There can be heated debate around whether or not you should include your residential property and mortgage in your Net Worth calculation. As heated as it gets in the Personal Finance world.
|Some Personal Finance bloggers brawling over the proper way to do a Net Worth calculation.|
Buying a property, for most of us, means taking out a mortgage. Essentially a very long term loan, the repayments of which are linked directly to the underlying base rate (even a fixed rate isn’t forever).
I struggle in the mornings not to put the porridge in the fridge, pour the milk on the flooor and then put the bin in the microwave. Yet I took on a mortgage with barely a blink of the eye. Locked into a huge loan with decades of uncertainty ahead. It’s almost like I was conditioned to accept it as normal.
Value of interest payments
Our mortgage payments consist of an element of capital repayment (woohoo) and another of interest (boo).
Most of us know what our outstanding mortgage balance is, there or thereabouts at least. Yet few of us are aware of how much we have yet to pay in interest to service the loan. And it’s so easy to work out;
Total interest to be paid = (Monthly payment * number of months remaining) – Capital outstanding
It might not be a bad idea to include this somewhere, if you include your house in your Net Worth. If nothing else, it’s a reminder how how staggeringly large the aggregated interest payments are. And hopefully a small kick up the arse to make some overpayments.
Interest rate risk
Consider someone who purchased a £250k house, with a £200k mortgage at 2.5% interest. We could show this like;
Including the future value of interest payments somewhere in our Net Worth, even as a foot note it can serve as a reminder of just how much interest we will pay, even in the current low interest rate environment, and perhaps how exposed so many of us are to movements in interest rates.
I’m saying nothing about the benefits of buying or renting, or about paying down your mortgage vs. investing in a low interest rate environment. Simply how exposed I am, and the majority of people with a mortgage are, to interest rate movements. Interest rate movements tends to be viewed along the lines of affordability… can my salary gobble up any increase in mortgage payments. Once we are locked into the mortgage we almost don’t want to know how much it will cost us in the long run.
I doubt that including the total value of interest payments as a deduction to your Net Worth would ever catch on, most people want to increase their Net Worth, not decrease it. Not to mention it would fire up any accountants beyond the point of no return. “It doesn’t make any sense!” they would scream in between bouts of praying to the gods of double entry.
But to have the total value of the interest payments in one figure is a good shock tactic, even if only as a footnote to your impressive Net Worth. I’ve added it to mine.
A reminder that one of the smartest moves is one of the simplest, pay off your mortgage completely and get rid of that footnote. Investing might get you a better return in the long run, but paying down your mortgage quicker will save you money in the long run, As ever, diversification is king, a combined approach is probably best.
It would make a less exciting film than the time travelling in The Butterfly Effect, but the impact of a mortgage on our portfolio is something worth considering.
You might have a mighty impressive £80k in equities and £20k in cash/bonds. An aggressive 80/20 split. But what if the house in the first example above is added to this…
£80k in equities, £20k in cash/bonds, £250k in property and £200k in a mortgage (a ‘negative bond’ position).
We could look at this with the mortgage set against the cash position – £80k in equities, £250k in property and (£180k) in bonds/cash.
So much for a diversified portfolio. That’s a 53/-120/167 portfolio in equity/cash&bonds/property. Pretty different.
Needless to say the impact of the property means the portfolio allocation is nowhere near the diversification we were hoping for.
Our residential property doesn’t generate any income, it is for us to live in, we don’t really care about the capital value if we plan on staying there. So we could argue that it doesn’t need to be included in our Net Worth. Yet the exposure to the loan, that negative cash position, has some argument for being included.
But we are skipping merrily along the borders of a completely different subject here, which I will leave alone.
I need to have a chat with Boris for mocking my idea.