A lot of people are down on home ownership these days, some for good reason.
- Young people with student debt can’t be enthusiastic because it’s too painful. Their debt takes them out as homebuyers.
- Those who overreached during the bubble are still recovering. At best, they are a long way from having the trauma of being “upside-down” become nearly a bad memory. At worst, they are renting a single-family home they would once have purchased.
- Retirees and near-retirees may be selling their homes simply because “that’s where the money is”— home equity is their biggest asset and they need to use it to produce retirement income.
This is also a big demographic shift. It probably means fewer Americans will be homeowners in the future.
But none of that should obscure this reality: Owning a home is still the best, most effective and most fundamental way for most people to build their net worth. Why? Owning a home is the most reliable way to put inflation on our side, instead of against us.
It would be difficult to overstate how important this is. Inflation works against us in almost every other area of our lives. On the spending side, inflation is against us in the supermarket. We fight it with our medical bills and insurance. We fight it in the cost of the cars we buy.
On the earnings side, it’s just as tough. Millions of Americans are very aware that their earning power has not kept up with inflation.
Homeownership won’t win those battles. But having inflation on our side in shelter is a massive advantage. It doesn’t take any real effort.
We can explore this with some simple arithmetic: According to the National Association of Realtors, the median sale price for a home at the end of the first quarter was $191,600, up 8.6 percent from $176,400 in the same quarter of the previous year. Clearly, it was a great time to own a home. If you had purchased a year ago with 20 percent down and a 4.5 percent mortgage on the balance, you would have made $8,580 in mortgage payments while your house appreciated by $15,200.
Even if you added the real estate taxes and insurance bill for the house—perhaps another $3,500— your $12,080 in out-of-pocket expenses was less than you gained in (tax-free) appreciation.
Spoilsports will be quick to point out that home values don’t rise by 8.6 percent every year. That’s quite right. Hoping for that kind of appreciation year after year would be foolish. (Unless you’ve been asleep for the last decade, you’ve probably figured that out.)
Fortunately, we don’t need much appreciation for owning a home to be a great way to convert an out-of-pocket living expense into net worth. Let’s go back to that mortgage cost again. At $8,580 a year, the payments are equal to 4.9 percent of the original cost of the home, of which a tiny amount was actual loan amortization. So if the home had appreciated at 4.9 percent, the homeowner would have recouped every dime of debt service expense in appreciation.
Better still, as the home becomes more valuable, it will take a smaller and smaller appreciation rate for the mortgage payments to be recouped as home appreciation. Long before the mortgage is paid off, the annual appreciation will be larger than the fixed mortgage payment.
Combine a small amount of inflation (or call it appreciation) with a small loan reduction every year, and it doesn’t take much to put every dime of mortgage payment into your net worth. If that $176,400 home appreciated in price at the 2.9 percent inflation rate of the last 30 years, it would be worth nearly $416,000 when the mortgage was paid off. That means your home equity is the same as the value of the house, $416,000.
Now let’s compare that to your mortgage payments. Over those 30 years, your mortgage payments were ‘only’ $257,412. Sell the house and you would be getting back $123,308 more than you paid out for the down payment and all mortgage payments. It clearly pays to “stay put.”
I haven’t mentioned tax benefits because they are transient or illusory for homes at the prices most people pay. But if you have some, they won’t hurt.
Is this a discounted-present value analysis, the kind financial analysts like to use? Sorry, no. It’s a “what’s-in-your-pocket-at-the-end-of-the-game” analysis.