Wealth and Homeownership
In my interviews with homeowners, 25% of them say they bought their home first for an investment and second for a place to live. The other 75% say they bought a home simply as a place to live with little expectation for it to be a good investment.
What’s your opinion of homes as an investment? Maybe you heard your parents’ voices telling you that you should “stop throwing your money away on rent and buy something”. And, on the other side, maybe you also heard your college friend or work colleague telling you that the stock market is a much smarter place to put your money than in a down payment.
What the research says
On a national average, homes appreciate about 0.8% a year, after taking into consideration inflation. A 2005 study by Karl E. Case, John M. Quigley and Robert J. Shiller “Comparing Wealth Effects: The Stock Market vs. the Housing Market” calculated that investments outpace a future payoff from buying a home.
A recent study from the Joint Center for Housing Studies at Harvard titled “Is Homeownership Still an Effective Means of Building Wealth for Low-income and Minority Households? (Was it Ever?),” minimizes the difference. When compared to other investments based purely on growth, homes may be slightly below returns on stocks, but are not measurably different.
But in fact, there is no substitute for homeownership in building wealth. Here are the four main reasons why.
1) Forced savings
Let’s face it, unexpected medical bills, child care costs, student loan debt and other modern realities can make it difficult for people to sock away money as effectively as a mortgage payment and down payment force you to.
Simply by paying your mortgage payment you are building up your savings. Isn’t that incredible?
When you make a mortgage payment, a portion goes to paying down your loan balance, which builds equity in your home. Home equity is part of your net worth. When it comes time to sell your home, your home equity becomes cash from the sale.
Contrast that with renting. As a renter, you still pay for housing but all of that money goes to the landlord.
2) Reaping the benefits of appreciation with a (relatively) small investment
Since home appreciation is estimated to be about 0.8% per year, including inflationary effects, it generates a 26% increase in value over 30 years, based on the national average.
But, by financing a home, you leverage the effects of home appreciation. You may put 20% down or less, but get the full effect of home appreciation. Should you sell, the extra home equity is yours to keep.
3) Tax benefits
If you are able to take advantage of the mortgage interest deduction, a homeowner can realize a tax benefit on interest paid.
Also, capital gains tax is exempt for single homeowners up to $250,000 and couples up to $500,000 on the sale of a property. There is no other investment where your capital gains are as tax free as homeownership.
4) As a hedge against rising rents
Recent rent increases in major cities have been as high as 15% per year in the hottest markets. Buying a home locks you into today’s home values, avoiding annual increases in rent. If you are in an area where rents have historically risen faster than average, you can gain even more benefits than if you rent. Meanwhile, your mortgage payment stays the same (if you have a fixed-rate mortgage where the initial interest rate stays the same over the life of the loan. This is not necessarily true for adjustable rate mortgages where your mortgage can adjust upward over time). Compounded over time, this can be a huge benefit.
A fixed rate mortgage is a truly level payment. What else stays the same price over 15 or 30 years?
If your income rises during that time, you have another source of wealth. The stability of a fixed payment over a long period of time creates tremendous power and options for you compared with those who rent.
Homeownership is a proven driver of wealth. Even though home prices are up, the same forces are at work to make homeownership a smart decision for the long term. Forced savings, reaping the benefits of appreciation, tax benefits and as a hedge against rising rents makes homeownership a goal worthy of most everyone.