Five Ways Buying a Home Can Improve Your Long Term Wealth
You may not care that much about the “American dream” of owning a home, but you might want to think about how it can build your wealth. A home is likely the most expensive investment you will make in life so it’s important to consider the financial impacts.
Think about whether, over the long-term, owning a home will impact your net worth and your ability to build wealth. Increasing your net worth, the true picture of how you’re really doing financially, is the key to achieving financial independence and reaching retirement.
Here are five ways that owning a home may help you increase your personal net worth.
1. Payments build equity.
As a homeowner makes a mortgage payment each month, he or she builds equity in that home. As equity—the amount of paid-off home he actually owns—grows larger, that becomes part of the homeowner’s net worth. A renter could choose to invest a mortgage payment-like amount each month to build their own net worth, but Harvard research shows they generally do not. Government data shows that people who own their own homes typically amass more wealth than those who rent.
A typical homeowner’s net worth was 36 times greater than that of a typical renter in 2013, the most recent year for which figures are available, according to the Federal Reserve’s Survey of Consumer Finances. According to the Federal Reserve, a typical homeowner’s net worth was $195,400, while that of renters was $5,400. Government data shows that people who own their own homes typically amass more wealth than those who rent.
2. More income available in the future.
When your house is paid off, you can continue to live there without ever making another payment. It may seem far off, but it’s an important consideration. Because you’ll no longer have to pay for housing (beyond maintenance, taxes and insurance), you’ll be able to use that extra money to invest in other things that will grow your wealth further, such as stocks, bonds and additional real estate. On the other hand, renters must continue to make monthly payments for as long as they live in a rental property. As a result, their income allotted for housing payments may not be freed up for other things.
3. Increase in home value.
Housing in some locations will increase in value more than others, but generally, home values do increase at a rate slightly higher than inflation. According to the Federal Housing Finance Agency’s house price index, the annual growth rate in home prices exceeded inflation by .8 percentage points. When your home increases even modestly over time, those increases compounds over a longer period of time. “Assuming just a .8 percent annual real increase in house values over 30 years, an owner will experience a real gain of about 26 percent in the overall house value,” according to a report from the Joint Center on Housing Studies at Harvard University.
4. Ability to trade up.
Even if you relocate before your mortgage term is complete, you will likely be able to take the equity from selling your home and apply it toward purchasing the next home. This ability to trade up allows you to continue creating wealth while also providing housing for yourself and your family.
5. Federal income tax benefits.
Homeowners are able to deduct mortgage loan interest and property taxes from their federal taxable income, which can provide a significant tax savings, allowing you to put more money in your pocket (or invest in other ways). In addition, if you sell your home at a profit, there are exemptions for capital gains taxes. Based on the Taxpayer Relief Act of 1997, you will pay no capital gains tax on the first $250,000 you make when you sell your principal residence as a single person, and married couples get a $500,000 exemption. For other investments, capital gains taxes will be at least 15 percent.
Homeowners are able to deduct mortgage loan interest and property taxes from their federal taxable income, which can provide a significant tax savings, allowing you to put more money in your pocket.
At the end of the day, determining whether home ownership will improve your overall financial situation depends on the person. Keep in mind that in addition to paying the mortgage, homeowners need enough available income to pay for home maintenance, insurance and taxes. If you want to make sure your home purchase will be positive for your long-term net worth, consider your own habits, discipline, and ability to pay for various housing costs. Owning a home can be an American dream for some, but could become a financial burden for those who aren’t prepared.