Owning a home is the best way to build family wealth—that's been the prevailing wisdom, at least, for the last several decades. And despite the 30% drop in home equity that hammered millions of households during the recent recession, Americans continue to believe in the wealth-building power of homeownership.
New research from Washington University in St. Louis suggests that owning a home does not lead directly to improved financial status. Rather, the details of your mortgage strongly influence whether or not your real estate proves to be a profitable investment over the long term.
Authors of the study looked at the difference in household wealth between moderate- and low-income homeowners and at that between moderate-and low-income renters. The researchers analyzed underlying factors, as well, finally determining that mortgages contributed to net worth only if:
• The buyer paid low fees in the application and approval process.
• The interest rate was low.
Applying these lessons learned can help middle-income borrowers get on the right track:
• Shop around for a low interest rate that is sustainable and accompanied by low fees.
• Understand all fees (property transfer fees, ancillary costs for inspections, and so on). Charging some or all of them will put you behind the curve.
• Calculate the impact of paying down the loan principal in advance. In the first five years of the loan, making a couple of extra mortgage payments can trim several years from your repayment schedule, because you are left to pay less interest on the balance.
• Don’t forget to consider the carrying costs of property insurance, taxes, and other expenses that may negate the appreciation of your property.
• Weigh decisions based on the assumption that you will hold onto the property for the foreseeable future. While selling costs amount to at least 6% of the asking price, that percentage represents a much higher proportion of your actual equity.