November 15, 2021

Do You Truly Understand Equity?

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One of the things that was profound to me while speaking with my clients, was how little the average person understands how equity gains in a home, work.  I want to share with you a simple way to understand how important a home can be to building your family’s wealth.

Let’s say you make $50,000 a year.  You take 5% of your money and put it in a 401k through your employer.  Let’s say your employer matches that same amount.  In most cases, you must be with that company for a minimum of 3-6 years to become “vested”, simply meaning that they will only let you keep that money if you spend enough time employed by them.

So, at the end of the first year, you have put in $2500 and your employer has matched that same amount.  An EXCELLENT return on your investment would be 10%.  Each month that goes by, you are putting a little over $200 into your 401k and at the end of the year, you have made a little over $500 on your hard earned money, assuming you stay with the company long enough to get that whole amount.  Otherwise, you have made a little over $250.  You can’t touch that money without an automatic 20% early deduction tax, and you will pay income taxes on any gains if you take it out before your retirement age.  It will take a very long time before you really build any long-term wealth that way, right?

Now, you make a rent payment every month.  That goes to someone’s bank account and you will never get any of that money back.  On top of that, you will pay deposits, first and last, in order to secure that place you are living in, draining your bank account.  You never know when your landlord is going to sell their property or decide not to renew your lease, and you are starting all over again just throwing money away every single month, not to mention rent prices can go up at any time without notice.

If you take that same money that you are paying rent with and you put it into a mortgage, not only does some of that money pay down the balance each month but you also get to keep the gains on the bank’s money.  To put it into perspective, since the beginning of census reporting, home prices have gone up an average of 3% per year.  So, let’s say you buy a home for $200,000.  Assuming you get at least that 3% growth, you would make $6000 in just the first year of owning your home.  The next year, you would make $6180, which means at the end of your second year you would already have netted $12,180.  If you sell your home after 2 years, you don’t pay capital gains on this, you get to keep the money for yourself.  You also can gain access to this equity over time through refinancing or adding a second mortgage.

So, when thinking about how much home you can afford for a monthly payment, doesn’t it make sense to put that money in a vehicle that grows from borrowing other people’s money rather than putting all your hard earned money into an account that you can’t touch until you are in your 60’s or 70’s?  Why would you want to wait another day to be a homeowner?  It is the fastest way for an American family to build wealth and security.