Is Your House a Good Place to Park Your Wealth? Is it Earning a Return?

Source Is the wealth in your house (equity) earning a return? To answer that question you must first understand what we mean by return. Let’s define return as the interest or growth you receive on money you invest. Do you know the actual return on the wealth in your house? Many people believe the return on the wealth in their house is somewhere between 3% and 20%. In other words, they believe the wealth in their house grows at the rate that their house appreciates, http://nolensvillemarketsquare.com/wp-json/oembed/1.0/embed?url=http:/nolensvillemarketsquare.com/community-workshop-presents-plans/ and that is simply not the case.

Imagine that you own a house that is currently worth $300,000. If the house value increases by 4% your house will now be worth $312,000. You will have an additional $12,000 of wealth in the house. However, the increase in wealth came as a result of return on the house, not a return on wealth in the house. The wealth in the house had nothing to do with the increase of wealth.

If you own a house that is currently worth $300,000, and you have a $300,000 mortgage, what would happen if you chose to repay $12,000 of that mortgage? The mortgage balance would decrease to $288,000. This action would have no impact on the value of the house and it would not increase your wealth. However, it would increase your wealth in the house. You simply moved $12,000 from your checking or savings account to the mortgage company and increased your house equity by an equivalent amount.

Zero Percent InterestThe truth is that your wealth in the house earns a 0% return. Wealth in the house (house equity) is the difference between the value of your house at any given time and the balance of any outstanding liabilities attached to the house at that same time. For example, if your house is worth $350,000 and the current mortgage balance is $300,000, you have $50,000 of your wealth in the house, and that wealth is simply a measurement between two values, and, as such, has no return.

Wealth in the house can only change in two ways: 1) Market Appreciation or Depreciation, and 2) Wealth Transfers, such as a down payment and principal reduction. Your wealth in the house is constantly changing in accordance with the amount of principal you pay monthly against your outstanding mortgage balance and fluctuations in the value of the house.

There are two important facts to consider related to appreciation and depreciation of a house:

  • Appreciation and deprecation are influenced by the general market conditions at a state and national level, as well as local market conditions at a county, city, and neighborhood level. Of course, the overall condition and appearance of a house also affects its value.
  • The market is always “right.” In other words, a buyer has overriding influence on the value of a house in terms of what he or she is willing to pay for the house relevant to the market as a whole.

There is little a homeowner can do to affect the market appreciation or depreciation of their house, but the growth of wealth in the house via wealth transfers (principal reduction) is entirely under each homeowner’s control. The primary reason homeowners locate their wealth in the house is to reduce the interest they pay to the mortgage company over time. Many argue that any principal payment a homeowner with a mortgage sends to the mortgage company reduces the interest that they pay and, as a result, saves the homeowner interest equal to the interest rate of the mortgage (e.g., 5.000%). While that may be true, saving money is not the same as making money. In fact, the savings may not be equal to the interest rate of the mortgage because the ability to deduct interest payments on your tax return helps reduce the Effective Percentage Rate™ (EPR™) of the mortgage (e.g., 3.285%).

How to Determine Facebook and Twitter ROIYour return on principal payments you make to the mortgage company is equal to your current EPR™ (e.g., 3.285%), but to the degree that you could earn a return greater than your current EPR™ by investing those principal payments elsewhere, you actually lose money and the ability to earn compound interest, while at the same time subjecting your wealth to the Safety, Liquidity, Return, and Tax Treatments issues.

In the next post in this series we will ponder the question “Is Your Wealth in the House (Equity) Receiving Favorable Tax Treatment?

If you’re interested in learning more about the house as an investment and how owning a house can help you grow your wealth contact us to schedule a time to talk about your specific circumstances.

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