The Financial Paradox of Owning a Home

Real estate is a concern since the homes of people’s wealth are increasingly concentrated in their homes.

According to data from the Federal Reserve, the average family’s largest asset was their house.

As home prices rise to all-time highs in 2020, this trend is expected to keep going.

This is both good and terrible news for the two-thirds of Americans who own their own homes.

On the other hand, owning an asset that appreciates in value enhances your net worth.

Housing equity, on the other hand, provides little to help you achieve financial independence.

Here, I talk about the housing dilemma and how to move your money away from your house and into assets that will help you become financially free.

The quickest way to enter the middle class is to own a home.

Homeownership has been one of the best ways for people to get out of poverty and into the middle class in the past, along with starting a business and going to college.

It’s become fashionable for personal finance writers to scoff at the concept of homeownership.

While I agree that there are numerous disadvantages to buying (many of which I will discuss in a moment), I believe the rent vs. buying debate has swung too far.

While buying a home at any price is a risky financial move, doing it at the right price and at the appropriate moment in your life is an excellent way to start creating wealth.

1. You are the owner of a valuable asset.

As much as I wish that people wanted to invest in the stock market as much as they wanted to acquire a home, that is not the reality.

Many people’s first homes are their first assets other than house accounts.

Let’s keep this basic because we have a tendency to overthink things.

If you want to accumulate wealth, you must begin amassing assets as soon as possible.

It’s also something you can pass down to your children as an asset.

We should never underestimate how strong that is, particularly for people from low-income families.

2. Buying a home forces you to save money.

The majority of people take out mortgages to purchase a home.

When you have a mortgage, you have to make a monthly payment, which forces you to save.

People are terrible at saving money, but they are fantastic at paying their mortgages.

Unlike preparing for retirement, not paying your mortgage has immediate, harsh, and often frightening implications.

I’ll never forget how sad it was for my parents to lose the house where I grew up due to foreclosure.

We can easily understand how it would feel to be evicted from our home.

As a result, most people will go to any lengths to meet their monthly mortgage payments.

Every time you make a mortgage payment, a portion of it goes toward paying down your mortgage principle.

In addition, every dollar you pay in principal raises your net worth by a dollar.

3. There is a chance that home values will rise.

The value of homes has risen in lockstep with the demand for housing over the decades.

Many middle-class workers who own a home have benefited as a result of this.

While I never expect my home’s value to rise, when it does, it’s a nice surprise that has hastened my wealth accumulation.

Many people have become billionaires just by purchasing a home and paying down their mortgage over a 30-year period while the home’s value increases.

1. It is expensive to own a home.

If you believe buying a house is too pricey, try owning a house.

Here are some of the annual charges you’ll have to factor into your housing budget.

mortgage

Mortgage protection insurance is a type of insurance that protects

taxes on real estate.

Maintenance is required (such as reshingling the roof or fixing a broken pipe.)

Renovations and improvements are being made.

Fees for a Homeowners Association (HOA) or a condominium

Expenses for utilities

insurance for your home.

The expense of a mortgage

Three things determine the amount of your monthly mortgage payment:

The entire amount is owed on your loan.

That mortgage’s interest rate

Your mortgage’s amortization period

For instance, if you had a $500,000 mortgage with a 3% annual interest rate and a 30-year amortization, your monthly payment would be $2,103, or $25,236 annually.

Mortgage insurance is a type of insurance that protects

You will be required to pay mortgage insurance if your downpayment on a home is less than 20%.

In the United States, FHA loans require an upfront insurance cost of 1.75 percent of the loan value paid at closing, as well as an annual payment of 0.45 percent to 1.05 percent of the loan amount.

You should expect to pay an extra $8,750 at closing and $2,250-$5,250 every year on a $500,000 mortgage.

Taxes and maintenance expenditures are two of the most expensive aspects of owning a property.

As a rule of thumb, annual property taxes and annual maintenance costs for owning a home should be roughly 1% of the home’s worth.

If you bought a $500,000 house, you might set aside $5,000 for property taxes and $10,000 for annual maintenance.

Renovations to the home

In North America, we have a cultural fixation on real estate and home renovations.

According to Home Advisor’s annual actual cost study, the average American homeowner spent $7,560 on home repair projects in 2019.

Fees for Condominiums and Homeowners Associations

You will almost certainly be forced to pay homeowner association (HOA) fees if you own a condo.

HOA payments are used to cover common area costs and benefits for all property owners in the association.

HOA fees provide shared areas, building maintenance, and amenities like a gym or pool in apartment-style condos.

Detached homes also have to pay HOA fees in some neighborhoods for things like neighborhood gardening or extras like a tennis court.

HOA fees in the United States range from $2,600 to $6,850 per year, depending on where you live.

Bills for utilities

Water, heat, power, waste removal, phone, and internet costs in the United States are roughly $2,060 per year.

Insurance for your home

According to Value Penguin, the average home insurance policy premium in the United States is $1,445.

2. a lack of variety

If you spend $500,000 on a house, you’ve made an unwittingly concentrated investment in a single asset class (housing), with the asset’s value connected to a fairly restricted geographic area (your neighborhood).

Having the majority of your net worth invested in your house is the definition of “all your eggs in one basket.”

Home values can soar as swiftly as they can fall, and when they do, your net worth might plunge.

If the market changes and housing as an asset class loses value, or if the community where you live becomes less appealing to buyers, the value of your home may not be able to be fixed.

That is exactly what happened to black and Hispanic households in the United States during the 2008–2009 financial crisis, according to research from the St. Louis Federal Reserve.

Housing accounted for more than half of the net worth of black and Hispanic families, compared to only 30% for white families.

Gaining access to housing in the decades preceding the financial crisis aided minority households in gradually reducing the wealth gap.

Two decades of development were lost in two years as housing prices fell, as shown in this graph.

Source: Federal Reserve Bank of St. Louis

3. Your house can become a financial snare if you don’t take care of it.

Owning financial assets such as stocks and bonds will get you closer to financial freedom, but home equity will not.

The reason for this is that accessing your home’s equity is quite complicated.

If your home is worth $500,000 and you owe $100,000 on it, you have $400,000 in equity (wealth).

The difficulty is that you only have two options for getting your hands on that $400,000 to pay for your lifestyle.

You should sell your house.

Take out a second loan.

Both of these alternatives have clear flaws.

You’ll still need to find a place to live if you sell your home.

This means that either you need to buy or rent a new home.

Taking out a second mortgage increases your debt and decreases your monthly cash flow.

Both alternatives increase your monthly spending while depleting your equity.

Given how difficult it can be to access the equity in your home, you don’t want your house to account for too much of your net worth if your objective is to achieve financial independence.

This is exactly where a lot of individuals find themselves.

According to the Federal Reserve’s figures,

In 2016, the median house price was $185,000.

Financial assets had a median value of $23,500.

In the United States, the average person’s house is worth approximately eight times their overall financial assets, which include deposit accounts, retirement accounts, equities, bonds, rental properties, and business equity.

Households in the United States are becoming wealthier, yet their primary dwellings contain a disproportionate amount of that wealth.

The financial trap of having too much of your net worth invested in your home is illustrated here.

Your net worth rises in tandem with the value of your home.

This gives you a sense of wealth.

However, because most of that money comes from where you live, the dream of financial independence has become a dream.

Your net worth is equal to the whole value of your assets minus the total amount of your debts.

As previously said, owning a home can help you raise your net worth, but getting access to that net worth can be tough.

In a word, this is the housing paradox.

That is why, as a homeowner, my major financial goal is to raise my “accessible net worth.”

Your net worth minus the value of your home equals your accessible net worth.

An illustration of your available net worth

Let’s imagine you had the following assets and debts:

Assets

A house costs $500,000.

Ten thousand dollars in cash

$100,000 in a retirement account

Other types of investing

$5,000

$615,000 in total assets.

Debts

Net worth of $365,000

This is how your available net worth would appear.

Assets

Ten thousand dollars in cash

$100,000 in a retirement account

Other types of investing

$5,000

$115,000 in total assets.

Debts

Net wealth that can be accessed: nil.

$135,000

Consider your accessible net worth to be the amount of money you could have if you never sold your home.

There are two ways to increase your available net worth with your money.

Pay off your debts.

Invest in new investments to diversify your portfolio.

Remember that paying off your debt increases your net worth by a dollar for every dollar you pay off the principle.

There was a previous case where you had a $250,000 mortgage and your accessible net worth was negative $135,000. If you paid off the mortgage, your net worth would be positive $115,000.

Investing in financial and corporate assets, on the other hand, can help you diversify your wealth and put you on the road to financial independence.

Stocks are number one.

Many people assume that stock market investing is too difficult.

People who think are under the impression that picking stocks and making money requires a high level of knowledge.

The truth is that the most profitable approach to investing in the stock market is also the most straightforward.

All you have to do to make money in the stock market is buy a few low-cost index funds and never sell them until you reach retirement age.

This essay will not be able to explain what index funds are or how they work.

This post will give you a crash education in index investing.

Bonds are number two.

When you buy a bond, you are essentially lending money to a company or the government.

Bonds offer a lower projected return but are less volatile than equities.

Depending on your circumstances, it may be worthwhile to forego some return on investment in order to lower your overall risk.

That’s especially true if you’re getting close to old enough to retire or if your job security is in question.

Bonds have historically worked as a hedge against stock market crashes, which is one of their strongest features.

Remember that stock market investment is a psychological game.

When investing in index funds, the only way to lose money is to sell at a loss when the market is down.

A bond’s assets holding their value amid a market meltdown may help you remain cool and avoid selling at the bottom.

Investment properties

In three ways, investing in rental properties can help you generate wealth.

The rent you collect generates monthly financial flow.

Your mortgage is paid off.

A boost in the value of your properties is possible.

Running a profitable real estate venture, on the other hand, takes a lot of effort and money.

It also raises the question of diversity.

If your home and rental properties account for the majority of your net worth, your wealth is inextricably linked to the real estate market.

If your house is your only asset, you should probably invest in stocks and bonds before purchasing more real estate.

Starting a company

Previously, starting a firm required a significant financial and time investment.

Many people were discouraged from trying their hand at business as a result of this.

That isn’t the case now.

Starting a digital business as a side hustle has never been easier or more affordable.

I’ve been running a digital side business while working a 9–5 job for the past three years.

Gone are the days when starting a business required selling a physical product at a physical location for a set number of hours.

It’s easier for me to work when, where, and how long I want because I can sell a digital product that doesn’t need much customer service.

As my company grows, I invest 100% of the profits in stocks, bonds, and real estate, allowing me to diversify my assets and increase my available net worth.

Resolving the housing conundrum

There’s nothing wrong with owning your own house.

It’s one of the tried-and-true methods for putting yourself on the road to financial success.

Given how difficult it is to access your home’s equity, it’s critical that your home does not account for too much of your net worth.

Once you’ve purchased a home, you should begin diversifying your assets and concentrate on your available net worth.

There are three techniques to boost your net worth that are easily available.

Debt repayment

Stocks, bonds, and rental properties are examples of financial assets.

Starting a company

Owning a home is an excellent way to begin accumulating wealth.

The crucial thing to remember is that it should be the first, not the last, move you make.

Ownership of a home is great, but if it’s your only source of income, you will never be able to be financially free.