Owning a home is more than a white picket fence dream. It's a wise money move. Why? Because homeowners end up a lot richer than folks who rent. Specifically, homeowners enjoy 40x greater net worth than renters.
To understand why, let's break down the four factors (really just 3) that lead homeowners to steadily and inevitably grow their net worth.
Lock-In Payments: No Inflation Squeeze
As we discussed in last week’s
letter, your mortgage is what we call "self-liquidating debt." In simple terms? You pay off the loan to finance your purchase over time with money that would otherwise go to your landlord for monthly rent. Let's look at why that's a big win for homeowners.
Over time, renters get hit with increasing rent costs. You can see visually in the chart below, that even recessions have not led to lower rents.
As a homeowner with a 30 year fixed rate, you lock in your monthly payment for the life of the loan. (With the potential to refinance, you actually have an option for LOWERING your payment over time). Let’s look at an example to see why this is so powerful.
You could buy this home in Fresno California for $500,000. Assuming a 5% down payment and a 7% interest rate, the total monthly payment, including taxes, insurance and mortgage insurance would be $3,875 for a buyer with good credit.
Currently the same home would rent for less than $3000 a month. Let’s call it $2800. You might say, “easy decision…I save over $1000/mo by renting.” BUT, there is no 30 year fixed rent. If rents rise at 3.5% annually over the next 10 years (less than the 3.7% average over the last 13 years), the rent would spike to $3971 per month.
Forced Savings: The Money Pile You Didn't Know You Had
Let’s consider another important factor that most overlook. Each mortgage payment has two parts - principal and interest.
Most people get hung up on the interest “cost.”
The magic is actually in the principal pay down. Every time you make a monthly payment, you grow your equity position and net worth.
Sticking with the example above, you can see exactly how powerful this forced savings can be. In year 1, the homeowner would pay down $4825 in principal, equal to $402 per month. While the monthly payment was $1075 more per month in the first year, after accounting for the principal reduction, the difference is actually $672.
Over time, a homeowners principal reduction increases. In year 10, $9043 of the monthly payments goes towards reducing the loan balance. That’s $754 a month. While rents increased to over $3900 a month, the mortgage payment net of principal reduction is now $3121.
Over the first 10 years, the homeowner added $67,391 to their net worth through principal paydowns.
Renters Don’t Save This Way. Rent checks cover living space, and that's it. No principal reduction, no equity buildup, no ownership, no future money pile. But most importantly, as we discussed in the first section,
there is NO 30 Year Fixed Rent and the renter can look forward to 3%+ annual rent increases..
Advantage to the homeowner. And the gap continues to grow year after year as rents increase and more of the monthly payment goes to pay down the mortgage.
And Then One Day There Are No More Payments. Each monthly payment you make gets you closer to owning your home free and clear. Renters? They pay rent forever.
If you’re 35, this may not seem like a huge deal.
Now imagine you are at age 65 or 70 and considering retirement and a fixed income. That retirement looks a lot more enjoyable as one of the
38.7% of Americans that currently own their home outright with no monthly mortgage payments.
Leverage: Small Money, Big Returns
When you buy a house, you don't pay the full price upfront. You put down a small down payment to control the entire asset. Here's why this is magic.
Let's say you buy that $500,000 home in the example and put down 3% or $15,000. If your home's value goes up by 3% in one year, you've just made $15,000. That's a 100% return on your down payment in one year!
Renters don't get this benefit. They get a place to live but zero chance of making money from the property going up in value. Since 1987, home prices have appreciated nationally by 4.4% per year. This steady long term growth makes it impossible for a renter to keep pace.
Tax Benefits of Home Ownership: Not Dead Yet
Finally, you may have heard that Trump’s 2017 tax changes cut homeowner benefits. This is partially true, but some borrowers still benefit. It’s complicated, but I’ll explain it in detail next week!
For now, when you're thinking about your financial future, remember these 3 (maybe 4) big wins of owning a home. Got questions? You know I'm here to help.
Looking Forward,
Josh
Josh Lewis is a mortgage industry veteran with over 25 years of experience. Josh is committed to empowering you with the knowledge and resources you need to navigate the complex world of real estate. Josh creates content to help guide you through financial pitfalls, provide clarity, and help you on your successful journey to home ownership.
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