Saturday, April 8, 2017

Your house is not an asset.


If you are like me and many other Canadian homeowners, your house is probably one of your biggest asset. This is what most people believe, but I am going to explain to you why it's not.

OK... before you get all upset and financial on me, yes, from an accounting perspective, your house is considered to be an asset. I even put my house down as an asset when I calculated my own net worth. However, hear me out. Your house is not an asset, but more of a liability. Here is why:
  • When you take out a mortgage to buy a house, you already incur a huge liability from the mortgage itself with accumulated interest. In case you didn't know, a $200,000 mortgage, with a 25 years amortization period at 2.35%, will cost you $65,689 in interest. That's assuming the interest rate stays low. That's why it's always a good idea to make extra payments or increase your payments whenever possible.
  • You property tax usually costs around 1% of your property value.
  • Over the life time of your house, you'll need to perform various repairs and maintenance that will cost you $$$ out of the blue.
  • The most important point is that your house will NEVER generate value, unless you rent out the basement or sell it when the market is doing well. Even if you sell your property, you'll still need a place to live.
Why does it matter? If you accept this concept, you'll realize that spending a fortune on your house and over leveraging your mortgage is not a good wealth building strategy. I am not suggesting to not purchase a house, but to always purchase a property within your means. If you are in a hot housing market like Toronto, then maybe getting a small condo unit, or to rent a place is a good strategy until the market cools. Instead, invest your extra income and let the power of compound interest work for you. At the end of the day, what you want to achieve is to diversify your assets. Here are two examples. These breakdowns are just for argument sake:

Joe 1 ($1 Million)
House - 25%
Stock - 25%
Bond - 25%
Other Investment - 25%

Joe 2 ($1 Million)
House - 80%
Stock/Bond/Other Investment - 20%

Joe 1 has 75% of his assets providing an annual return, while Joe 2 has only 20%. Lets say that they all give a 10% return just for simplicity. Joe 1 will get $75,000/year and Joe 2 will only get $20,000/year. Keep in mind that these assets will continue to provide annual return even after retirement. Also, Joe 2 probably paid way more than Joe 1 on interest for his mortgage just because he purchased a beautiful $800,000 house.

Just because you can afford a bigger house doesn't mean you should. Putting all your eggs in one basket is never a good idea. If you are still not convince then go search "house is not an asset" on Google.

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