What to know about homeownership and wealth

It’s a tough market for first-time homebuyers, who face rising home prices and interest rates while navigating one of the most significant financial decisions they will ever make.

With so much at stake, it’s understandable that first-time buyers would get tunnel vision on affordability and question whether buying a house is really worth it.

Despite these obstacles, homeownership is still the largest source of wealth among families. For those looking to build their wealth, buying a home continues to be one of the smartest financial decisions they can make.

How does owning a home build wealth?

In plain terms, wealth is the measurement of the value of all the assets a person owns. But to many, wealth is the financial legacy they pass on to the generations which follow them. It holds both practical and emotional value.

This is especially true of a home — which serves both as an important financial investment and as a family’s focal point. But how are wealth and home ownership linked beyond this emotional tie?

Anyone who has been looking for a home in the past two years knows just how scarce a commodity housing is right now. In fact, some estimates suggest that there is currently a shortage of 5 million homes.

As the owner of such a commodity, you benefit from several financial advantages. These factors work together to compound homeowners’ gains to wealth.

Tax benefits

Since 2017, homeowners can deduct the mortgage interest on a mortgage loan of up to $750,000, and an additional $10,000 of property taxes each year. These significant deductions contribute to the overall financial benefits of owning a home rather than renting.

And if you sell your home, you’ll be able to exclude a portion of your profits — $250,000 if you’re single or $500,000 if you’re married — from capital gains taxes.

Hedge against rent inflation

When you close on your home, you’re “locked-in” to your mortgage rates and terms. That means you know every payment you will make — the amount and due date — until you pay off the loan, or you choose to refinance. The security and certainty of guaranteeing your housing costs can provide a significant financial gain, especially compared to renting, which offers no guarantees and can change dramatically year to year.

Forced savings

If you’ve ever struggled to put away money on top of paying off your bills, then you’ll understand the advantage of forced savings. The savings of buying a house come in two forms:

1. The money you saved to buy your home, and
2. The equity you build over time by paying off your mortgage.

In this way, your house essentially acts as a piggy bank where every mortgage payment is a deposit into that savings account.

Appreciation

Now imagine that piggy bank becomes more valuable over time, too. 

The longer you own a home, the more it will be worth, thanks to appreciation. This is the process by which a home becomes more valuable because of increased demand or weakening supply.

Currently, there’s both. According to the U.S. Census, from 2012 to 2021, 12.3 million American households were formed and just 7 million new single-family homes were built. This inventory shortage amid growing demand promises to drive house prices up for years to come.

Effects of price appreciation on equity

Your home equity is the value of your home that you don’t need to repay to your mortgage lender. This may be because you already paid it off, or because your home’s value has increased from the purchase price.

As your home appreciates, your equity increases too because you own that value outright. Think of it this way: in the balance sheet of your assets vs. debts, the amount your home appreciates goes solidly in the assets column.

In the past five years, home values have increased at an annual pace of 9.7%, meaning that a homeowner who purchased a home five years ago will have gained $125,300 in equity from price appreciation alone.

Here's a look at NAR estimates of the equity you could expect to have gained in your metro area over the past 5, 10, 15, and 30 years (as of Q1 2022):

For particularly competitive markets like Dallas and Denver, the estimated gains in equity over that same time period are even greater:

Net worth of homeowners vs renters

Net worth is a valuable measure of financial wellness because it factors in what your assets are worth vs. what you owe. Your net worth will compound as you pay down your debts and add more assets, or the assets you already own gain value (for example, through price appreciation).

This can make a big difference in the wealth of homeowners, especially as compared to renters. According to a survey conducted by the Federal Reserve, the net worth of homeowners was 40 times more than that of renters — at an average of $255,000 vs. $6,300, respectively.

So if you’re thinking about homeownership and wealth, don’t let the initial sticker shock of buying a house scare you. The gains to your net worth and wealth in the long run may far outweigh the cost of entry.

Check out this resource to understand more about renting vs buying.