Despite a slowing of the real estate market in the fourth quarter of 2018, real estate in every state except North Dakota and Louisiana has increased in price over the last year. The U.S. as a whole has seen home prices increase 4.49% over the last twelve months.
What most people don’t understand is how the leverage of your mortgage can help you build wealth faster than just about any other investment and in many cases the return on your cash invested is far better than what you might see in the stock or bond market. Let me explain.
Let’s assume you purchased a $250,000 home in January of 2018 and it appreciated (or went up in value) at the U.S. average of 4.49% over the last 12 months. That would mean your home as of February 2019 is now worth $261,225. Not bad!
Because the market moved higher, your home value benefited and you now have more equity in your home.
Equity is the difference between your current home value and the amount you owe on your home.
Appreciation of the real estate price is not the only way to build equity, you can also count on the amortization (repayment schedule where you pay down a loan balance) on your loan to help you build equity. Each month as you make your monthly mortgage payment, you will be paying interest on your mortgage first and then principle as well.
Let’s assume you put down a five percent or $12,500 down payment on your $250,000 home. Your starting loan balance in January of 2018 was $237,500. Let’s also assume you financed that balance at a 4.25% interest rate and made standard 30 year repayments.
That means your mortgage balance would be down to $233,496 after your twelve payments. Your equity now is the difference between your mortgage balance of $233,496 and the current value of your home, which has appreciated to $261,255 (based on 4.49% average for the U.S. over the last 12 months).
Wow now you are getting somewhere!
Now just for fun, let’s calculate your total return or equity compared to your initial investment of $12,500 (down payment).
Your total equity is the difference between the $261,255 value and the $233,496 mortgage balance or $27,259. Your initial investment was only $12,500…
You more than doubled your initial investment in one year. How did that happen?
That is the power of leverage with a mortgage. You see your entire home value of $250,000 increased by 4.49%, but you only had to put down $12,500.
As a rate of return per year, your investment increased at 218%. That’s right, your initial investment of $12,500 turned into $27,259 in equity in one year — that is a 218% return on your down payment in one year.
Now to be fair, homeownership comes with the responsibility to maintain the taxes, insurance, monthly mortgage liability, and of course the property. Granted there are other costs that come along with homeownership that do not come with owning stocks or bonds, but the point is that there is no other investment that can offer this kind of leverage and incredible wealth building potential over the long haul as real estate.
Sure 2018 was a great year for real estate, but where are home values headed in the years ahead?
None of us have a crystal ball, but the experts at CoreLogic predict that home values across the U.S. will actually appreciate faster in 2019 than they did in 2018 (see the predicted increase for your state above). The main reasons for that is a growing job market, with historically low unemployment, increase in wages for many Americans as the labor market remains incredibly strong, and builders not being able to keep up with demand, creating a shortage of housing in many areas of the county.
CoreLogic is not the only group forecasting positive home values and appreciation over the next year. The Home Price Expectation Survey is also predicting higher real estate prices.
In fact, the Home Price Expectation Survey expects positive appreciation for the next six years and estimates your $250,000 home would be worth $292,617 by 2024.
Now remember equity is not only the value of your home, it also takes into consideration your mortgage balance. If you would have made standard payments under a 30 year repayment plan, your mortgage balance would be down to $215,668 by January 2024.
Now let’s see how your initial $12,500 investment has done. Your estimated home value is $292,617 and your mortgage balance is $215,668, the difference being home equity equaling $76,949.
Said another way, your initial investment (down payment) of $12,500 is expected to increase by over 600% in the next six years.
Granted this is all hypothetical, it would be nice if we had some real data to look back upon…
Thanks to the NAR (National Association of Realtors), we do have real data to look back upon. The economists at NAR looked back at the average real estate purchase price and appreciation rates over the last 5, 10, 15, and 30 years to create the average wealth (equity) gains chart.
What they determined was that the average American home owner saw an increase in housing equity or wealth of $79,488 from 2013 to 2018, a $91,081 increase in wealth from 2008 to 2018, a $124,564 increase in wealth from 2003 to 2018, and an astounding $243,740 increase in wealth from 1998 to 2018.
I find it incredible to look at the ten, fifteen and thirty year numbers. These were people who bought before, during, or at the peak of the real estate bubble, and in spite of the Great Recession and Mortgage Meltdown, still build substantial wealth by owning real estate.
The most recent data shows us that millennials are starting to figure this out. Even after the greatest real estate crash since the Great Depression, real estate has proved to be a great long term investment. Millennials are learning that owning and holding real estate over the long run is a winning strategy.
The U.S. Homeownership Rate declined significantly throughout the Great Recession and only started to change direction in 2016. As the Homeownership Rate was going down, more and more Americans were renting, many frightful of the real estate market and having watched their parents and friends lose homes during the Great Recession, many out of fear decided to rent.
What we are seeing now is that millennials are leading the way back to homeownership. Overall the Homeownership Rate is up 1.1% since bottoming in 2016, but if we look at those under 35 (generally considered millennials), we see that the Homeownership Rate for this group is up 2.2% meaning that those under 35 are making the decision to buy versus rent twice as fast as those renters over 35.
Millennials appear to be shaking off the fear from the Great Recession and joining the millions of homeowners that have figured out what equity is and how to build wealth with real estate.
Loan Officer NMLS 219996
Josh Mettle NMLS #219996 is an industry leading author and ranked top 1% of mortgage originators 2018 by Mortgage Executive Magazine, specializing in financing physicians, dentists, CRNA, and other professionals with highly specialized professional loan programs. You can get more great real estate and mortgage advice here or his by visiting his book site. Josh is also a fourth generation real estate investor, and owns a number of rental homes, apartment units and mortgages. Josh is dedicated to helping physicians and other professionals become more financially aware and able; listen to “Physician Financial Success” podcast episodes or download Josh’s latest tips and advice here.