4.3 The impact of home buying on the balance sheet

Stage 1 of the diagram shows a horizontal line with the labels ‘Assets minus Liabilities equals Net worth’. Assets, liabilities and net worth are all zero. 1: Jack has a goal of buying a home. For simplicity, we’ll assume that he has no assets and no liabilities before he purchases a house. His net worth is zero.

Stage 2 shows a column of assets, additionally labelled ‘Unspent income is saved’. There is also a column of net worth of equal height to the assets. 2: Jack’s first task is to save for a deposit. He makes sure to spend less than his income. The income he does not spend goes into a savings account. His assets and net worth rise.

Stage 3 shows the assets column has increased, as have liabilities. The column for net worth is unchanged from Stage 2. 3: Jack takes out a mortgage, which he uses with the deposit to buy a house. He now has a large asset (the house) and a large liability (the mortgage). But he owns part of the house (bought with the deposit) outright, so his net worth is positive.

Stage 4 shows that assets have remained at the same high level. Liabilities have reduced as part of each mortgage payment reduces the mortgage. Net worth has increased. 4: Jack has a repayment mortgage, so part of each payment reduces the amount he owes on the mortgage. As the remaining mortgage falls, his net worth rises.

Stage 5 shows that assets have remained the same. There are no liabilities. Net worth has increased and is now equal to assets. 5: Eventually, the whole mortgage has been paid off. Jack now has a large asset (the house) but no longer has any liabilities, so his net worth is substantial.