Sunday, April 24, 2005

Making, Saving Money Key Points In Real Estate Ownership

For the first time home buyer, the question will come up at some point -- should I wait to purchase at another time? Will the home prices drop? Will they escalate more? Will interest rates drop/increase?

These are all very valid concerns and I'm not going to waive them off, point to historic appreciation of real estate overall and tell such a buyer to just dive in. For those in an escalating market, buyers are always afraid of buying now and then having the market turn, leaving them caught with a mortgage worth more than the house. It's happened in the past to some buyers and it will happen in the future -- it's just a natural ebb and flow of the real estate cycle.

Unfortunately, someone's going to get caught between an out of control market and it's demise to a buyers market. It's bound to happen. Nevertheless, you must look at the basic structures of a sellers market to determine if it will continue -- job growth and supply of houses. If the job growth is on the upswing, but the supply is not matching this growth, then that's a good sign that the escalation of prices will continue. When you start hearing about rebates, free upgrades, and cash back from new home builders, the market is discontinuing its upward swing and turning to a buyers market.

Nevertheless, there are several other reasons why the ownership of real estate, despite the market, is a wise move.

Regardless of the direction of the marketplace, homeowners will always be able to build equity through the paying down of their mortgage. As you move closer to the end of your mortgage, you actually have something to show for it (unlike the renter counterpart). For those who own property for a prolonged period of time, the equity grows in two ways: through debt reduction and through inflation. While homeowners may not stay in the same house and pay off the mortgage in that home, the equity build up provides them with the funds for an even larger down payment for that final home where the mortgage will be paid off. At some point, you will owe less than the value of the home and eventually, it could be completely paid off.

If consumers get caught in a declining market, historically, it's usually for the short-term and it will recover, continuing its traditional inflationary move upward. This equity is probably the largest part of most Americans' financial make up -- thus the American dream of homeownership.

That appreciation is the second reason why homeownership is a great place to put your monthly income. Most people have to pay some sort of amount of money for living somewhere -- it may be a mortgage payment or a rental payment. If you're renting, then you're not letting your income work for you. Instead, you're providing income for someone else through that rental payment.

As your home appreciates, the return on your down payment and the cash you're paying into that home each month, continues to increase.

For instance, if you purchase a home for $200,000 with 10 percent down, your $20,000 down payment is now going to increase in value according to the leveraged amount of $200,000. Thus, if it grows at 3 percent per year (which is half of the national average) the cash return the first year is $6,000 -- that's a 30 percent return on your $20,000 down payment. As each year passes -- the return on investment grows and grows.

A third part of the wealth-building power of real estate is through the tax savings/deductions you'll receive for purchasing a home. For most tax payers, the interest and taxes paid on a home is completely deductible from your income -- thus creating a huge reduction in your tax bill. You'll never get that benefit from renting.

Finally, if you're investing in real estate, another benefit of owning real estate over other investments, is that with a renter -- someone else's money is growing the above three benefits. The rental payment is increasing the equity, allowing the benefit of appreciation, and paying the taxes and interest on the mortgage.

Published: April 15, 2005


Second Class Citizen said...

As a lifetime low earner, I believe I will never be able to buy a home. But I have been a profitable long-term tenant. So I figure I am carrying the full costs of ownership and then some. How can I get a piece of the equity and appreciation for which I am paying?

Anonymous said...

I guess you are part of D. Lereah "Realtor Cheerleading Club" (TM).

"Regardless of the direction of the marketplace, homeowners will always be able to build equity through the paying down of their mortgage. "

Holy smoke, if the market turns, which it will soon, then how on earth do you "build equity"? You have a loan for $500k on an asset worth $300k then please tell me how you are going to build equity.

Where I live (McLean) some condos have gone up 200%, houses more than 100% in 4 years. If you think that is sustainable and indeed irreversible then you are trying to flog a "new economy" myth and are denying the power of the business cycle. DC saw very tepid appreciation in the late 1980s, but now has entered the major leagues of housing bubbles. "You've got another thing coming."

deb said...

A growing segment of "homeowners" are not building equity at all. They have taken on the latest greatest financial invention, the interest only mortgage (not used in large numbers since the 1920's). Couple that with a low down payment and adjustable rate, they will be crushed in a flat market. I hate to think what will happen to these naive homeowners if they had to weather an all out decline.

It costs almost 8% just to sell a home. You owe all the principle regardless of which direction the market has gone. People are not thinking about the risks involved in making a purchase and loan commitment of this size.

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