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Yesterday, I pointed out that the house you live in is an essential part of your net worth calculation. But determining the value of your house, especially if it’s the house you live in and not something you track as an investment, can be tricky.

It’s easy to determine the value of your mortgage to include that in your net worth calculation. Just look at the latest statement from the lender. The statement will highlight your remaining balance, and it’s a number you can’t escape if you do in fact, as you should, look at your statement every month.

The house can be trickier to value. But if you include your mortgage in your net worth calculation, you should also include some value for your house. And it should be a value that makes sense. There are at least three ways to determine your home’s value for the purposes of your net worth calculation.

1. The value of your home is the price you paid.

When you purchased your house, you and the seller agreed upon a value. You then paid the seller that much money, whether you borrowed the money or not, and paid additional fees to complete the purchase. It’s not wrong to consider the purchase price the value of your house for your net worth calculation purposes. No one could say that your figure would be wrong if you use this approach. After all, this was the last market-confirmed value, and there won’t be another market-confirmed value until you sell the house.

This is a problem if you’ve lived in this house for a substantial amount of time. Your community may be more desirable than it was when you moved in, or it may be less desirable. Your neighbors in similar houses might have sold their homes for more money in the intervening years, and the sales price of “comparables” may effect the potential sales price of your own home. You may have made improvements to your home or you may have let it fall apart. All of these factors can change the value of your home, and you can’t be sure until you put it on the market and receive at least one offer.

The big benefit of using your house’s purchase price as the value of your house in all future net worth reports is that it ensures your net worth progress reflects mostly the financial decisions you make on a day-to-day basis. That would allow your net worth progress to present a better picture of your behavior with money, but it wouldn’t really represent your true net worth at any one time.

If however, you own your house for a sufficiently long time, there’s a great chance the value of your home will be so far off from the purchase price that your net worth with a number in old dollars is relatively meaningless. An interesting remedy would be to use your purchase price initially, and then adjust your home’s value on your balance sheet once a year based on the rate of inflation. This will allow you to continue using the house’s purchase price, but it was always be in “today’s dollars,” just like your mortgage and the rest of your balance sheet.

2. The value of your home is defined by appraisal or competitive market analysis.

In order to pay property tax, your local government depends on appraisals. Appraisals provide a way for the government to look at your land, your home, and any changes to either since the purchase of your home to determine the amount of your tax bill. Appraisals also come into play when you’re going through the process of selling your home. When you pay tax, you want the appraisal to be low, while when you’re selling, you want the appraisal to be high. And if an appraisal isn’t inline with the owner’s expectations, the owner can challenge it.

Using the latest appraisal in your net worth statement offers a more timely valuation, but it may not be a valuation you agree with. It may not be a valuation that has any relevance to the amount of money a buyer would be willing to pay, either. It is the result of someone’s opinion — a professional’s opinion — but a real estate agent familiar with your home and your neighborhood may be better professional to offer such a valuation. And if you ask a professional who doesn’t have any reason to exaggerate, you can probably get a relatively accurate estimate.

A real estate agent might be willing to do a competitive market analysis for your property if you appear to be intending to use that agent to represent you in a sale. And certainly, an agent who is willing to do this work for you will feel he or she is in a good position after doing a significant amount of work for you to choose that agent as your broker.

A competitive market analysis may be more accurate than an appraisal, but neither of these would you do every month to keep your net worth calculation “accurate,” or to follow the potential of a sale price that might change on a month-to-month basis.

3. The value of your home is provided by Zillow.

Anyone who has shopped for a house in the last few years is likely familiar with Zillow. I’ve only just begun to look at houses — and I’ve paused those efforts during my latest round of travel — and I’ve been using Zillow to plan most of the visits. Zillow’s estimate — or Zestimate — for one property I was interested in was a good $100,000 or more higher than the seller’s asking price.

So how does Zillow come up with their estimates for each property? Zillow uses public data about recent sales and uses a calculation — a proprietary formula — that takes factors about the home and its neighborhood into account. A few real estate agents I’ve talked to don’t like Zillow’s estimates. It seems to make their job more difficult, and they believe it could lead buyers or sellers to make bad decisions. I think it’s important to remember this value is just an estimate, but it is based on data, and that makes it appealing to people wishing to track their net worth (as well as to people house shopping).

A publicly-recorded sale of one house in a neighborhood can send Zestimates in one direction or another without much warning, even if that house bears little resemblance to one’s own. And that’s one of the possible reasons house values are fluctuating month to month on the net worth report submissions from Naked With Cash. Zillow offers verifiable data to support a valuation on a balance sheet, and it gives someone the comfort level of not having to guess the value of their property on a day-to-day or month-to-month basis.

The question is whether Zestimates are correlated to actual sales prices. And there have been a few analyses completed outside of Zillow to determine if there is a trend of Zestimates to be higher or lower than realized prices, but every area seems to be different.

What is your method for including a value for your house on your balance sheet? I have not owned a house in the past, and I don’t own one now, so I’ve had no reason to decide on a method for myself. I’m curious how other people think about the value of their house while they own in.

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Naked With Cash is an ongoing series at Consumerism Commentary in which readers share their households’ finances with other readers. These participants benefit from the accountability that comes from tracking their finances publicly and the feedback of the four expert Certified Financial Planners (CFPs).

For more information, read this introduction.

This year, we have four participants who will share their financial reports, exposing the results of their financial choices. Each participant is paired with one of our Certified Financial Planners. The experts will provide insight and guidance that will help our participants take their finances to the next level by the end of 2014. Learn about this year’s participants and experts.

Betsey works as a government analyst. She is single, and lives with roommates to keep costs down. She is an aggressive saver, and plans to retire early enough that she can start a business specializing in craft beers. (Read her update from last month.)

After reading Betsey’s comments, you can see video commentary from Sara Stanich, CFP. Sara Stanich appears courtesy of Stanich Group and Cultivating Wealth. This month, Betsey will share information about her emergency preparedness efforts.

Read the full article →

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Naked With Cash is an ongoing series at Consumerism Commentary in which readers share their households’ finances with other readers. These participants benefit from the accountability that comes from tracking their finances publicly and the feedback of the four expert Certified Financial Planners (CFPs).

For more information, read this introduction.

This year, we have four participants who will share their financial reports, exposing the results of their financial choices. Each participant is paired with one of our Certified Financial Planners. The experts will provide insight and guidance that will help our participants take their finances to the next level by the end of 2014. Learn about this year’s participants and experts.

Laura and Leon, together, earn more than $125,000 a year. Their main focus right now is paying off student loans, and they want to have that done in order to be better ready to start a family. Laura and Leon hope that they can focus better on their finances, and learn to manage their money more effectively. (Read last month’s update.)

After reading Laura and Leon’s comments, you can read commentary from Roger Wohlner, CFP. Roger Wohlner appears courtesy of The Chicago Financial Planner. This month, there is a focus on emergency preparedness.

Read the full article →

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Net worth is a calculation that immediately defines an individual’s or household’s financial position. It’s only one piece of a greater financial puzzle, but it’s an important piece. The concept of wealth relies mostly on net worth, which contrasts with the concept of poverty, which is generally related to a different financial equation, income.

Wealth however, is relative, while net worth is absolute. Place someone with a net worth of $50,000 in the middle of New York City, and she’s likely to have problems living the same lifestyle as those around her. Place the same individual with the same net worth in rural Kentucky, and the wealth will go further. Visit a developing nation elsewhere on the globe and $50,000 will feel like a million bucks.

In the Naked With Cash series, readers are sharing their net worth every month. And before that, I shared my financial reports publicly since 2003. Readers who stayed with me since the beginning — and there were many — followed my journey from a net worth of $21,000 in July 2003 (a few years after I began trying to improve my financial situation) to a “non-business” net worth of $373,000 in December 2011. (If I had included my business net worth, which would have consisted of income earned from my business but not distributed to me personally and the proceeds from the sale of that business, the figure would have been significantly higher.)

As a net worth calculation is valid only for one specific moment of time, seeing net worth change over time provides some context to a net worth calculation and offers more insight into one’s financial condition.

How do you calculate net worth?

The equation is Wn = A – L. Wn is your net worth, the value you want to calculate. A is the value of all of your assets. L is the value of all your liabilities. Being able to calculate your net worth depends on understanding what your assets and liabilities are.

Assets include everything you own. That means everything from bank accounts in your name to the value of your furniture and linens.

Liabilities include everything you owe. Your credit card debt is a liability, but so are the taxes you will owe on your investments when you sell them.

Add up the value of all your assets, add up the value of all your liabilities, subtract your liabilities from your assets, and the result is your net worth. It’s a fairly simple calculation, but people often get in trouble when trying to determine the value of their assets and liabilities. It’s not always straightforward. In fact, most of the time, people don’t include all their assets and liabilities. When you want to track your financial progress from month to month, sometimes it makes sense to exclude certain factors, and settle for a “modified net worth” equation.

When I reported my net worth each month, and when the Naked With Cash participants do the same, the number on the bottom line is a “modified net worth,” not a true net worth, because there is room for some customization of the equation. We don’t need to show every asset and every liability to get a continuing picture of financial progress.

How does a house fit into net worth?

The house one lives in is a curious asset. It’s so curious that some people refuse to believe it is in fact an asset. This seems to have started with a popular book promoter and seminar salesperson, Robert Kiyosaki, who in his influential book declared that houses are liabilities. It’s blasphemy! Regardless of whether you have a mortgage, a house is a physical object you own. Liabilities are not physical objects, at least when it comes to liabilities on a balance sheet (the net worth equation).

The word “liability” can have a broader meaning: anything that has the potential of causing you trouble. In that sense, children are liabilities. Responsibilities are liabilities. Performing your own electrical maintenance is a liability. Your neighbor’s dog is a liability. Therefore, your house is a liability. But don’t include it as a liability on your balance sheet, because your house is an asset when it comes to your finances.

There is absolutely no argument otherwise. I’m always happy to entertain dissenting views on Consumerism Commentary, and I’ve been proven wrong on issues before, but your house is an asset.

So now that we know your house is an asset, with absolutely no room for disagreement, why is a minority of financial experts so adamant that houses are liabilities? If they are, they’re not talking about the net worth equation. They simply want to point out that owning a house is a money-draining endeavor. There are two categories of assets that can appear on your net worth statement: income-producing assets, and expense-producing assets. In Kiyosaki’s infinite wisdom, he has completely confused his legion of fans by calling the first category “assets” and the second category “liabilities.”

It’s like a famous chef deciding to call unhealthy meats “meats” and unhealthy meats “vegetables,” and then inspiring a rather loud community of followers, after heavy promotion on The Food Network, to believe that healthy meats are actually vegetables.

Your house is an asset.

Where does a mortgage fit into net worth?

Your mortgage, if you have one, is a liability. The remaining balance of your mortgage loan is included on the liability side of a balance sheet. It, along with all the other amounts of money you owe someone else, is subtracted from the total value of your assets to determine your net worth.

If you take the value of your house (more on determining this value) and subtract the balance of you mortgage, you have your house equity. That’s the same calculation for any secured loan, or a loan that is “attached” to an asset. But your equity does not need to be included separately in your net worth, because you’re already accounting for the value of your house on the asset side and the balance of your mortgage on the liability side.

The idea is that by paying your mortgage bill each month, your equity increases. Some mortgage loans are structured in such a way that your equity would only increase if the underlying value of the house increases. That’s the case with interest-only mortgages. For a long period of time, borrowers who have interest-only mortgages never get to the point where they’re decreasing the principal balance of the loan.

Why not just leave your house and mortgage off your balance sheet?

If you rent the space where you live, you generally don’t include your future rent payments as a liability, even though they are, in one sense. Furthermore, the increasing or decreasing value of your house has little relationship to your financial activities on a day-to-day basis. Your net worth could be increasing every year due to your living in a developing neighborhood, but this could be masking financial problems with credit and debt, or other decisions with money that will eventually get you into trouble.

What good is your net worth bottom line if it reflects positive increases during a period where your checking account is dealing with overdrafts and your credit card balances are increasing?

This is why it’s important to look at more than just the bottom line of a net worth statement. When you see an increase in net worth from month to month, look at the details. Did he receive a windfall inheritance? Is he changing his house’s value every month based on an estimate? Did she pay off her debt but completely deplete her emergency fund? Context and details are important in a net worth calculation. Otherwise, it’s just a number that doesn’t explain much about one’s financial situation.

But how do you come up with the right value for your house? I’ll look at some methods for determining your house’s value for the purpose of net worth in a future article.

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Naked With Cash: Brian, August 2014

by Luke Landes
Brian - Naked With Cash

Naked With Cash is an ongoing series at Consumerism Commentary in which readers share their households’ finances with other readers. These participants benefit from the accountability that comes from tracking their finances publicly and the feedback of the four expert Certified Financial Planners (CFPs). For more information, read this introduction. This year, we have four ... Continue reading this article…

1 comment Read the full article →

Naked With Cash: Jake and Allie, August 2014

by Luke Landes
Jake and Allie - Naked With Cash

Naked With Cash is an ongoing series at Consumerism Commentary in which readers share their households’ finances with other readers. These participants benefit from the accountability that comes from tracking their finances publicly and the feedback of the four expert Certified Financial Planners (CFPs). For more information, read this introduction. This year, we have four ... Continue reading this article…

0 comments Read the full article →

Tipping Housekeepers: Whose Responsibility Is It to Pay Hotel Staff?

by Luke Landes
Hotel Room

The prevalence of tipping is simply a fact of society. On several occasions, a friend of mine bemoaned the perceived necessity of tipping a specified amount to restaurant servers while dining out. He would ask the rest of our friends eating together at a restaurant, “When did the expected base tip go from 15 percent ... Continue reading this article…

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Reader Question: Where Is My Cash Now?

by Luke Landes
Piggy Bank via Flickr

A reader asks where I keep my savings and whether I’m still a customer of Capital One 360.

7 comments Read the full article →
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