Is Homeownership the Key to Wealth Accumulation?

Yes… especially if you do it right. Unfortunately, most people don’t.

Let’s see if I can give you a different perspective on home ownership.

Imagine you’re 25 years old. You’re done with school, working a job (hopefully in your desired field). While you aren’t making anywhere near the money you want to be making just yet, you’re on track. You have some savings, are feel pretty stable and are thinking about buying a home.

You go to your bank (if you bank with one of the large national banks you’ve already made a mistake and one you will most certainly pay for, even if you work for the bank and receive their “employee pricing”) to determine how much house you can afford. You bank assigns a mortgage banker who informs you the bank is willing to offer you a mortgage based on a total payment (including P.I.T.I principal, interest, taxes and insurance) of up to 40% of your gross monthly income.

This is Where Most Home Buyer Mess Up

Financial Mistake #1 is when homebuyers “shop by payment” and buy the most expensive house they qualify for without thinking about how long they’re going to be paying for it, or how much debt they’re taking on.

Financial Mistake #2 is that most home buyers are still using a 30 year mortgage, or worse yet an adjustable rate mortgage (ARM in a rising interest rate environment) which isn’t the best mortgage option if your primary goal is to build wealth. Banks push the 30 year mortgage product because it’s where they make the most money and because they know most people are focused on payment instead of price. While many buyers rationalize this by saying “I’ll just make extra payments” in reality fewer than 2% of borrowers actually do this.

Financial Mistake #3 is that at some point along the way, most people will refinance and start the loan over for another 30 years.

30 Year Fixed Rate Example

Let’s consider some real numbers for a minute to help you better understand how your mortgage related decisions impact your wealth. Assume you’re mortgaging $250k and your base payment is about $1,122 per month. In the real world it would be a little higher but I’m leaving out taxes, insurance, Private Mortgage Insurance (PMI), Homeowner’s Association Dues (HOA), etc for simplicity and so we can focus only on the principal mortgage and debt.

Fast forward a bit and pretend you’ve made that payment every month for ten years. At the ten year mark, you’ve made $135k worth of payments to the bank however, more than half of this total — approximately $77k — was pure interest. You still owe the bank $192k. On top of that, you still have another 20 years to go before your mortgage is paid off. By the time you pay that house off, you’ll have given the bank more than $400k for a $250k house.

That’s insane.

People tend to rationalize this by talking about appreciation however, most have never actually done the math. But let’s take a look at this starting with the average rate of appreciation here in Columbus. On average homes in Central Ohio appreciate at 3-4% per year (however, in years this has been much higher). But using an appreciation rate of 4% we would calculate the compound interest on our $250K house by taking our 1.04 to the 30th power. If you’re using an Apple iPhone with can be done by tilting your phone into the landscape or horizontal position to bring up the Scientific Calculator. You would then type in “1.04, hit the xy key, type in 30 then hit the multiplication key and type in 250000″. If you did this correctly this should return a value of 810,849.38, if not click here for a video explanation. Thus in this example your home should appreciate to $810,849.38 and if we subtract out the $400,000 paid to the bank you come out ahead $410,849.38.

Factors to consider here, these calculations are based on today’s mortgage interest rates which remain at historical lows. Outside of a handful of real estate markets, most houses don’t appreciate at an annual rate that’s higher than the property taxes + interest.

15 Year Fixed Rate Example

Now let’s look at the same scenario but on a 15 year fixed mortgage. Same $250k borrowed. Your payment will be a little higher — $1,787 (instead of $1,122) — but the long term math looks very different. At the ten year mark, you’ve made $214k in payments, but you owe just $92k (as opposed to $192k) and only paid $56k worth of interest, with just five years to go instead of 20!

Let me say that again…

Your house will be completely paid off in five more years. You will never have a house payment again. If you started when you were 25, your 40th birthday present to yourself will be a fully paid off house.

Think about where you’re going to be in your career path at age 40 vs age 25. You’re probably established. You’re probably making a lot more money. You probably have some investments, some savings, and a decent retirement savings excluding the house.

But on top of all that, you have no house payment. What would your savings account and those other investments look like in a few years when you can start contributing what would have been your house payment into this pot every month? Fast forward another ten years and if you were disciplined with the money you would have otherwise applied to your house payment, you could have a $500k+ investment portfolio just from these savings! Plus any investment gains and appreciation in your house itself!

By the time you’re 50, you could easily have a net worth north of $1 million this while all of those folks used a 30 year mortgage or refinanced along the way are still paying off their mortgage.

Home ownership can be key to wealth accumulation, but only if you actually own it. If the bank owns it, you’re just giving your money and your equity to them. When you stay in debt, the bank is the real winner. Why do you think they advertise refinancing so aggressively? It’s because it lets them start the loan over which keeps your money flowing into their pockets.

Don’t get me wrong, this is a lifestyle choice and it’s about your priorities. There are plenty of other factors that come into play for example, will you and your spouse both work, do you intend to have children and how many, when do you both plan on retiring, etc. Also, what makes you happy, is it financial freedom or having a larger well appointed home. There isn’t a right and for many a home truly is their castle and something that brings them joy and a sense of accomplishment.

However, if building wealth is a top priority for you, stick to a reasonable house price relative to your income and finance your purchase with 15 year loan. The sooner you’re “living rent free” the sooner you can start really growing your money.

If you, or someone you know is considering Buying or Selling an Investment Property in Columbus, Ohio please give us a call and we’d be happy to assist you!

The Opland Group Specializes in Real Estate Sales, Luxury Home Sales, Short Sales in; Bexley 43209 Columbus 43201 43206 43214 43215 Delaware 43015 Downtown Dublin 43016 43017 Gahanna 43219 43230 Grandview Heights 43212 Galena 43021 Hilliard 43026 Lewis Center 43035 New Albany 43054 Pickerington 43147 Polaris Powell 43065 Upper Arlington 43220 43221 Westerville 43081 43082 Worthington 43235