Homeowner Equity and Wealth Accumulation

National homeowner equity grew in the fourth quarter of 2020 by $1.5 Trillion or 16.2% year-over-year based on a CoreLogic analysis.  The study was done on the six out of ten homeowners who have mortgages on their home.

The fourth quarter of 2020 also saw the number of mortgaged residential homes with negative equity decrease by 8% from the third quarter.  Compared to the same quarter in 2019, negative equity decreased by 21%.

Equity is defined as the value of the home less the mortgage owed.  Negative equity means that the homeowner's debt is more than the value of the home.  Appreciation is the dynamic that is moving homeowner's equity to the positive position.

On a national basis, according to National Association of REALTORS®, annual price growth for the last ten years has been 6.4%.  In the last five years, it has grown at 7.3% annually.  According to the CoreLogic Home Price Index, home prices in December 2020 were up 9.2% from the year before.

Frank Nothaft, Chief Economist for CoreLogic, is quoted as saying "the amount of home equity for the average homeowner with a mortgage is more than $200,000."

Equity in a home is a significant component of net worth.  The latest Survey of Consumer Finances reports the median homeowner has 40 times the household wealth of a renter: $254,000 compared to $6,270.  According to the 2019 Survey of Consumer Finances by First American, housing wealth was the single biggest contributor to the increase in net worth across all income groups.

The study also concluded that housing wealth represented nearly 75% of total assets of the lowest income households.  For homeowners in the mid-range of income, it represented 50-65% of total assets and 34% of total assets for the highest income households.

Renters do not benefit from the appreciation of housing or the amortization of the mortgage which are significant contributors to home equity that results in net worth.  Examine what a down payment can grow to in seven years with a Rent vs. Own.

It Costs Less to Own

The rent to income ratio is the monthly affordable rent as a percentage of monthly income.  Ideally, tenants should keep it within 30% of monthly gross income.  In some markets, in may not be possible because the shortage of available rental units.  In these situations, tenants are required to spend more than 30%.

Let's assume that a person/couple makes $100,000 a year which would be $8,333 per month.  Thirty percent of their monthly gross income would be $2,500 which would be at the top of the ratio for their rent.

If they were to buy a $300,000 home on an FHA loan at 3.00% for 30 years, the total payment, principal, interest, taxes, insurance and mortgage insurance premium would be around $2,034 or almost $450 less per month than their rent.

If you factor in the monthly principal reduction and the monthly appreciation, assuming 3% annually, the net cost of owning the home would be under $1,000 a month.  The people would be paying about $1,500 more per month to rent than to own.  In a year's time, it would amount to over $18,000 lost by renting which is more that the $10,500 down payment for an FHA loan and the closing costs.

 

Rent vs Own Example
Purchase Price	$300,000
Mortgage at 3.00% for 30 years	$294,566
Monthly Payment ... principal & interest	$1,241.90
Monthly Tax & Insurance escrow (estimated 2.25%)	$562.50
Total Payment (PITI + MIP)	$2,033.89
Less Monthly Principal Reduction	$512.50
Less Monthly Appreciation	$750.00
Plus Estimated Monthly Maintenance	$150,00
Plus HOA fee	$20.83
Net Cost of Housing	$942.22
Monthly Rent for Comparison	$2,500
Monthly Cost of Renting vs. Owning	$1,557.78
Annual cost of Renting vs. Owning	$18,693.30
Down Payment	$10,500
Estimated Equity after 7 years at 3% Appreciation	$121,579

One of the benefits of renting for tenants is that they are not responsible for the maintenance and repairs.  At the end of the lease, they are able to move without having to dispose of a home.  However, they also do not benefit from the increase in value due to appreciation nor do they benefit from the equity buildup due to amortization of the mortgage.

Disregarding the monthly net cost of housing in the example above since it considers both appreciation and amortization, the payment alone is over $450 less than the rent in this example.  If you look at the cumulative results, the down payment, or initial investment, of $10,500 grows to $121,579 in equity in seven years.  The owner of the home, in accepting additional risk, reaps the rewards of the equity as well as the lower cost of housing.

In the case of a tenant, their landlord will receive the benefits of the appreciation and the equity buildup.  Whether you rent or buy, you pay for the house you occupy...either for yourself or your landlord.

To plug in your own numbers, go to the Rent vs. Own.  If you have questions with the calculator or would like to visit about anything, give me a call (616) 402-3535.

Skip the Starter Home

For generations, people have begun their homeowner experience with a "starter" home.  Part of the logic may be that by beginning with a smaller home, they can learn what it takes to run the home and discover some of the unexpected costs that come along with it.  A slightly longer view into the future could suggest a different strategy.

As of March 4, 2021, the average 30-year mortgage rate according to Freddie Mac was 3.02%; up .37% from the week of January 7th this year.  At the same time, in 2020, the rate was 3.29% and in 2019, it was 4.41%.  That is a difference of 28 and 139 basis points.

The principal and interest payment on a $300,000 mortgage would have been $236 higher two-years ago and $44 more one-year ago.  Today's low mortgage rates are saving buyers lots of interest especially when you factor in the median tenure for sellers is approximately ten years.  Even though prices have increased over the last two years, some people may be able to afford more now with the lower rates.

Anticipating the future wants and needs now may present some opportunities for preparing for the inevitable.  By purchasing a larger home today, a buyer can lock in today's low rates and prices to allow themselves room to grow without the expenses of moving.

Each time you sell and purchase a home, there are expenses associated with each side of the transaction.  Purchase costs could be 1.5 to 3% while sales expenses could easily be 2.5 times that much.  These expenses lower the value of your equity. 

Instead of looking at the low mortgage rates as generating a savings from the payment you might normally have to make, consider it an opportunity to purchase more home that will possibly meet your needs for a longer time while eliminating the cost of selling and purchasing in the transition.

Your Refund Could Open the Door

One of the silver linings to filing your income tax return is finding out that you are going to receive a refund that could literally open the door to owning a home.  If you happen to be one of these fortunate taxpayers, your next decision is what to do with it. 

With the average tax refund near $3,000, it could be the ticket to buying a home sooner rather than later.  Regardless of the size of your refund, it can be used toward the down payment or closing costs of the home.

Most people think it takes 10% or more down payment to purchase a home, but actually, it is much less because of several low down payment mortgages .  There are VA and USDA mortgages that allow for no down payment for qualified buyers.  FHA has a 3.5% down payment program and FNMA and Freddie Mac have 3% down payment mortgages for qualified creditors as well as 5% down programs.

Closing costs for originating new mortgages can easily range from two to three percent of the purchase price but most lenders will allow the seller to pay part or all of them based on the agreement in the sales contract.  If you are using a VA or USDA loan, your refund could go toward paying the closing costs.

On a practical matter, if you are due a refund, have it deposited directly into your account.  It is necessary to trace the source of the funds.  Cashing a refund check and depositing the cash adds an unnecessary aging requirement.

Maybe you have the money saved for your down payment and closing costs but you have other debt that is keeping you from qualifying for a mortgage.  The IRS refund could be used to pay down that debt.  However, you need solid advice from a trusted mortgage professional before you do that.

While the average tax refund might not cover the down payment on the median price home, it certainly helps.  Your refund could make it a simple as 1-2-3 to get into a home.

1. Get the hard, cold facts for the homes and mortgages in your area and price range.
2. Get pre-approved with a trusted mortgage professional.
3. Start looking at homes.

Download the Buyers Guide and contact me at (616) 402-3535 or Linda@BuyTheLakeshore.com to get started.