While becoming a homeowner may not return much value in the short term, sticking with a property for the long run can be a sound financial decision. But as with any investment, it’s important to consider a number of factors, such as your time horizon, expected rate of return, costs, and risks. Here’s how to consider homeownership as a long-term investment, how to build equity, and the various factors and risks to consider before buying.
Homeownership Is a Long-Term Investment
Home prices are cyclical, which means that they can fluctuate in the short term, with periods of growth followed by downturns and periods of stagnation. That said, the national average annual appreciation over the 25-year period before the coronavirus pandemic began was 3.9%, according to Black Knight. So, let’s say you buy a home for $300,000 and live in it for 10 years before you sell. An average 3.9% appreciation rate would give you a sales price of roughly $440,000. Of course, the average appreciation rate can vary depending on where you live. In Salt Lake County, Utah, for instance, home prices increased by 5.1% on average from 1996 to 2020. Take the same $300,000 home, and your property would be worth more than $493,000 after 10 years.
Building Home Equity
Home equity is the value of interest that you have in your home—or the portion of your home’s value that’s not financed. For example, if you buy a $300,000 home and put down $60,000, you immediately have $60,000 in equity in the property. Your equity grows over time as the value of your home increases and the principal balance of the mortgage loan decreases. When you ultimately sell the home, your investment return will effectively be your equity minus selling fees. Here are some steps you can take to set yourself up to have good equity:
Put more money down: A down payment provides instant equity when you buy your home. The more money you put down, the more equity you’ll have. Just be sure to avoid putting so much down that you don’t have any emergency savings to cover maintenance and repairs.Make extra payments: Some people opt to make additional mortgage payments to pay down their loan faster and increase their equity. For example, you can pay a set amount on top of your regular monthly payment, use windfalls like a tax refund or work bonus to make a large one-time payment now and then, or split your monthly payment in half and pay that every two weeks—this last option results in one full extra mortgage payment every year.Opt for a shorter repayment term: If you get a 15-year loan instead of a 30-year loan, a larger portion of your monthly payments will go toward paying down the loan balance, helping you accumulate equity more quickly. Just be sure to run the numbers to know whether you can afford the higher payments.Improve your home: Investing in home renovations can increase the value of your home, even if they don’t always return as much as you put into the projects. According to the Zonda Cost v. Value report, the renovations with the best return on investment include a new garage door (93.8%), the addition of stone veneer (92.1%), and a minor kitchen remodel (72.2%).
Keep Location in Mind
Where you live has a big impact on your home’s appreciation rate. For example, home prices across the U.S. grew by a little more than 100% between the years 2000 and 2020. But over that same period, San Jose, California, saw nearly 250% growth, while homes in Cleveland, Ohio, appreciated by a little more than Of course, deciding where to live is about more than just how much the value of your home will go up. But if you’re serious about using your home as an investment, it should be an important factor as you consider your options.
Tax Deductions
When buying a home, you can generally only deduct the prepaid mortgage interest—often called points—that allow you to effectively buy down your interest rate. Throughout your homeownership, you’ll also be able to deduct some or all of the interest you pay on your mortgage loan. That said, you can only deduct these interest expenses on your tax return if you itemize your deductions. According to the IRS, roughly 17.5 million taxpayers itemized their deductions on their 2018 tax returns—the latest data available from the tax agency. That’s just 11.4% of all tax returns for that year. Consider speaking with a tax professional to understand just how much these deductions can add value to your investment, if at all. When you sell the home, you may be able to exclude up to $500,000 of your gains on your tax return for that year, which can save you tens of thousands of dollars. The exclusion is $250,000 unless you’re filing jointly with your spouse, then it’s $500,000.
Risks of Homeownership as an Investment
While homeownership generally provides an opportunity to increase your net worth over time, there are some risks associated with it:
Home prices can depreciate in the short term, which may not matter over the long run, but it can hurt your investment if it comes at the wrong time.Upfront costs make homeownership a poor short-term investment—it takes an average of four years to break even on closing costs.Home equity isn’t liquid, so if you put too much of your cash into a home, you could experience financial hardship if you need that cash later on. Experts call this being “house poor.”Ongoing maintenance and repairs can be costly, especially with older homes.Certain areas are at higher risk of earthquakes, floods, and other natural disasters that could destroy your investment—make sure you’re properly insured.
High upfront costsMaintenance and repairs can be costlyEquity is illiquidLess flexibilityPotential for depreciation
However, home prices do tend to increase over time, albeit at a relatively low rate, and buying a home can allow you to diversify your assets.
