The Four Pillars of Homeownership
Homeownership is one of the most effective long term wealth building strategies available today.
Real estate outpaces every other investment vehicle including the stock market, 401K, savings accounts and anything else you can possibly think of.
The great real estate crash of 2008 is a great example of the ability for home values and interest rates to survive even the most challenging of economic influences.
While owning a home is a great emotional triumph for many Americans, the financial facts and wealth building strategy around real estate is incredibly powerful, and quite simple once you understand the facts.
In short, the benefits of homeownership can be summed up very simply in what we are calling “The Four Pillars of Homeownership”.
Four Pillars of Homeownership
The four pillars of homeownership describes four fundamental truths about homeownership that supports the fact that owning real estate is the best possible long term wealth building strategy that you and your family can invest in.
The goal of this podcast is to deliver sound advice, based on decades of experience, with no expectations of financial benefit.
Why is this important? Quite simply, most folks in the real estate and mortgage industry are paid by commission only, AFTER the transaction is closed.
For this reason, there is often a very aggressive push to get you to commit to working with one of these sales people, so that they can secure an opportunity to earn a commission.
The problem with aggressive sales people is that it’s “sales strategy” that drives their business, not ethics, experience, or an in depth knowledge of their products or services.
Now that we have the housekeeping out of the way, let’s run through the four pillars so you can determine for yourself if homeownership is the right decision.
First Pillar: Fixed Housing Costs
The argument between buying or renting usually revolves around whether it’s cheaper to buy or rent, and what that payment looks like.
The payment burden is definitely a strong argument either way, but what it lacks is the long term position you will find yourself in by continuing to rent, as opposed to buying.
When you buy a home, your interest rate is most like a 30 year fixed rate. The result is that you lock in your total housing expenses until you choose to refinance, or sell and buy into a different payment.
When you rent, you are subject to rent increases whenever the market warrants, or whenever the landlord wishes.
I found the above graph in an LA Weekly article from April 2015, shows that National rents increased from 2014 to 2015 at a pace of 2.5%. California almost doubled that rate of increase and clocked in at 4.9% over the same one year period.
Now think about the long term impact this kind of growth can have on your family’s ability to budget your expenses from year to year. Bottom line, if you rent, your housing expenses are variable. If you own a home, you control your housing costs, and have the ability to fix those costs for up to 30 years or more.
Second Pillar: Forced Savings
It’s easy to say that you’re going to put aside a few hundreds bucks every month, and sometimes that works until there’s an emergency, or things get tight one month. It’s hard to stick to a savings plan if you have access to it.
When you own a home and make your mortgage every month, it’s actually a forced savings plan that will build wealth for you even if you do have an emergency or tight month and you have to dip into your bank account to cover your bills.
Mortgage loans are fully amortized, which means that each month you are paying the interest due on the balance of the loan, as well as making a principal payment, paying the loan balance down.
This is the “equity” in your home, and is fairly difficult to access without a lot of paperwork and trouble. The barrier to accessing this equity makes saving money easy!
In an emergency, you can access this money by selling the home, or if you have enough equity built up, you can refinance and take a portion of the equity out.
The second part of the forced savings pillar is the growth of that equity. Every day that you drive up your driveway, your real estate investment grows. Historically, home values (equity) have doubled every 10 years since they have been tracking those numbers in the 50’s.
Yes, there are ups and downs. Let’s look at 2008 for a moment when real estate led an economic depression that saw home values drop almost in half in many areas of the Country.
Here we are 8 years later, and in California, our home values are back up to where they were in 2006, before the great crash. Now, this isn’t a “doubling” of equity in the past 10 years, but it definitely supports an upward trend in equity growth.
The real reason behind the great crash of 2008 was simply that lenders allowed homeowners to strip out all of their equity with almost no proof that the loan could be paid back. Many say that home values were way over-valued in 2006 because of these loans.
With home values returning to those 2006 levels, you could almost say even if home prices were over inflated in 2006, we’ve come back around and can support those values now, 8 years later.
Third Pillar: Leverage
Leverage is probably one of the most powerful tools you can use when investing. Essentially leverage means that you invest a very small amount, like 3% to 5% of the purchase price, and you own an asset worth tens to hundreds of thousands of dollars.
All you have to do to protect this investment is to continue to make your payments on the loan.
Even if your home doesn’t appreciate one dollar over 30 years, your $15,000 investment (5% of $300,000) has given you a return of $285,000!
Where else can you invest $15,000 and get a return of $285,000 with almost no risk? I say there is almost no risk because because this is assuming that your home’s value does not increase one red cent in 30 years.
What’s the chances of you seeing no equity growth in 30 years? I’m going to go out on a limb and say that it has never, and never will happen.
Fourth Pillar: Tax Benefits
Many real estate and mortgage professionals like to lead with the tax benefits of homeownership, but I think this is where they go wrong. In my opinion, the tax benefits are amazing, but they are minimized by the amazing strength of the other three pillars.
If you have not owned a home before, you may take a tax deduction for:
- Interest paid on a mortgage against your primary residence
- Property taxes paid on your primary residence
How this tax deduction works is that you can take the total amount of the interest and taxes you pay over the year, and reduce your taxable income by this amount. The result is that you pay taxes on a lower income base, and therefore pay less taxes.
I encourage most homeowner’s to adjust their withholdings with their employer to take more more money each month as opposed to taking too much taxes out, and getting a bigger refund at tax time.
I also recommend all potential homeowners consult a CPA or Accountant to discuss the tax benefits and advantages of homeownership. I am not a licensed tax professional, and I encourage you to consult a professional to see how homeownership will affect your tax liability.
Comments, Questions and Answers
If you have questions about homeownership, or anything we’ve covered, or did not cover in this article, please drop me a question or comment below and we can start a conversation about putting your four pillars in place, and setting you and your family up on a wealth building plan that simply cannot be matched.