Many Canadians view their home as their single biggest asset. But does that mean it is also the single biggest asset in their financial plan, and should it be?

Let’s first define that a home is a place to live whether it be owned or rented. The choice to rent or own a home over the long-term is a personal preference, and comes with its own financial implications. If you’re a homeowner, or plan to buy a home, how should you view your home in the context of a financial plan? Will homeownership positively or negatively affect the success of your financial plan, and who will this impact?

Your home as part of your net worth

Your net worth is the value of what you own less what you owe. Items that you own are considered assets, including chequing accounts, savings accounts, investments, vehicles and real estate. Amounts that you owe are considered liabilities, which include credit card balances, lines of credit, loans and mortgages. 

A home typically becomes the most significant asset in your net worth following its purchase. For those early in their financial journey, net worth may initially be low, possibly even negative, primarily due to student loans combined with new mortgage debt. 

A forward-looking net-worth statement may grow over time. In the context of home ownership, this is the result of two factors—the value of your home typically increases over time while the amount you owe on your mortgage decreases as you pay it down. 

Increasing your net worth is a good thing, however, if the increase is solely based on the  increased value of your home, it doesn't necessarily create easily accessible cash.

Your financial plan should consider the future value of your home as accurately as possible. This requires that the market value be adjusted to reflect current market conditions. In addition, estimating a future growth rate (not just relying on inflation) for your specific real estate market over the long term will provide better information for planning decisions. Some of those decisions include plans to downsize, leveraging opportunities or estate distributions.

Your home’s impact on your cash flow

Housing costs make up a significant portion of your monthly cash flow. It is important to understand the impact of fixed and variable housing costs on your finances. Fixed costs are known and can be accurately anticipated, such as mortgage payments, property taxes and home insurance. While some fixed expenses like a mortgage payment may end at some point in the future, other fixed costs will continue for as long as you own the home, such as property taxes.

Variable costs are unknown. They include repairs, maintenance, appliance replacement and refurbishment. If you own your home for a long time, say over 20 years, many of these variable expenses may happen more than once. Another consideration is that as you age and if you choose to age in place, many of the regular maintenance activities that you previously took on yourself may now require a service, which will add to your variable costs.

Your financial plan should account for as many foreseeable variable expenses as possible. It is also important to accurately illustrate both current and future fixed expenses that may occur during home ownership. 

A simple change regarding an upcoming renewal interest rate could have a significant impact on your future cash flow. This may also include taking out a home equity line of credit to manage those out-of-the-blue variable costs and to accurately illustrate the impact those payments would have on your future cash flow.

Your home should match your current lifestyle

What stage of life were you in when you bought your current home? Was it close to schools for your young children? Was it within walking distance to your workplace? Maybe it was close to friends who have since moved away?

The point is, does your current home suit your current and future lifestyle? Maybe your future home should be closer to essential or preferred services. Is living a little closer to loved ones a priority? Is walkability to and from your daily activities a priority? 

By understanding the long-term suitability of your home to your retirement lifestyle you will be able to determine if right-sizing is required. 

Your financial plan should clearly identify the timing and costs of right-sizing your home. Right-sizing should also be defined. Is the result a larger or smaller home? Is it a detached or townhome? Are you selling out of the market to become a renter? Do you plan to live in the country or a more urban setting? Read this article for a more in-depth look at the realities of aging in place.

Any right-sizing decision will likely change the composition of your net worth—shifting dollars from one category to another. For example, if you sell your home to purchase a less expensive one, the value of your principal residence will be lower, however, you may have a larger investment account or a lower mortgage. 

Your monthly cash flow will also be impacted through lower or higher fixed and variable costs depending on the net result of the transaction.

If you choose to sell your current home and opt to enter a retirement rental facility—your net worth will likely stay the same. What has changed is that you have swapped out a tax-free ‘asset’ for a taxable investment account. While you now have now accessed the equity, it’s now in a taxable environment. That equity, which is now invested, may earn a higher rate of return versus the growth of the home but it has also lost the tax advantage associated with the principal residence exemption.

Home ownership risk

While you may not think there is an inherent risk in home ownership, in the context of a financial plan, the risk is more associated with the value and the concentration of that value in relation to your total net worth. Put another way, does your home make up a large part of your net worth?

You may have a goal in your financial plan to leave a specific amount to your beneficiaries. Having a large amount of your estate’s net worth tied up in a single asset like a home may put that goal at risk.

The impact of the home in the estate

Assuming you live in your home until you and your spouse pass away, the home may make up a large portion of your final estate. What happens to your home will be dictated by the will of the last to die. 

Upon last death, the home is deemed to have been sold by the deceased just prior to their passing. Where only one property has been owned at any given time, the gain is typically shielded by the principal residence exemption for every year it was owned. If the value of the home increases in value from the date of death to the date it is sold, the estate is responsible for paying the capital gains tax on the appreciation. Likewise, if the value of the home decreases after the date of last death, the loss could be carried back to the final tax return to reduce the overall tax payable. 

The bigger questions come when you are in the midst of creating your estate documents:

1. Does anyone want the house? 
2. Assuming there is more than one beneficiary, will there be enough ‘other assets’ to equalize the distribution? 
3. What mechanism can be put in place to facilitate a smooth transfer?

Final thoughts

Your financial plan should look after you first. If you have the means to distribute significant assets to your beneficiaries after you have fully funded your retirement, then careful consideration should be given to addressing how your real estate assets will be distributed by your executor or personal representative.

Your home will have a significant impact on your financial plan. Ensuring its value and utility is captured correctly during every planning conversation will help you put real context to current and long-term decisions.