m financially independent!”. Then one year later when he’s 50, he would have paid off his 25-year mortgage. His expenses will now shoot down by £15,264 per year. People may think that’s great; he’s got a surplus! But that’s not the case. Alex actually wasted 7 years of his life working when he no longer needed to. It’s like hitting your FI number, then doing it all again “Just to be safe.”
People could actually be working decades extra in jobs they hate, missing watching their children grow up and not living the life they choose, only to realise that when they actually retire, they’ll have a surplus of cash that they don’t need.
What Could Alex Have Done?
If Alex had realised that his house equity is basically just an alternative bank account, at 17 years when he had a pot of around 400k, he could have released his built up house equity (£200k) and invested it to make him financially independent. If he wanted to still eventually pay off his mortgage but not work for as long as 24 years, he could have acknowledged the fact that if he carries on with his initial mortgage term, he’d overshoot his FI pot total by a big amount and adjusted accordingly. He could have released say, 50% of his equity, invested the difference and been one step closer to FI. Another option for Alex could have been to increase his term back to 25 years and lowered his monthly payments to bring his expenses down.
There are a lot of things which Alex could have done, but there’s only one main point to consider in your planning process -
If you can sell your home, invest your equity, rent a property, and your money covers your expenses. You’re financially independent.
Don’t let anyone else tell you otherwise. If you don’t follow this rule, you’ll be at a huge disadvantage to the non-home-owners (as you can see from the calculations!) You may choose to own a home and still pay it off and invest even after you’ve reached your combined FI number, but if you do, remember this - At that stage, you’re already FI, you’re just paying more to increase your safety net.
Nothing frustrates me more when I hear people say, “My FI number is 500k and a paid off house.” What they should be saying is, “My FI number is 1 million.” If they choose to distribute 500k into a paid off house to lower their expenses or rent a house with 1 million invested, that’s up to them! However, their FI number is most definitely not 500k.
FI numbers shouldn’t be subjective - the first comment poses the question, “But how much is your house worth?”. You can’t possibly plug that into a FI calculation. One person’s house may be worth 500k, another 200k. Your predicted FI date should go off a single pot figure. It should cover all of your expenses, including the cost of your house, this way you can get an accurate portrayal of your actual FI date and not be lumped with double what you actually need after working your socks off for double the required time.
Join The Discussion Below
- Do you think your house equity should be included in your net worth?
- What’s do you think your final house pot / investment pot split will be?
- Would you rather FI on time or continue paying off your house equity?