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Building Generational Wealth Through Homeownership

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If you dream of being wealthy in the United States—or at least financially stable—homeownership is a goal worth pursuing. Part of the reason this is true is because we have built a system that offers many benefits to people who own their own homes.

This guide to building wealth through homeownership will explain four ways a family’s wealth can increase through homeownership over time, three keys to sustainable homeownership, three hidden benefits of homeownership, and how to know if you’re ready to buy a home.

4 Ways Homeownership Builds Generational Wealth

The United States’ tax code, inheritance laws, and banking system have all been adjusted over time—and the end result is a country that offers financial incentives and rewards to people who own property and homes. To see how, you need to understand the idea of equity, the history of real estate values, the tax savings available to homeowners, and the opportunity to develop multi-generational wealth by passing a home on to someone through inheritance.

1. Equity Equals Ownership

Equity is an ownership stake in something. It doesn’t necessarily mean you own something outright. For instance, if you pay 20% of a house’s value as a down payment when you buy a home, you immediately have a 20% ownership stake when you sign your closing documents. You own 20% of the equity in the home (if you put 3% down you would have 3% of the equity, and if you put nothing down you would have no equity). The people who offer you a mortgage have the rest of the equity. 

This is one of the key things to understand about buying a home. Your down payment, along with the specifics of your mortgage, will determine how much equity you have at the start and how quickly you accumulate more as you make your monthly payments. It’s important to think about how much of a down payment you can make on your first home. Many people believe 20% down is required to buy a home, and often that’s a much larger amount than people can afford. But you actually don’t need 20% down to buy a home. There are also many down payment assistance options available to help you buy your first home.

2. Increasing Value of Homes

When it comes to the amount of equity you have in a home, your monthly payments are not the only thing that affect it. If a home increases in value after you buy it, you have more equity—at least on paper. Keep in mind that you don’t have that increased value in your hands unless you sell the home for that higher price.

There have been periods of time, like the housing bubble between 2006 and 2011, when home prices decreased, but in general they have gone up. This is due to both inflation and the impact of supply and demand for homes. Population growth means more homes must be built to keep up with demand. Minnesota dramatically underbuilt the number of homes it needed to keep up with population growth following the housing bubble, so demand has pushed home prices up and will likely continue to do so for some time until the supply rises.

Inflation generally increases both prices and wages. If you buy a home with a fixed-rate mortgage it will require a certain percentage of your income each month. Over time, you will hopefully (and likely) make more money, in part because of inflation. This will help make your mortgage more affordable relative to your future income. 

This is not likely the case for rent. Rents generally rise with inflation and continue to consume the same percentage of your income (approximately) each year.

Year Average Home Sales Price in Minneapolis
2018 $233,000
2019 $259,000
2020 $269,950
2021 $294,250
2022 $309,618

3. Tax Savings for Homeowners

There are several ways homebuyers and homeowners save money on their taxes. One of the biggest ongoing benefits is the mortgage interest deduction. In fact, this is the largest subsidy in the country given by the government for any type of housing in terms of total dollars. People with mortgages can deduct the interest they pay each year from their taxable income (if they itemize their deductions). This can save you thousands of dollars over the life of a mortgage.

Another place homeowners may be able to save on their taxes is by deducting their property tax

Note: Deduction of state and local income, sales, and property taxes is limited to a combined total deduction of $10,000 a year. See the IRS website for more detail.

Buying or selling a home can also create unique tax-saving opportunities. If you pay mortgage points to lower your interest rate when you buy, you can deduct those costs. And when you sell, you can deduct the cost of home improvements you made for things like finishing a basement, adding an extra room, or replacing the roof.

Perhaps the very best tax advantage of homeownership—and the one that really makes wealth creation easier—is not having to pay capital gains taxes on the profits from a home sale. If you have lived in your home two out of the last five years, the first $250,000 of profit (or $500,000 if you and your spouse file taxes jointly) is exempt from taxes. This means that if you bought a home for $300,000, lived in it for 10 years, and sold it for $400,000 you would get $100,000 tax free (along with all the equity you amassed).

4. Passing a Home Through Inheritance

A home is the single biggest investment most people ever make. Passing a home on to the next generation is an amazing gift that builds generational wealth. 

The person receiving a home gets what’s called a “step-up in basis,” which can save them money on future taxes. This relates to tax on the proceeds from a home sale, as discussed above. When a person inherits the home, the “original value” is adjusted to the current market value. This means even if someone bought a house for $200,000 several decades ago, if the current market value is $300,000, that number will be the basis for figuring future capital gains. So if the home was eventually sold for $350,000, capital gains taxes would only be owed on $50,000, not $150,000. Keep in mind you avoid paying capital gains on the profits from a home sale if the home has been your primary residence for two of the past five years. 

A person who inherits a home that still has a mortgage also enjoys the benefit of being able to take over the mortgage without being subject to approval by the lender. This can be extremely beneficial if there is a fixed interest rate on the mortgage.

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3 Keys to Sustainable Homeownership

Homeownership isn’t a silver bullet that guarantees you will increase your family’s wealth. It really only works if you are in a sustainable situation where the home is affordable long term and your investment is protected. The key to this is getting a mortgage you can afford, protecting your investment with insurance, and maintaining your home so it holds its value.

1. What Makes A Mortgage Affordable

An affordable mortgage is a must when it comes to homeownership. If you are spending too much on your housing each month, you won't have enough money for other necessities. Historically, a good rule of thumb has been spending no more than 30% of your income on your housing

The monthly payment on your mortgage will be determined by how much money you have borrowed and what the interest rate is on the loan. Your payment may also include money for property taxes and insurance if you pay those through escrow (which is common).

A lender will look at your credit score, employment history, and other financial information to help you decide how much of a loan you can afford. They will consider your debt-to-income ratio, so it’s important to do things like pay off credit cards or avoid taking on a new car payment if you’re planning to pursue homeownership in the near future. Looking into financial coaching programs is one way to get started with this process.

Keep in mind that you must think of the affordability of a mortgage long term. Buying a home is a commitment and can be an expensive mistake if you are not able to make the payments in years to come. Think about your life situation and whether you will have stable income enabling you to live in the home years (and maybe decades) from now. Whether or not you get an adjustable rate mortgage can impact this. An adjustable rate mortgage can become more expensive if interest rates increase.

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2. Protect Your Investment

Insurance on a home is a requirement from lenders when you’re buying a home with a mortgage. Since they own most of the equity in the home, they want to be sure that asset is protected in case of things like a fire. 

Even if you own a home outright, insurance makes sense. You are taking a very big gamble with your biggest investment otherwise. Insurance will help you rebuild if your home is destroyed by a fire or get a new roof if you have storm damage. Insurance can also help cover the costs of legal fees if someone is injured in your home.

Another way to protect yourself financially is to make sure you get a comprehensive home inspection before you buy the home. It may look okay at first, but a trained professional can spot things that could become expensive problems in the future. They will look for things like water damage, mold, a bad roof, foundation cracks, or HVAC and electrical system issues. An inspection is critical to start your home-owning experience off right.

3. Maintain Your Investment 

A home has value to you because you can live in it. It only has value to others if you can sell it. Homes in bad shape can quickly lose their value. Part of buying a home is being ready to maintain it. 

You should expect to spend about 1% of a home’s value on maintenance each year. Some years it’ll be less, and some years you’ll have major expenses, like a new furnace. It’s important that you do maintenance work regularly. In Minnesota, this means getting a home ready for winter (which includes many things that can be done for free or low-cost). You also need to keep the yard and exterior in good shape and fix minor things before they become big problems (this is especially true for plumbing).

Pets can be a loving addition to a home, but they can also destroy one. Make sure you pet proof your home as much as you can so it doesn’t sustain any permanent damage.

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3 Hidden Benefits of Homeownership

Owning a home can be a pathway to greater financial strength for a family, but there are other tangible benefits to keep in mind. Stable housing makes families more resilient to hardships, can improve overall health, and opens the door to more opportunities in both education and employment.

 

1. Stability During Challenging Times

Consider the advantages owning a home had during the pandemic. A home generally allows a family to have more space than an apartment. This allows for things like working from home or taking in family or friends who may need a place to stay. 

Twin Cities Habitat for Humanity has been partnering with families to purchase homes affordably since 1985, and staff often hear stories of how a home has helped a family navigate a particularly challenging time. Here are a few of those stories if you’d like to read them yourself.

2. A Chance for Better Health

A lot of studies have found a link between homeownership and improved health outcomes for families. It impacts things like respiratory illness rates, mental health, and exposure to harmful chemicals. Another lesson from the pandemic is how valuable it was to be able to quarantine sick people at home in private spaces like extra bedrooms. 

“A safe, decent, affordable home is like a vaccine. It literally prevents disease. A safe home can prevent mental health and developmental problems; a decent home may prevent asthma or lead poisoning; and an affordable home can prevent stunted growth and unnecessary hospitalizations.” 

— Dr. Megan Sandel, Associate Professor, Pediatrics, at Boston University School of Medicine, testifying before Congress.

3. A Chance for Greater Success

Healthier kids do better in school, but that’s not the only educational benefit linked to homeownership. Studies on how homeownership impacts education are challenging because so many variables are involved. However, research has shown that the following are also true:

  • Children in homeownership situations achieve better education outcomes, including high school completion and college attendance, than children in rental households.

  • The benefits associated with homeownership are especially strong for low-income households.

  • An affordable mortgage means parents don’t have to work second or third jobs and can spend more time with their family.

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Buying Your First Home

Buying your first home is an exciting yet huge decision that you should not make lightly. If done correctly, it can be an opportunity to increase your family’s financial security and grow wealth. While homeownership is possible for everyone, not everyone’s timeline is the same. Here are some signs that you may be ready for homeownership.

1)  Your income is stable and your debt is manageable

Any lender should consider your debt to income ratio before they offer you a mortgage. You can calculate it by dividing your monthly debt by your monthly gross income. See what your debt-to-income ratio must be below in order to qualify to buy a home with Twin Cities Habitat for Humanity by visiting the TruePath Mortgage page.

2) You aren’t planning on moving anytime soon

There’s guidance that says you should plan to stay a minimum of 5 years in a home in order to make the process worth it at all. Each situation will be different, but the longer you know you won’t be moving the better your chances are for homeownership to benefit your family.

3) There are homes you’d be happy with in your price range

You can have the initial conversation with a lender to see how much you would be able to afford and then research online if there are homes in that price range in areas you’d like to live or connect with a local Realtor for assistance. This will give you a good sense of whether homeownership is viable for you now. 

4) You are ready for the responsibilities of homeownership

It’s not just the money (although you need to be prepared to pay for regular maintenance projects). There are things like doing your own yard work, shoveling, and handling anything that does go wrong with your home. It’s going to be more work than renting.

If you are considering taking the next step toward buying a home, check out Twin Cities Habitat’s guide to first-time homeownership.

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