Homeownership and Wealth: How Owning Your Home Closes the Wealth Gap

You've probably heard that buying a home is a good investment, and it is when it's done right. Homeownership can build financial stability and even help close the racial wealth gap in America, especially for low-income households.

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Those who owned their own home rather than rented had a median net worth that was 80 times greater than the median for renters, according to the U.S. Census Bureau. Since we're all on a journey to building generational wealth, let's dive into how you can increase your wealth through homeownership, too. And I'll share some tips for buying a home that's an asset, not a liability.

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How does owning a home build wealth?

Homeownership builds wealth in four major ways: appreciation, equity, tax deductions, and cash flow. Each of these helps to increase wealth for the owner and can even create a monthly income. Let's explore each one.

1. Appreciation

When you buy a home, its value can appreciate, or grow, increasing your net worth and your chances of making money when you sell the house. Appreciation is when your home increases in value. Most homes appreciate about 3.5-3.8% every year, which may not sound like much, but it is.

There is also something called forced appreciation, which is when you buy a house that needs work and fix it so that the value increases because of the repairs you made. This is how a lot of house flippers make their money.

Over time, appreciation can add ten to hundreds of thousands of dollars to your net worth. However, it’s important to know that while appreciation is almost guaranteed in the long term, it’s not such a sure thing in the short term.

Home prices fluctuate based on a lot of factors that you can’t always control, which can send your home price up or down. Things that increase home appreciation include:

• Good location
• Near good schools
• The house is in good shape
• Having multiple bedrooms and bathrooms

2. Equity

Owning a home allows you to build equity versus paying rent. There's nothing wrong with renting. For many people, it's better than owning a home, like if you travel a lot or are not financially ready to purchase a home. That's because owning a home can be expensive. Between the mortgage payment, repairs, and property taxes, it can really add up.

However, owning a home allows you to build equity, which is the difference between what you paid for the house and the increased value of the property. Renting doesn’t allow you to do that. When you move out of your rental, you might get your deposit back. But if you sell a house with considerable equity, you technically made money on that sale.

Let's say you buy a home for $250,000. Over time, you spend $2,000 on some upgrades, like new paint and flooring, and the value jumps to $275,000. If you sell the house, you'll actually make $23,000 (minus the cost of the upgrades). That's a super simple way of looking at it, but that's generally how it works.

3. Tax deductions

Homeownership can lower your tax bill every year. It makes you eligible for mortgage interest deductions and other tax deductions. The IRS offers tax breaks to make homeownership more affordable by offering a credit to mortgage-paying homeowners. Mortgage interest deduction allows homeowners to deduct the interest they pay on mortgage debt.

4. Cash flow

You can build a lot of wealth from potential future rental properties. For example, when you’re ready to move out of your home, you can rent it instead of selling it, which can create cash flow for you and your family. And for single people, you can rent out the extra rooms in your home and have someone else pay your mortgage for you.

Does buying a house create generational wealth?

Yes, it does! A home is one of the most valuable assets many of us will own in our lifetimes. The equity built up through property appreciation and paying down the mortgage can grow your net worth through direct and indirect building of wealth.

1. Inheritance

Inheriting appreciated assets such as stocks, real estate, bonds, ETFs, cryptocurrency, etc., have big tax benefits, thanks to the "step-up in basis." The value of an inherited asset is "stepped up" to the fair market value on the date an original owner dies.

If a heir sells the property, the step-up in basis will reduce capital gains taxes due. Any capital gain from the sale of inherited property is usually considered long-term. Current long-term capital gains taxes are 0%, 15%, or 20%. These depend on your filing status and income.

Imagine using this stepped-up basis provision for several generations. An heir could sell a significantly appreciated asset and pay a small amount in capital gains tax or none at all, as long as the asset was included in the decedent's estate.

2. Indirect Benefits

Generational wealth can also be indirect. Homeowners are usually more financially secure than renters, passing that security on to their children.

Homeowners can borrow against the equity to boost the value of the home or take care of other financial needs. However, I'm not an advocate for doing, since it adds another mortgage to the property.

Another benefit people don't think of when buying a home are the social and education benefits of buying in a good area. Homeowners located in districts with high-performing schools enhance overall opportunities for their children.

Down the line, the equity in a home can help finance retirement and health care needs, shielding adult children from that financial burden. These factors can positively affect the next generation and add to their wealth.

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How does homeownership correspond with wealth inequality?

Rising house prices cause a housing affordability crisis, but also increase homeowners' wealth. A house is both a shelter and a wealth-generating asset. Housing market dynamics result from the interaction between these possibly conflicting dimensions. On the one hand, households seek good-quality housing to shelter their families. On the other, homeowners concentrate large shares of their savings on housing and, in recent decades, have seen their wealth increase due to rising house prices in many places.

Because of historical disenfranchisement of Black people and minorities overall from the housing market, many aren't seeing the wealth housing and homeownership can generate. Numerous factors contribute to the racial wealth gap between minority and white households transitioning to homeownership, such as financial fragility and affording homes in undesirable locations that don't see as much appreciation being the main reasons.

By purchasing homes in areas that are more likely to appreciate in value, and ensuring we can afford home ownership to begin with, we can positively affect wealth in the Black family and generate lasting wealth.

Home-buying tips for first-time buyers

So you want to use real estate to build generational wealth? Great! Just keep these things in mind when you're looking for property, so you don't end up with an expensive property that doesn't actually help you build wealth.  

1. Make sure you can afford it. Consider these things:

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Down payment

Your down payment depends on the lender and the type of mortgage you choose. Some conventional loans for first-time home buyers with excellent credit allow as little as 3% down. But even a small down payment can be challenging to save. For example, a 3% down payment on a $300,000 home is $9,000. Use a down payment calculator to decide on a goal, and then set up automatic transfers from checking to savings to get started.

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Monthly mortgage payment

The Consumer Financial Protection Bureau advises requesting loan estimates for a similar mortgage from various lenders to compare the costs, interest rates, and origination fees. Use a discount points calculator to decide.

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Closing costs

Your down payment is not all that you need to close on your mortgage loan. You also need to cover closing costs before taking control of your property. Closing costs are upfront expenses you give your lender in exchange for arranging some loan services. Some common closing costs are:

• Appraisal fees
• Attorney fees
• Discount points
• Escrow fees
• Homeowners insurance
• Pest inspection fees
• Property taxes
• Title insurance expenses

You can see your specific closing costs on the closing disclosure. Generally, you can expect to pay about 2 – 5% of your total loan amount in closing costs.

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Repairs

Seek more than one estimate for expensive repairs, such as roof replacements. A good real estate agent should be able to give you referrals to contractors who can give you estimates. But you also should seek independent referrals from friends, family and co-workers so you can compare those estimates against the ones you receive from contractors your agent refers.

2. Choose a good area

Check out potential neighborhoods keenly. Select one with amenities that are important to you, and test out the commute to work during rush hour.

3. Work with professionals

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Mortgage broker and lender

A mortgage broker works as a middleman that connects with prospective lenders. They remove much of the legwork from home buying by recommending loan options you are most eligible for from these lenders.

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Real estate agent

A real estate professional can help by:

• Attending showings with you to establish what you want as a homeowner
• Helping you decide how much to pay for a property
• Helping you negotiate with sellers or the seller's agent after submitting an offer
• Showing you properties that suit your needs and price range
• Submitting an offer letter on your behalf

General contractor for repairs

Some general contractors specialize in specific projects, like roofing or painting houses, while others are multifaceted. For whichever project they are hired, contractors are responsible for providing the labor, equipment and materials necessary. General contractors can handle:

• Electric
• Flooring
• New construction
• Painting
• Plumbing
• Remodel
• Renovation
• Roofing
• Woodworking

4. Do your research

Purchasing a house is a major commitment. Before buying, you should do your due diligence:

• Assess the local amenities and public transport available to ensure it's a reasonable travel distance from your job or favorite stores.
• Can you see yourself living there?
• How about in five years' time?
• Venture out one weekend to the area and get a feel for the surroundings and general atmosphere.
• It's even worth researching online to see how it compares to other suburbs and what people have to say.

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5)    Be patient; don't rush.

Patience ensures you can get the best deal, pick the best neighborhood, and work with the best people. Rushing into the buying process makes you prone to getting raw deals and possibly higher prices for properties you may have gotten at lower prices.

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Final Thoughts

Homeownership and wealth go hand-in-hand! Low-income households thus have the chance to create significant wealth via owning homes. Use these tips for purchasing a home, and start moving your family toward generational wealth.

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