Homeownership: The Pathway to Wealth
The New York Times recently published an editorial that discussed owning a home and creating wealth. Using research from Harvard University’s Joint Center for Housing Studies, a conclusion was made that one method of building wealth was to own a home.
The 2013 research done at Harvard in which valuable information was uncovered. For one thing, researchers found that purchasing a home and carrying a mortgage forces a person to save money by making principal monthly payments.
Typically, when comparing the pros and cons of renting opposed to buying, everyone looks at the monthly payments, as well as the buying cost being a function of the mortgage payment to include property taxes and insurance. However, as part of the mortgage payment is a component of interest and principal.
The way that payments are split between interest and reduced principal will begin to change as time passes. Simply put, the longer an individual has a home loan the more the share of payments it will pay down. In other words, the principal payment as the loan ages is a type of forced savings plan with growing deposits but without taking more money out of pocket.
Price increases along with periods of price declines are currently abnormal. In looking at things long-term, compound return of home prices on an annual basis have gone beyond inflation by nearly one full percentage point. Even though there are periods of positive and negative value changes, over time home prices increase faster than inflation does.
It is those increasing values that over longer periods compound. As an example, if someone who owns a home saw an average gain in the price of homes starting in 1975 and ending in 2012, the inflation adjusted gain over 30 years would be 26 percent. Therefore, adjusting for inflation at the end of a 30-year mortgage loan would boost the value of the home 26 percent greater in dollars.
The example used by Harvard was a buyer who put 5 percent down and saw appreciation of 4 percent. Five years later, the value of the home would be approximately 22 percent more, meaning the home’s value is over five times the initial down payment.
Some homeowners also deduct annual interest paid on a mortgage and property taxes with a mortgage-interest deduction. In addition, when a home sells, gains up to $500,000 are exempt from capital gains.
Historically, the price of homes will outpace inflation but the way to enjoy more protection from the threat of rising rent is by purchasing a home and carrying a mortgage. This mortgage is what locks in most housing costs. Although there is no change in monthly payment, due to inflation the real payment declines so that over time, the share of income spent on housing actually decreases.
Harvard researchers concluded that owning a home is still part of the “all American dream” but in addition to achieving that goal, owning a home has tremendous financial benefit that over time creates the opportunity for household wealth.