Build Long-Term Wealth
The real estate market like any asset class is cyclical and has its ups and downs. Owning a home is a long-term investment to truly build wealth and you need to look past the the ups and down in the short-term based on how the broader economic and local markets are performing. Real estate is in short supply in many markets and the supply and demand equation will only drive prices up over time. As wages increase over time, people can also afford more which further drives prices. Real estate is also generally an investment that protects you against inflation.
Build Equity Through Principal Payments on Your Mortgage
Each month that you make a mortgage payment, a portion of it is going towards principal and increases the amount of equity that you have in your home and also functions as a forced savings plan. Over time, principal payments increase as you pay down your mortgage as a lower portion of the monthly payment will go towards interest on the principal loan balance.
Your Mortgage Allows You to Leverage Your Return-on-Equity (ROE)
Being able to finance your investment allows you to enhance your return-on-equity (ROE). For example, if you purchase a home for $800,000 and put 20% or $160,000 down, at 3% annual appreciation or $24,000 per year, your ROE is $24,000 on $160,000 initial equity investment or 15%. Your return on your total home value is 3%, but your ROE is enhanced because of the money you have borrowed to purchase the asset. The same scenario with 10% down and 3% annual appreciation yields a 30% ROE.
This is the beauty of leverage and compared to many people who invest money in stocks or other asset classes, it is usually not on borrowed money, so a 3% appreciation in stock price is a 3% ROE, not 15-30% in the scenarios above.
Tax Write-Offs
- Mortgage interest: The Federal tax code allows homeowners to deduct the mortgage interest on their tax returns up to a certain limitation, which is often over and above the standard deduction. Interest payments in the early part of a loan are usually much higher than an aged loan, allowing for greater amount of tax deductions.
- Closing costs: Loan origination fees are tax deductible in the first year that you purchase a home, so a 1% origination fee on a $500,000 loan will result in additional $5,000 in deductions.
- Property tax: Property taxes paid on your primary residence and a vacation home are deductible for income tax purposes up to a certain dollar limit.
- Home equity lines: deducting interest on home equity lines are allowed in certain scenarios after the most recent tax law change, specifically if it is used specifically for home improvements.
Equity Vantage Real Estate Inc. does not provide tax advice and we highly recommend speaking to an independent financial advisor and/or CPA to discuss where you can benefit most from the tax write-offs of owning real estate.
Capital Gains Tax Exclusion at Sale
If you buy a primary residence and live in it for two years or more then you will qualify for not having to pay capital gains tax up to $250,000 if single or $500,000 if married if you do not plan to roll the equity into the purchase of your next home.
Buying vs. Renting Will Save Money Long-Term
Over time rents rise and your interest payments on your mortgage become lower. Also, because of the interest tax deduction, paying the same amount on a mortgage is not the same as paying the same amount on rent due to the tax write-off of the interest and property tax. For example, if you have an extra $20,000 in write-offs per year because you are itemizing your deductions instead of taking the standard due to the interest and property tax deduction, at a 35% tax, you are effectively paying $7,000 per year less in tax. On a break-even basis, you could pay nearly $585 per month more in a mortgage versus renting and still have the same net cash flow per month. Lastly, when you are renting, you are paying off the landlord’s mortgage and only helping them to build wealth while you walk away with nothing.