Problem with housing equity accumulation
You fixed some problems with the housing report a while back, but there is one fix I keep watching for and have not seen. It has to do with the amount of my mortgage payment that you add to my home equity. If I tell ESP that I in 2009 I will take out a $680,000 mortgage at 6.75 percent for 30 years, the housing report shows my mortgage cost as $51,873 in the first year. My interest for that year should be over $45,000, so I shouldn't expect my equity to improve by more than about $7,000. The report shows my equity building by more than $27000 for that year, and similar numbers for subsequent years. This doesnt affect me much, but if I planned to sell that house after 10 years and take out the equity to live on, ESP would be giving me an unrealistic amount that I could take out. Also, if the balance of the payment is considered interest for tax purposes, that calulation would be off as well.
RSS
Richard,
What is the annual real appreciation rate you're using for your home? If you've set it at 3% that would account for the $20k increase in equity over and above your $7k payment of principal.
Best regards,
Dane
Dane - that's a good point and one I had not though of - but I checked and I have real appreciation set at zero.
Richard:
I think you are seeing some kind of problem in dimensions. We are used to looking at an amortization chart that does not account for inflation or project next year's numbers in today's dollars. In ESPlanner, you are seeing the future in today's dollars. That's of course why your mortgage is declining relative to inflation. Equity too is presented in that dimension. So it's really pretty confusing to look at. If you change your inflation rate (see Assumptions) to 0%, the numbers may start to look more familiar. That may be part of the puzzle. Equity, I believe, is built up three ways: payment of principal, appreciation, and inflation. You've already zeroed appreciation. Zero inflation as well, and then your numbers should square with an amortization table. I think. :) Try it and see. Just change inflation to zero and leave appreciation at zero. Then look at equity. You'll see your equity is the sum of your principal payments. If I'm not right about all of this, I hope Dick Munroe or someone will correct me.
Dan
Dan,
You're spot on. With inflation at 3%, the mortgage balance is declining 3% in real dollars each year. The house, however, at 0% real appreciation is staying even with inflation and maintaining a constant value of $680k in real dollars. The mortgage balance at the end of the first year is just under $673,000 in nominal dollars, but only a little over $653,000 in real dollars. As a result the real equity is roughly $27,000.
I did a couple quick runs on ESPlanner using Richard's mortgage info with both 3% inflation and 0% inflation to validate that it in fact works this way.
Best regards,
Dane
Oh good . . . it seemed that it was this kind of problem, I just wasn't sure how to proof it. It is easier to see when you set inflation at zero I guess.
Interesting. . . .
OK - now I get it. Thanks for the explanation. I know everything is in todays dollars, but I just didn't apply that thinking to the mortgage balance. This is a good thing - If it worked the way I expected I would be worse off!
Yes, good. I find it really pretty hard to grasp intuitively when I look at it still, even knowing what's going on. However, when I changed the inflation in assumptions to 0%, it started to be easier for me to see. Again, there are too many dimensions there. . . like trying to understand a three-dimensional model with two-dimensional picture or something. If I don't think too hard about it, it works fine! --Dan