Is prinicpal payment a saving or expense?

One major item is never present in every monthly savings rate report: my mortgage principal payment. Omitting this one item makes the difference between having 50% or 30%. So, am I cheating by leaving it out? Today I want to go over the details of my mortgage payment and give a clear answer to this question.

The main components of a mortgage payment

My mortgage payment is a constant monthly repayment and consists of two major elements that get paid over 25 years:

1. Interest: money paid regularly at a fixed rate of 1.47% for the use of money lent. In my case, the mortgage is €280,000. Each month this part becomes a bit smaller.
2. Principal: the actual capital I borrowed from BNP Paribas Fortis that I pay back in larger installments.

My mortgage also has mortgage insurance. It covers 100% of my mortgage if I pass away. I opted to pay it in full, costing me €3,639.20. As such, I don’t take it into account anymore. I wrote a one-time expense for it in February 2020.

With a basic understanding of what my mortgage is, it’s time to look at its position in my financial planning. An excellent place to start is looking at what the actual accountancy rules are for this type of financial instrument.

What do the accountancy rules say about a mortgage?

From an accounting point of view, it is not a savings or an expense. You simply transferred your assets from one form to another.

However, since that transfer also reduced your liability, you have a net saving on your future interest expenses compared to your more liquid monetary asset (only if your mortgage is higher than the rate of return on other investment opportunities).

How I implement my principal

Since the payment reduces my debt and that it goes into an appreciating asset I consider the principal payments savings.

It’s debt reduction, and therefore increases my net worth. The mortgage is for real estate that will get rented out. On top of that, real estate has gone up over the last couple of years in Belgium.

The roughly €830/m principal payment (at the time of writing) for me is just moving money from one row in the balance sheet to another. A paid-off house, whether for living or renting out, is a solid cornerstone for an Early retirement plan.
Principal payments are one form of “saving” towards that plan. This holds especially true if it’s a second home and not the primary residence.

I can make the same argument about debt reduction in other parts of my financial life. If I’m putting an extra €1000/mo toward a car or business loan, rental property mortgage, or student loans, you are saving in the sense that you’re reducing your liability and reducing what you owe interest on. In general, paying down debt improves your financial position just like saving money in a savings account or investing in stocks.

Other ways to look at it

1. Paying down the principal is slowly buying the house. Imagine you are purchasing it one brick at a time; each brick you own that you didn’t own before is an increase in your assets — i.e. your net worth has increased.
2. Another interesting view I found on Reddit said that you should consider yourself born short one house. i.e. since we all need a roof over our heads, you start with that need outstanding, so slowly buying a house is increasing your net worth, but it’s increasing it towards zero since you started off negative. It’s a good way of thinking of it because even if you sell your house, you still need another one to replace it, so you can never fully liquidate your primary residence.

In short, since the mortgage is a debt, and I use the money as paying off that debt, it’s a form of savings but not savings I can easily get access to. Additionally, while I originally planned to live in it for at least 3 – 4 years, things have changed and it will probably become an investment property to rent out. Chances are high I will sell it in the next 5 to 10 years. Because of this, it truly becomes an asset that brings in money, first through the rental income, and later when I sell it, through appreciation.

How it applies to my Savings Rate

By viewing it as savings, I treat it in a similar fashion to other savings, I don’t subtract them from my SR, otherwise, I would always be at 0 which doesn’t make sense when calculating your Savings Rate. Afterall all, in my monthly Savings Rate overview, the money I have left, goes towards different forms of savings which as clarified above also includes real estate.

It is true that the money I spent paying down principal is no longer in my possession, but it is not like that wealth disappeared. I now own more of the apartment than previously, I could cash in by selling the house. My debt has also decreased, meaning the payment is a risk-free investment at whatever interest rate my mortgage is at.

Make it match your planning

Of course, this is all pablum at the end of the day. Come up with your own system that makes sense for you and define principal repayment as savings (or not) based on what makes sense within your own financial system.

Don’t worry about the impacts on your savings rate for the purposes of discussing with others. Look at what works for you to reach your financial goals.