Notes on recording a house loan

[Michael T. Garrison Stuber]

<DISCLAIMER>I am not an account.  There may be better ways to do 
this</DISCLAIMER>

Okay, now that that part is over with, here are some detailed thoughts on 
recording a house loan.  Feel free to send comments/questions/complaints 
etc.  Also, if anyone want to further pretty this up and stick in the 
GnuCash manual they are welcome to.

For the purpose this discussion, let's assume that you are a GnuCash user, 
and you recently purchased a house.  How should this be recorded?  There 
are several things to keep in mind:

(1)	The house is an asset (at least from an accounting standpoint)
(2)	The mortgage is a liability (unless you hold the note)
(3)	The escrow account is an asset -- yours not your mortgage company's.
(4)	Mortgage interest is an expense, and a tax related one.
(5)	Property tax is an expense, also tax related.
(6)	Insurance is an expense.

Based on these notions, how do you set up your accounts?

To follow this example you'll need to start by creating the following 
accounts:

Asset:House
Asset:EscrowAccount
Liability:Mortgage
Expense:Fees
Expense:MortgageInterest
Expense:MortgageInsurance
Expense:PropertyTaxes
Expense:PropertyInsurance

Hopefully the account labels themselves are self explanatory.  You'll see 
how they're used below.  Obviously, you can name them anything you want. 
Personally, I name the Asset:House account based on the address of the 
property.

We'll also assume that you have a checking account:

Asset:Checking

The house asset account should represent the value of the house.  This may 
increase based on appreciation, or decrease because of adverse market 
conditions.  Initially, this is the price you paid for the house (note: not 
the size of the mortgage).  If you have the house reappraised (perhaps 
you're refinancing to drop PMI etc), you would increase the value in the 
house account.  I suspect this would come from an Income:Appreciation 
account, but I'm not certain (see the disclaimer).

The mistake that people often make is to think that paying their mortgage 
each month involves a transfer from the Liability:Mortgage to Asset:House. 
The reality is the value of your house neither rises nor falls based on 
what you've paid against the mortgage loan.  The value of your house is 
based on market conditions.  Your equity is what rises or falls based what 
you've paid against the mortgage loan, or what you've borrowed against the 
house.  Your equity in the house is the difference between what you owe on 
the property, and what the property is worth.  This is critical to 
understand.  If you do not record a home loan properly, the networth 
GnuCash will report will be incorrect.  If you were to transfer money from 
Asset:House to Liability:Mortgage you would (at least on paper) reducing 
the value of your house.  When you make a mortgage payment you are 
transfering money from some liquid asset account (your checking account) to 
at least two accounts (maybe four):  The Liability:Mortgage, 
Asset:EscrowAccount, Expense:MortgageInterest, and 
Expense:MortgageInsurance (unless you put 20% down on the property).  The 
opening balance of the liability account is created by transfering money 
into the asset account.  So how does this actual work?

You buy a house:

(1)	Transfer down payment from Asset:Checking to Asset:House
(2)	Transfer mortgage from Liability:Mortgage as a split to:
	Asset:House
	Expense:Fees
(note:  You can get really jiggy here, splitting out title insurance and 
attorney's fees, etc, if you feel like digging up your HUD-1, but it's 
probably not worth it unless there are tax or basis implications)
	Expense:Mortgage Interest
	Expense:Taxes

Now you have a liability account that shows what you owe, and an asset 
account that shows what the house is worth.  Your equity is the difference. 
Note:  If you don't track your house this way your net worth information 
will be wrong.

Going back to the monthly mortgage payment, each month your payment should 
look like:

Transfer from Asset:Bank as a split to:
	Liability:Mortgage
	Expense:MortgageInterest
	Expense:MortgageInsurance
	Asset:EscrowAccount

Over time, your liability decreases, though the value of the underlying 
asset (Asset:House) remains the same.  (Unless of course you adjust it). 
If you're doing this correctly if you run a transaction report on the 
Expense:MortgageInterest and Expense:MortgageInsurance at the end of the 
year, it should match your 1098 from your mortgage company.  Also, the 
balance on the loan (Liability:Mortgage) should match that is reported on 
any quarterly statements you receive.

The whole Asset:EscrowAccount thing may be obvious, but in case it's not: 
The idea here is that the money being held in escrow is your money.  It's 
not very liquid but it is yours.  Some mortgage companies even pay interest 
on it.  (I pay my taxes directly, so I don't have one).  When the property 
tax bill shows up you send it to the mortgage company and put in
a transfer from Asset:EscrowAccount to Expense:PropertyTaxes.  When the 
insurance bill shows up (again, assuming it's not paid directly) you would 
do a transfer from Asset:EscrowAccount to Expense:PropertyInsurance.

Expense:MortageInsurance probably deserves a special note.  Some mortgage 
companies do this through an escrow account, where you build up the value 
in the escrow account and the private mortgage insurance bill is paid once 
a year.  Other companies take a private mortage insurance payment every 
month.  In this later case, you would simply record it as an expense as 
part of the split used to record the monthly payment.  In the former case 
treat it the same as you would property taxes or property insurance.

Thus value in Asset:House stays constant, while the debt of 
Liability:Mortgage decreases, until you've paid it off and it goes to zero. 
You transfer the value out of Asset:House when you sell it.  Selling the 
house can be a little tricky, but the fundamental principals are the same. 
Selling the house is the only time when you transfer money from Asset:House 
to Liability:Mortgage, assuming you still owe money on the house when you 
sell it.  If you make money or lose money when you sell a house you'll need 
to have appropriate income or expense accounts to track it, beyond the 
liquidation of the value of the asset. When I sold my place in New York I 
had an eight way split that include tax credits, but that's another story . 
. .

One last note:  If you don't feel like entering all of your old mortgage 
transactions, you still set up the initial accounts the same as above, 
transfering from Liability:Mortgage to Asset:House.  To get 
Liability:Mortgage to reflect your current balance, do one massive transfer 
from an Equity account into Liability:Mortgage.  This will take care of 
what you've already paid against the loan, and at the same time reflect the 
fact you've paid in money in previous years.

This may all seem complicated, but it's really pretty simple once you've 
set it up.