Building Wealth Through Home Equity--Myth or Reality?

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JiggyWillis
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Building Wealth Through Home Equity--Myth or Reality?

Post by JiggyWillis » Thu Jan 10, 2019 10:27 am

The following article appeared in a recent home building industry publication discussing the benefits of home ownership for wealth accumulation. The premise seems to be that most Americans acquire the majority of their wealth through home ownership.

https://blog.bestinamericanliving.com/w ... nd-equity/

Of particular note is Figure 1--Aggregate Homeowner's Equity, suggesting that real estate equity has recovered to pre-crisis levels. The dramatic increase, like the one preceding the Great Recession, seems unsustainable. Note the link to the 2006 article on the topic.

I seem to recall that historic real estate appreciation is on the order of about 0.25% annually and cannot be expected to keep up with inflation. I thought this would be of interest to the forum.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Snowjob » Thu Jan 10, 2019 10:31 am

I think the actual figure is ahead of inflation by like a quarter percent or half a percent.

IMO its completely random. if you buy in the right area that takes off cause of economic growth? fantastic. [location dependent]
If you assume a 30 year mortgage right before a bout of massive inflation that reduces your debt in real terms? fantastic [broad economy dependent]

other than that, its a lifestyle choice. If you the above do not happen (and you don't rent out other rooms to people under the table) renting is more efficient. You can chose the optimal size and location of your place, and invest the difference in the stock market. This is especially true as you are younger since you are assuming the long term earnings potential of the stock market

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by GT99 » Thu Jan 10, 2019 10:43 am

This is not surprising at all because most people are not very good at managing their finances. Buying a house forces them to put money into that asset, which will usually appreciate (the number I recall seeing is more like 2% per year on average). Most people who are renting are not putting the monthly difference vs paying a mortgage (and other home ownership costs) into investments.

Not to say I'm advocating renting over buying. Buying has been great for me personally. There's no one correct answer for everyone when it comes to rent vs buy.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by lthenderson » Thu Jan 10, 2019 10:52 am

Highly dependent on location. After thirty years of owning houses, I'm guessing if I sold the one I'm in now, I've just about broke even. I lost $5k on the first house, I made about $5k on the second and this one after six years of ownership, I figure I could sell it for what I've put into it. I would have been much better off putting all that money into an index fund and letting it ride over the same 30 years. But I don't like living in apartments or renting in general so it is a price I'm willing to pay to tie up a large chunk of my money to keep a roof over my head. I freely admit I live in the rural midwest and things are much different elsewhere. Out here, the population has been drying up and moving to the cities for the last 100 years and I don't expect that will change anytime soon.

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unclescrooge
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by unclescrooge » Thu Jan 10, 2019 10:54 am

When your house is your largest asset, it is often your only asset.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Jack FFR1846 » Thu Jan 10, 2019 11:01 am

Home equity has traditionally been the only way to get people to not spend every cent they make. Unfortunately, being able to pull equity out has become very easy, so even that no longer keeps many families above water. So in a "Leave it to Beaver" world, where the family buys a home and pays until they can burn the mortgage, sure....equity builds. Today.....not so much.
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by A-Commoner » Thu Jan 10, 2019 11:16 am

Being Bogleheads (before we realized we were one), my wife and I bought our house in a very LCOL area in flyover country 20 years ago for 200k. 20 years later, we sold it for 200k. Ouch. No price appreciation for 20 years...factoring in inflation, we lost money on that one. Still, we had equity when we sold since we had paid down the mortgage. We also didn’t rely on our house for wealth accumulation, we viewed it as an expense. We funneled the savings from living in a cheap area into the stock market, and that paid off.

Lesson we learned is that living in a LCOL area will only benefit you if you actually invest the savings into somethng else other than your home. Homes in LCOL areas unfortunately don’t appreciate that much.

wolf359
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by wolf359 » Thu Jan 10, 2019 11:54 am

If you want to figure out how wealthy Americans build wealth, you should study wealthy Americans. Learning how to build wealth like an average American will teach you to be an average American, who is living paycheck-to-paycheck and is in debt up to their eyeballs. The average American has used this strategy to build a median net worth of $97,300 (according to the Federal Reserve).

It's true that most Americans have used home ownership to build their wealth, but it's not that effective. The fact is being touted as a positive by a lobbying group for home builders. They're not comparing it to alternate strategies.

Most growth in the economy has been due to business, not home value. The average American doesn't own any stocks or their own business. I'd expect real estate to grow roughly at the rate of inflation.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Kenkat » Thu Jan 10, 2019 11:59 am

Jack FFR1846 wrote:
Thu Jan 10, 2019 11:01 am
Home equity has traditionally been the only way to get people to not spend every cent they make. Unfortunately, being able to pull equity out has become very easy, so even that no longer keeps many families above water. So in a "Leave it to Beaver" world, where the family buys a home and pays until they can burn the mortgage, sure....equity builds. Today.....not so much.
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NextMil
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by NextMil » Thu Jan 10, 2019 12:24 pm

Sure, if you buy high and sell low, you are not making any money. The fact is that you cannot apply a hard and fast rule to every situation - location, time horizon, market etc all dictate if you are going to make money, and for all of us having different lives and priorities do not have the luxury of hanging onto a home until a market recovers and vice versa. People in Florida and Cali know this all too well, not to mention shale and oil country.

We can all anecdotally highlight when we either made or lost money, but it will be different for everyone. That said, home ownership can be forced savings for a lot of Americans, which for non-bogleheads that probably is not be a bad thing.

So what is the alternative? What if you picked the wrong time horizon to be a renter and your plan to rent and save the difference was met with dramatic yearly increases in rent?

No offense, but I find hand wringing over these sorts of issues to be unproductive. For me, my plan is continue to pay my mortgage and invest in retirement and taxable, and maybe someday become a landlord to continue to diversify my potential for income streams.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by nisiprius » Thu Jan 10, 2019 12:31 pm

The 381-year record of residential real estate in the Herengracht district in Amsterdam isn't encouraging. Sometimes you would have needed to wait a century to get back to even.

Doubling in 381 years is an average annual return of less than 0.2% per year.

Image

(If anyone knows where to find a chart or numbers with data past 2008, please post).

And one single residential unit isn't diversified.

And I don't think it's an "investment" if you aren't prepared to sell it at any time, based purely on financial considerations and ignoring the fact that it's your shelter. Salespeople like to pitch any expensive purchase as an "investment."
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by 2015 » Thu Jan 10, 2019 12:58 pm

It did for me but that was solely by accident. I never planned by financial picture around real estate. As I'm not one who derives contentment, self-worth, or pleasure from lots of spending, the proceeds have simply gone to increase legacy.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by randomguy » Thu Jan 10, 2019 1:16 pm

lthenderson wrote:
Thu Jan 10, 2019 10:52 am
Highly dependent on location. After thirty years of owning houses, I'm guessing if I sold the one I'm in now, I've just about broke even. I lost $5k on the first house, I made about $5k on the second and this one after six years of ownership, I figure I could sell it for what I've put into it. I would have been much better off putting all that money into an index fund and letting it ride over the same 30 years. But I don't like living in apartments or renting in general so it is a price I'm willing to pay to tie up a large chunk of my money to keep a roof over my head. I freely admit I live in the rural midwest and things are much different elsewhere. Out here, the population has been drying up and moving to the cities for the last 100 years and I don't expect that will change anytime soon.
And if you put all that money into index funds, you are living in a cardboard box down by the river:) Owning tends to be much cheaper than renting over 10+ year time periods for similar units. A lot of people don't make it to the long term with job changes, house upgrades, and so on though.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by cbr shadow » Thu Jan 10, 2019 2:10 pm

randomguy wrote:
Thu Jan 10, 2019 1:16 pm
lthenderson wrote:
Thu Jan 10, 2019 10:52 am
Highly dependent on location. After thirty years of owning houses, I'm guessing if I sold the one I'm in now, I've just about broke even. I lost $5k on the first house, I made about $5k on the second and this one after six years of ownership, I figure I could sell it for what I've put into it. I would have been much better off putting all that money into an index fund and letting it ride over the same 30 years. But I don't like living in apartments or renting in general so it is a price I'm willing to pay to tie up a large chunk of my money to keep a roof over my head. I freely admit I live in the rural midwest and things are much different elsewhere. Out here, the population has been drying up and moving to the cities for the last 100 years and I don't expect that will change anytime soon.
And if you put all that money into index funds, you are living in a cardboard box down by the river:) Owning tends to be much cheaper than renting over 10+ year time periods for similar units. A lot of people don't make it to the long term with job changes, house upgrades, and so on though.
This, again, depends a lot on the location. In some areas there's a strong case for renting (like here in the SF Bay Area). People buying in this area are hoping that the historic (past 30 years) appreciation continues. There is of course no guarantee that it will.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by KlangFool » Thu Jan 10, 2019 2:13 pm

JiggyWillis wrote:
Thu Jan 10, 2019 10:27 am
The following article appeared in a recent home building industry publication discussing the benefits of home ownership for wealth accumulation. The premise seems to be that most Americans acquire the majority of their wealth through home ownership.
JiggyWillis,

1) Survivorship bias
https://en.wikipedia.org/wiki/Survivorship_bias

The number does not account for folks that lost their houses from foreclosures and so on.

2) In my area, the house is not back to the 2004/2005 level yet.

KlangFool

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by DesertDiva » Thu Jan 10, 2019 2:16 pm

Sponsored by the NAHB - The National Association of Home Builders :annoyed surprise, surprise

Based on everything I've read and observed, wealthy people have a lower percentage of their assets tied up in their principal residence than the non-wealthy.
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adamthesmythe
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by adamthesmythe » Thu Jan 10, 2019 2:19 pm

Building wealth for retirement with home equity- is a high-stakes gamble that you are reasonably likely to win.

Ask yerself- do I feel lucky?

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Ed_Sandwich » Thu Jan 10, 2019 2:22 pm

GT99 wrote:
Thu Jan 10, 2019 10:43 am
This is not surprising at all because most people are not very good at managing their finances. Buying a house forces them to put money into that asset, which will usually appreciate (the number I recall seeing is more like 2% per year on average). Most people who are renting are not putting the monthly difference vs paying a mortgage (and other home ownership costs) into investments.

Not to say I'm advocating renting over buying. Buying has been great for me personally. There's no one correct answer for everyone when it comes to rent vs buy.
Don't forget it's also a highly leveraged asset. Most people don't borrow $500k to invest in the stock market, but a lot of folks borrow that much to invest in a home.

If that house and it appreciates 2% in a year you get $10k. If your down payment and mortgage payments for the year total $60k, you just made a 17% return in a year, on paper.

Easy to make a big return, but also easy to end up in the hole.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by KlangFool » Thu Jan 10, 2019 2:29 pm

Ed_Sandwich wrote:
Thu Jan 10, 2019 2:22 pm
GT99 wrote:
Thu Jan 10, 2019 10:43 am
This is not surprising at all because most people are not very good at managing their finances. Buying a house forces them to put money into that asset, which will usually appreciate (the number I recall seeing is more like 2% per year on average). Most people who are renting are not putting the monthly difference vs paying a mortgage (and other home ownership costs) into investments.

Not to say I'm advocating renting over buying. Buying has been great for me personally. There's no one correct answer for everyone when it comes to rent vs buy.
Don't forget it's also a highly leveraged asset. Most people don't borrow $500k to invest in the stock market, but a lot of folks borrow that much to invest in a home.

If that house and it appreciates 2% in a year you get $10k. If your down payment and mortgage payments for the year total $60k, you just made a 17% return in a year, on paper.

Easy to make a big return, but also easy to end up in the hole.
Ed_Sandwich,

<<If that house and it appreciates 2% in a year you get $10k.>>

You lose money since you borrowed at 4% to 5% to buy the house. The house needs to appreciate 4% to 5% just for you to breakeven.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Northern Flicker » Thu Jan 10, 2019 2:31 pm

Doubling in 381 years is an average annual return of less than 0.2% per year.
Per the graph I did not duplicate here, that is a real return. You also get the imputed income of rent not paid (less maintenance cost). Home ownership, especially factoring in a mortgage, hedges cost of living against inflation. With salaries struggling to keep pace with inflation, steady increases in employee share of health insurance cost, etc. not owning a home can lead to the financial rewards of career growth just keeping pace with cost of living over time.
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Thegame14 » Thu Jan 10, 2019 2:32 pm

it is mostly a myth, as you always need somewhere to live, the only way this works is if you live in HCOL or VHCOL area while working and getting high salary, then retire sell house in HCOL areas and relocate to LCOL area and get house for a lot cheaper, as you always need somewhere to live.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by simmias » Thu Jan 10, 2019 2:33 pm

DesertDiva wrote:
Thu Jan 10, 2019 2:16 pm
Based on everything I've read and observed, wealthy people have a lower percentage of their assets tied up in their principal residence than the non-wealthy.
It shouldn't be surprising that wealthy people need to tie up a smaller percentage of their assets in the basic necessities of life like food and shelter.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by bberris » Thu Jan 10, 2019 2:39 pm

KlangFool wrote:
Thu Jan 10, 2019 2:29 pm
Ed_Sandwich wrote:
Thu Jan 10, 2019 2:22 pm
GT99 wrote:
Thu Jan 10, 2019 10:43 am
This is not surprising at all because most people are not very good at managing their finances. Buying a house forces them to put money into that asset, which will usually appreciate (the number I recall seeing is more like 2% per year on average). Most people who are renting are not putting the monthly difference vs paying a mortgage (and other home ownership costs) into investments.

Not to say I'm advocating renting over buying. Buying has been great for me personally. There's no one correct answer for everyone when it comes to rent vs buy.
Don't forget it's also a highly leveraged asset. Most people don't borrow $500k to invest in the stock market, but a lot of folks borrow that much to invest in a home.

If that house and it appreciates 2% in a year you get $10k. If your down payment and mortgage payments for the year total $60k, you just made a 17% return in a year, on paper.

Easy to make a big return, but also easy to end up in the hole.
Ed_Sandwich,

<<If that house and it appreciates 2% in a year you get $10k.>>

You lose money since you borrowed at 4% to 5% to buy the house. The house needs to appreciate 4% to 5% just for you to breakeven.

KlangFool
You also got a place to live.
Add in to the return the rent you would have paid, and the taxes on income needed to pay the rent. Alternatively add in the taxes you would have paid on the income the down payment generated.

The real return of buying a house is the rent avoided, and it is tax free.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Starfish » Thu Jan 10, 2019 2:43 pm

nisiprius wrote:
Thu Jan 10, 2019 12:31 pm
The 381-year record of residential real estate in the Herengracht district in Amsterdam isn't encouraging. Sometimes you would have needed to wait a century to get back to even.

Doubling in 381 years is an average annual return of less than 0.2% per year.

Image

(If anyone knows where to find a chart or numbers with data past 2008, please post).

And one single residential unit isn't diversified.

And I don't think it's an "investment" if you aren't prepared to sell it at any time, based purely on financial considerations and ignoring the fact that it's your shelter. Salespeople like to pitch any expensive purchase as an "investment."

https://www.bloomberg.com/news/articles ... p-up-homes


House prices in the Amsterdam region rose 8 percent in the fourth quarter compared to the year earlier, statistics from realtors association NVM showed on Thursday. The median transaction price was 448,000 euros ($517,000), a new record. Although the pace of the rise was the slowest in almost four years, it was the 22nd consecutive quarterly price increase.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by DesertDiva » Thu Jan 10, 2019 2:46 pm

simmias wrote:
Thu Jan 10, 2019 2:33 pm
DesertDiva wrote:
Thu Jan 10, 2019 2:16 pm
Based on everything I've read and observed, wealthy people have a lower percentage of their assets tied up in their principal residence than the non-wealthy.
It shouldn't be surprising that wealthy people need to tie up a smaller percentage of their assets in the basic necessities of life like food and shelter.
Wealthy people didn't get that way by locking their money in a primary residence and paying a large mortgage, loaded upfront with interest. In the event of job loss or retirement, you can't live off your house unless you sell it. Your house doesn't generate wages, interest, rent or dividends.
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by KlangFool » Thu Jan 10, 2019 3:15 pm

bberris wrote:
Thu Jan 10, 2019 2:39 pm
KlangFool wrote:
Thu Jan 10, 2019 2:29 pm
Ed_Sandwich wrote:
Thu Jan 10, 2019 2:22 pm
GT99 wrote:
Thu Jan 10, 2019 10:43 am
This is not surprising at all because most people are not very good at managing their finances. Buying a house forces them to put money into that asset, which will usually appreciate (the number I recall seeing is more like 2% per year on average). Most people who are renting are not putting the monthly difference vs paying a mortgage (and other home ownership costs) into investments.

Not to say I'm advocating renting over buying. Buying has been great for me personally. There's no one correct answer for everyone when it comes to rent vs buy.
Don't forget it's also a highly leveraged asset. Most people don't borrow $500k to invest in the stock market, but a lot of folks borrow that much to invest in a home.

If that house and it appreciates 2% in a year you get $10k. If your down payment and mortgage payments for the year total $60k, you just made a 17% return in a year, on paper.

Easy to make a big return, but also easy to end up in the hole.
Ed_Sandwich,

<<If that house and it appreciates 2% in a year you get $10k.>>

You lose money since you borrowed at 4% to 5% to buy the house. The house needs to appreciate 4% to 5% just for you to breakeven.

KlangFool
You also got a place to live.
Add in to the return the rent you would have paid, and the taxes on income needed to pay the rent. Alternatively add in the taxes you would have paid on the income the down payment generated.

The real return of buying a house is the rent avoided, and it is tax free.
bberris,

That is another major myth/lie. Very few folks buy the same house as the house they rent. They upsize the house. Then, they kid themselves that they make money from the appreciation.

I buy a house because the PITI is 20% to 30% lower than the rent that I will be paying for the same house. Most folks go the other way. They buy a house with PITI at 20% to 30% greater than renting. Then, they pray that they make money from house appreciation.

KlangFool

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Phineas J. Whoopee » Thu Jan 10, 2019 3:27 pm

KlangFool wrote:
Thu Jan 10, 2019 3:15 pm
...
bberris,

That is another major myth/lie. Very few folks buy the same house as the house they rent. They upsize the house. Then, they kid themselves that they make money from the appreciation.

I buy a house because the PITI is 20% to 30% lower than the rent that I will be paying for the same house. Most folks go the other way. They buy a house with PITI at 20% to 30% greater than renting. Then, they pray that they make money from house appreciation.

KlangFool
I'd be very judicious about accusing other people of lying, Klang.

We understand by now you aren't speaking about others in general, just you and your immediate neighbors. You've posted that point repeatedly.

Not everybody is you. Not everybody is your immediate neighbors.

The correct financial comparison is renting or buying an equivalent dwelling. Of course each is unique, so the real comparison is renting or buying the very same space.

For another example, if you hypothetically wanted to claim buying a new Mercedes costs more than renting a used Toyota I wouldn't disagree with you, but the comparison would mean nothing.

PJW
Last edited by Phineas J. Whoopee on Thu Jan 10, 2019 3:45 pm, edited 1 time in total.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Phineas J. Whoopee » Thu Jan 10, 2019 3:42 pm

The building wealth through home equity trope isn't based on property appreciation at all, I'm afraid.

The idea is one borrows money to buy the dwelling, then gradually pays it back using a self-amortizing schedule.

The loan and the resulting home are equivalent. Borrow $80,000 and put down $20,000 on an $100,000 home, setting aside closing costs and the like, results in an unchanged financial position. Of course in real estate there is significant transaction drag.

It's unchanged net worth, if I may invoke such a term without being jumped on by people saying assets minus liabilities is meaningless.

With each self-amortized loan payment one pays back part of principal. That increases net worth. The dwelling is still the same, it's still there, but one owes less.

That's where the idea of forced savings comes from, and that's where the idea of building wealth through home equity comes from.

The idea of home equity simply separates the value of the dwelling from the asset side of one's personal balance sheet, and the outstanding mortgage principal from the liability side, and compares them in isolation.

It seems to me as if many controversies here could be solved if all of us took an online accounting class.

PJW
Last edited by Phineas J. Whoopee on Thu Jan 10, 2019 3:50 pm, edited 1 time in total.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Admiral » Thu Jan 10, 2019 3:46 pm

For MOST people, it's true, because MOST people save little to nothing.

For Bh's and others, it may or may not be true. There's this myth that all these people paying cheap rent are investing their massive housing savings in stocks. That is debateable to doubtful in (I would guess) 95% of the population (and particularly since most people don't own stock.)

People rent for lots of legit reasons, but MHO is that they don't do it because they think they'll be better off financially in 30 years not having owned a home. Anyone looking forward to paying rent when they're 80? Raise your hand!

Just my opinion, understand.

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by DesertDiva » Thu Jan 10, 2019 3:59 pm

Forced savings in the form of mortgage payments may not necessarily translate into wealth.

Homeowner A: $1,000,000 primary residence, $750,000 mortgage = $250,000 net in housing
Homeowner B: $300,000 primary residence, $225,000 mortgage = $75,000 net in housing

The two have the same income. As long as Homeowner B invests the difference between the two types of residences, he/she will have:
[*] lower expenses,
[*] more money to invest in tax-advantaged accounts
[*] more money to invest in other income-producing assets, e.g. rental property or businesses (that will in turn grow the Asset side of the balance sheet),
[*] more passive income, e.g., interest income and dividend (which can be reinvested, again growing the Asset side of the balance sheet)
[*] will be more likely to pay off the house earlier, saving interest expense and reducing the pull on the Liability side of the balance sheet
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by GT99 » Thu Jan 10, 2019 4:02 pm

Ed_Sandwich wrote:
Thu Jan 10, 2019 2:22 pm

Don't forget it's also a highly leveraged asset. Most people don't borrow $500k to invest in the stock market, but a lot of folks borrow that much to invest in a home.

If that house and it appreciates 2% in a year you get $10k. If your down payment and mortgage payments for the year total $60k, you just made a 17% return in a year, on paper.

Easy to make a big return, but also easy to end up in the hole.
That's not quite right - you're assuming you're getting that entire $60k back, but you don't get back your interest payments. And you're ignoring major costs (taxes, insurance, closing costs). Lets use a more realistic example. Let's say we bought a home for $500k, put 20% down, had a 4.5% mortgage rate, and sold after 5 years, assuming 2% annual appreciation, which results in a sale of $552,040 after 5 years.

Total Costs
$100,000 = down payment
$121,560 = total P&I payments over 5 years
$30,000 = Total Insurance and Taxes over 5 years (obviously varies widely based on location, but I think this is a good middle-point).
$5,000 = maintenance costs. This is low for most cases.
$33,122 = 8% closing costs on sale (8-10% is typical).
$289,682 = total costs

Total Proceeds from sale = Sale Price - Mortgage Balance = $552,040 - $364,681 = $187,359.

So in this fairly realistic (I'm not counting tax benefits, but I'm estimating low costs as well) scenario, you've lost $102,323,42. That's a 35% loss on your investment. Even if you do ignore closing costs, maintenance, Insurance, and taxes, it's still a loss.

But, it's not as bad as it sounds. If you'd rented a $2,500/month home for that same time period (and a $500,000 home typically rents for a heck of a lot more than $2500/month), you would have paid a total of $150,000 in rent.

So, you come out ahead IF you ignore the investment potential of the free capital when you rent. I'm not going further down that path right now. :D

Admiral
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Admiral » Thu Jan 10, 2019 4:03 pm

Phineas J. Whoopee wrote:
Thu Jan 10, 2019 3:42 pm
The building wealth through home equity trope isn't based on property appreciation at all, I'm afraid.

The idea is one borrows money to buy the dwelling, then gradually pays it back using a self-amortizing schedule.

The loan and the resulting home are equivalent. Borrow $80,000 and put down $20,000 on an $100,000 home, setting aside closing costs and the like, results in an unchanged financial position. Of course in real estate there is significant transaction drag.

It's unchanged net worth, if I may invoke such a term without being jumped on by people saying assets minus liabilities is meaningless.

With each self-amortized loan payment one pays back part of principal. That increases net worth. The dwelling is still the same, it's still there, but one owes less.

That's where the idea of forced savings comes from, and that's where the idea of building wealth through home equity comes from.

The idea of home equity simply separates the value of the dwelling from the asset side of one's personal balance sheet, and the outstanding mortgage principal from the liability side, and compares them in isolation.

It seems to me as if many controversies here could be solved if all of us took an online accounting class.

PJW
True, but what's missing is that the home value is not static. Is may gain in value, and it may lose value. It's irrelevant, of course, until it's time to sell. But you can't legitimately argue that it isn't one POSSIBLE way of building (or losing) money. Paying rent, OTOH, is a straight expense, with no ability to gain wealth and limited downside.

yousha
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by yousha » Thu Jan 10, 2019 4:06 pm

Purchased my home in 1971 and sold it in 2004 . Purchased it for $27,750 and sold it for $1,665,000.

Ed_Sandwich
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Ed_Sandwich » Thu Jan 10, 2019 4:07 pm

GT99 wrote:
Thu Jan 10, 2019 4:02 pm
Ed_Sandwich wrote:
Thu Jan 10, 2019 2:22 pm

Don't forget it's also a highly leveraged asset. Most people don't borrow $500k to invest in the stock market, but a lot of folks borrow that much to invest in a home.

If that house and it appreciates 2% in a year you get $10k. If your down payment and mortgage payments for the year total $60k, you just made a 17% return in a year, on paper.

Easy to make a big return, but also easy to end up in the hole.
That's not quite right - you're assuming you're getting that entire $60k back, but you don't get back your interest payments. And you're ignoring major costs (taxes, insurance, closing costs). Lets use a more realistic example. Let's say we bought a home for $500k, put 20% down, had a 4.5% mortgage rate, and sold after 5 years, assuming 2% annual appreciation, which results in a sale of $552,040 after 5 years.

Total Costs
$100,000 = down payment
$121,560 = total P&I payments over 5 years
$30,000 = Total Insurance and Taxes over 5 years (obviously varies widely based on location, but I think this is a good middle-point).
$5,000 = maintenance costs. This is low for most cases.
$33,122 = 8% closing costs on sale (8-10% is typical).
$289,682 = total costs

Total Proceeds from sale = Sale Price - Mortgage Balance = $552,040 - $364,681 = $187,359.

So in this fairly realistic (I'm not counting tax benefits, but I'm estimating low costs as well) scenario, you've lost $102,323,42. That's a 35% loss on your investment. Even if you do ignore closing costs, maintenance, Insurance, and taxes, it's still a loss.

But, it's not as bad as it sounds. If you'd rented a $2,500/month home for that same time period (and a $500,000 home typically rents for a heck of a lot more than $2500/month), you would have paid a total of $150,000 in rent.

So, you come out ahead IF you ignore the investment potential of the free capital when you rent. I'm not going further down that path right now. :D
You're right I did ignore a lot of things which do add up. I guess the point I was making was simply that it is (a large amount of) borrowed money which is invested in something that can be volatile in both directions, which nobody really does at any other point in life. It's a big gamble.

KlangFool
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by KlangFool » Thu Jan 10, 2019 4:23 pm

Phineas J. Whoopee wrote:
Thu Jan 10, 2019 3:27 pm

The correct financial comparison is renting or buying an equivalent dwelling. Of course each is unique, so the real comparison is renting or buying the very same space.

PJW,

Okay. So, what do you call folks that never intended to rent a 3,400 square feet single family home but use that rent to justify the purchase of that house?

People, in general, do not rent the same place as what they are willing to buy. They upsize.

KlangFool

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Sandtrap » Thu Jan 10, 2019 4:28 pm

Kenkat wrote:
Thu Jan 10, 2019 11:59 am
Jack FFR1846 wrote:
Thu Jan 10, 2019 11:01 am
Home equity has traditionally been the only way to get people to not spend every cent they make. Unfortunately, being able to pull equity out has become very easy, so even that no longer keeps many families above water. So in a "Leave it to Beaver" world, where the family buys a home and pays until they can burn the mortgage, sure....equity builds. Today.....not so much.
Beaver: Hey, Wally, why’d ya get a HELOC to take Margaret to the sock hop? You know you can’t afford that.
Wally: Aw, shut up, Beav. Margaret is swell.
Oh yea.
That "Eddy Haskell" is even more swell.
Since he started working as a finance officer for the bank, he'll loan money to everyone.
Everyone loves Eddie Haskell :shock:

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Sandtrap
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Sandtrap » Thu Jan 10, 2019 4:34 pm

Wealth through Home (or other R/E) Equity = Reality . . . sort of.

1. Location. (normally HCOL or UHCOL or stratospheric COL)
2. Area economics and trends.
3. Supply and demand . . . . and increasing demand.
4. Limited quantity.
5. Funds and income available to "play the game".
6. Timing.
7. Luck.

Of course there are many in the UHCOL areas of high appreciative value who are "house rich" but otherwise in debt or poor.

Addressing "wealth accumulation through property value appreciation" (vs cumulative through mortgage payments, etc).
Yes.
Sort of.
Again, #1-7.
Area and regional specific. Very specific.
Last edited by Sandtrap on Thu Jan 10, 2019 4:44 pm, edited 1 time in total.

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Phineas J. Whoopee
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Phineas J. Whoopee » Thu Jan 10, 2019 4:36 pm

KlangFool wrote:
Thu Jan 10, 2019 4:23 pm
Phineas J. Whoopee wrote:
Thu Jan 10, 2019 3:27 pm

The correct financial comparison is renting or buying an equivalent dwelling. Of course each is unique, so the real comparison is renting or buying the very same space.

PJW,

Okay. So, what do you call folks that never intended to rent a 3,400 square feet single family home but use that rent to justify the purchase of that house?

People, in general, do not rent the same place as what they are willing to buy. They upsize.

KlangFool
I call them people who are neither you nor your immediate neighbors, as I wrote but you didn't quote. You use yourself and your immediate neighbors in your upscale community as representative of everybody. Of course you're free to do so, and you've repeatedly posted that's what you mean.

The question isn't what you believe your immediate neighbors do.

The question is one of a meaningful financial comparison.

PJW

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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Northern Flicker » Thu Jan 10, 2019 4:41 pm

KlangFool wrote:
Thu Jan 10, 2019 4:23 pm
Phineas J. Whoopee wrote:
Thu Jan 10, 2019 3:27 pm

The correct financial comparison is renting or buying an equivalent dwelling. Of course each is unique, so the real comparison is renting or buying the very same space.

PJW,

Okay. So, what do you call folks that never intended to rent a 3,400 square feet single family home but use that rent to justify the purchase of that house?

People, in general, do not rent the same place as what they are willing to buy. They upsize.

KlangFool
That is totally irrelevant to evaluating the benefits of home ownership because nobody is forced to do that. People make bad financial decisions sometimes, but that doesn’t mean you have to follow suit.
Taking a break from Bogleheads.

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Midnight Schooner
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Midnight Schooner » Thu Jan 10, 2019 4:46 pm

GT99 wrote:
Thu Jan 10, 2019 4:02 pm
Ed_Sandwich wrote:
Thu Jan 10, 2019 2:22 pm

Don't forget it's also a highly leveraged asset. Most people don't borrow $500k to invest in the stock market, but a lot of folks borrow that much to invest in a home.

If that house and it appreciates 2% in a year you get $10k. If your down payment and mortgage payments for the year total $60k, you just made a 17% return in a year, on paper.

Easy to make a big return, but also easy to end up in the hole.
That's not quite right - you're assuming you're getting that entire $60k back, but you don't get back your interest payments. And you're ignoring major costs (taxes, insurance, closing costs). Lets use a more realistic example. Let's say we bought a home for $500k, put 20% down, had a 4.5% mortgage rate, and sold after 5 years, assuming 2% annual appreciation, which results in a sale of $552,040 after 5 years.

Total Costs
$100,000 = down payment
$121,560 = total P&I payments over 5 years
$30,000 = Total Insurance and Taxes over 5 years (obviously varies widely based on location, but I think this is a good middle-point).
$5,000 = maintenance costs. This is low for most cases.
$33,122 = 8% closing costs on sale (8-10% is typical).
$289,682 = total costs

Total Proceeds from sale = Sale Price - Mortgage Balance = $552,040 - $364,681 = $187,359.

So in this fairly realistic (I'm not counting tax benefits, but I'm estimating low costs as well) scenario, you've lost $102,323,42. That's a 35% loss on your investment. Even if you do ignore closing costs, maintenance, Insurance, and taxes, it's still a loss.

But, it's not as bad as it sounds. If you'd rented a $2,500/month home for that same time period (and a $500,000 home typically rents for a heck of a lot more than $2500/month), you would have paid a total of $150,000 in rent.

So, you come out ahead IF you ignore the investment potential of the free capital when you rent. I'm not going further down that path right now. :D
I went further down the path and calculated the IRR of the home-buying decision (some rounding made):

Year 0: Deposit -$100,000, Closing costs -$15,000. Year FCF = -$115,000
Year 1: Mortgage (with taxes and insurance) -$30,100, Repair -$5,000, Rent Alternative +30,000. Year FCF = -$5,100
Year 2: Mortgage (with taxes and insurance) -$30,200, Repair -$5,100, Rent Alternative +30,600. Year FCF = -$4,700
Year 3: Mortgage (with taxes and insurance) -$30,300, Repair -$5,200, Rent Alternative +31,200. Year FCF = -$4,300
Year 4: Mortgage (with taxes and insurance) -$30,400, Repair -$5,300, Rent Alternative +31,800. Year FCF = -$3,900
Year 5: Mortgage (with taxes and insurance) -$30,600, Repair -$5,400, Rent Alternative +32,500, Equity $187,900, closing costs -$33,100. Year FCF = +$151,300

So in summary the free cash flows per year are: -115k, -5.1k, -4.7k, -4.3k, -3.9k, +151.3k compared to renting (at $2.5k pm) for an IRR of 2.8%. There's your opportunity cost. I.e. Could you have invested this money and done better than 2.8%? The likelihood is you could have, and so it would have been better to rent under this example.

Midnight Schooner

28fe6
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by 28fe6 » Thu Jan 10, 2019 5:13 pm

KlangFool wrote:
Thu Jan 10, 2019 4:23 pm
Phineas J. Whoopee wrote:
Thu Jan 10, 2019 3:27 pm

The correct financial comparison is renting or buying an equivalent dwelling. Of course each is unique, so the real comparison is renting or buying the very same space.

PJW,

Okay. So, what do you call folks that never intended to rent a 3,400 square feet single family home but use that rent to justify the purchase of that house?

People, in general, do not rent the same place as what they are willing to buy. They upsize.

KlangFool
That may be true but I'm about to do the opposite:

1) buy 350k house on 15yr mortgage at $2400/mo payment. I do not want to do a 30-year mortgage.

2) rent a house valued at 425k for $1800/mo, and save $600/mo extra into a MM account

in this case I am favoring option 2. I will be renting a house I can't afford to buy (on my terms)

KlangFool
Posts: 11060
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by KlangFool » Thu Jan 10, 2019 5:26 pm

28fe6 wrote:
Thu Jan 10, 2019 5:13 pm

That may be true but I'm about to do the opposite:

1) buy 350k house on 15yr mortgage at $2400/mo payment. I do not want to do a 30-year mortgage.

2) rent a house valued at 425k for $1800/mo, and save $600/mo extra into a MM account

in this case I am favoring option 2. I will be renting a house I can't afford to buy (on my terms)
28fe6,

You prove my point. You are not comparing the rent and buy on the same house. Folks use renting house A versus buying house B to justify their decision to buy or rent. Almost nobody uses the same house.

KlangFool

Broken Man 1999
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Broken Man 1999 » Thu Jan 10, 2019 5:37 pm

No idea if our home has built wealth or not. We are in the midst of a remodel that will cost about a third of what our home's purchase price was 30 years ago, about $50,000 vs original purchase price of $151,000 in 1989. We put a down payment of $80,000, proceeds of sale of agriculture land in citrus grove. The large down payment allowed WE to be a SAHM until children were in pre-school.

At some point in time I will consider a reverse mortgage line of credit to drain as much of the equity out that I can. All children are suitably housed, so no reason to include house in any legacy. Might be ideal for LTC expenses instead of using investment portfolio, as growth in investment portfolio would likely grow more than house equity.I

Lots of difference s in the housing decision. Worked for us.

Broken Man 1999
“If I cannot drink Bourbon and smoke cigars in Heaven than I shall not go. " -Mark Twain

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Phineas J. Whoopee
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Phineas J. Whoopee » Thu Jan 10, 2019 5:40 pm

KlangFool wrote:
Thu Jan 10, 2019 5:26 pm
28fe6 wrote:
Thu Jan 10, 2019 5:13 pm

That may be true but I'm about to do the opposite:

1) buy 350k house on 15yr mortgage at $2400/mo payment. I do not want to do a 30-year mortgage.

2) rent a house valued at 425k for $1800/mo, and save $600/mo extra into a MM account

in this case I am favoring option 2. I will be renting a house I can't afford to buy (on my terms)
28fe6,

You prove my point. You are not comparing the rent and buy on the same house. Folks use renting house A versus buying house B to justify their decision to buy or rent. Almost nobody uses the same house.

KlangFool
I imagine more might if you stopped discouraging them from making rational choices.

PJW

DesertDiva
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by DesertDiva » Thu Jan 10, 2019 5:49 pm

Phineas J. Whoopee wrote:
Thu Jan 10, 2019 5:40 pm
KlangFool wrote:
Thu Jan 10, 2019 5:26 pm
28fe6 wrote:
Thu Jan 10, 2019 5:13 pm

That may be true but I'm about to do the opposite:

1) buy 350k house on 15yr mortgage at $2400/mo payment. I do not want to do a 30-year mortgage.

2) rent a house valued at 425k for $1800/mo, and save $600/mo extra into a MM account

in this case I am favoring option 2. I will be renting a house I can't afford to buy (on my terms)
28fe6,

You prove my point. You are not comparing the rent and buy on the same house. Folks use renting house A versus buying house B to justify their decision to buy or rent. Almost nobody uses the same house.

KlangFool
I imagine more might if you stopped discouraging them from making rational choices.

PJW
Often it's the mortgage broker who encourages their clients (especially first-time buyers) to get as much house as they are able, with the pitch of write-offs on mortgage interest and real-estate taxes on Schedule A. The broker collects a bigger commission with the larger mortgage, thus the incentive to abandon rational thought processes.
♫ Stocks go up ♫ Stocks go down ♫ Stocks go up ♫ Stocks go down ♫

michaeljc70
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by michaeljc70 » Thu Jan 10, 2019 6:14 pm

Of course that is reality. Most people have no other savings or real assets. If 40% of Americans cannot handle a $400 emergency..... Bogleheads are exceptional savers (and on average earners too).

Olemiss540
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by Olemiss540 » Thu Jan 10, 2019 6:17 pm

Phineas J. Whoopee wrote:
Thu Jan 10, 2019 5:40 pm
KlangFool wrote:
Thu Jan 10, 2019 5:26 pm
28fe6 wrote:
Thu Jan 10, 2019 5:13 pm

That may be true but I'm about to do the opposite:

1) buy 350k house on 15yr mortgage at $2400/mo payment. I do not want to do a 30-year mortgage.

2) rent a house valued at 425k for $1800/mo, and save $600/mo extra into a MM account

in this case I am favoring option 2. I will be renting a house I can't afford to buy (on my terms)
28fe6,

You prove my point. You are not comparing the rent and buy on the same house. Folks use renting house A versus buying house B to justify their decision to buy or rent. Almost nobody uses the same house.

KlangFool
I imagine more might if you stopped discouraging them from making rational choices.

PJW
Which would require a bit of empathy.
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

MnD
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by MnD » Thu Jan 10, 2019 6:59 pm

JiggyWillis wrote:
Thu Jan 10, 2019 10:27 am
The premise seems to be that most Americans acquire the majority of their wealth through home ownership.
The median US household value of all financial accounts (retirement and non-retirement) is around $16,000.
So it is not surprising that household wealth is in home equity for most, given that everything else for most is nothing or next to nothing.

inbox788
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by inbox788 » Thu Jan 10, 2019 7:12 pm

MnD wrote:
Thu Jan 10, 2019 6:59 pm
JiggyWillis wrote:
Thu Jan 10, 2019 10:27 am
The premise seems to be that most Americans acquire the majority of their wealth through home ownership.
The median US household value of all financial accounts (retirement and non-retirement) is around $16,000.
So it is not surprising that household wealth is in home equity for most, given that everything else for most is nothing or next to nothing.
Is that a blessing or a curse? What is the household wealth for non-homeowners? More or less than $16,000? Is there a class of non-homeowners that has managed to save/invest equivalent amount in financial accounts? The characteristics of such a subgroup would be interesting to see.

FWIW, median home home price is around $200k [Thu, 29 June 2017] to $222,800 [Data through Nov 30, 2018].

https://www.cnbc.com/2017/06/29/what-th ... he-us.html

https://www.zillow.com/home-values/

So even if a home is fully paid off, the wealthbuilding is often limited, especially if you own a median or below median priced home.

michaeljc70
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Re: Building Wealth Through Home Equity--Myth or Reality?

Post by michaeljc70 » Thu Jan 10, 2019 7:36 pm

inbox788 wrote:
Thu Jan 10, 2019 7:12 pm
MnD wrote:
Thu Jan 10, 2019 6:59 pm
JiggyWillis wrote:
Thu Jan 10, 2019 10:27 am
The premise seems to be that most Americans acquire the majority of their wealth through home ownership.
The median US household value of all financial accounts (retirement and non-retirement) is around $16,000.
So it is not surprising that household wealth is in home equity for most, given that everything else for most is nothing or next to nothing.
Is that a blessing or a curse? What is the household wealth for non-homeowners? More or less than $16,000? Is there a class of non-homeowners that has managed to save/invest equivalent amount in financial accounts? The characteristics of such a subgroup would be interesting to see.

FWIW, median home home price is around $200k [Thu, 29 June 2017] to $222,800 [Data through Nov 30, 2018].

https://www.cnbc.com/2017/06/29/what-th ... he-us.html

https://www.zillow.com/home-values/

So even if a home is fully paid off, the wealthbuilding is often limited, especially if you own a median or below median priced home.
According to this (and other articles I have seen corroborate this):

"The average homeowner has a net worth of $195,400, 36 times that of the average renter’s net worth of $5,400."

https://www.curbed.com/2018/3/13/171115 ... -net-worth


I'll just throw out there that in the past, middle class and up mostly always bought. Many millennials might have a different take and these stats may change over the next many years. On the other hand, my belief is they were shocked by the financial crisis temporarily (due to recency bias) and other generations after them (not seeing that) will may homes.

Locked