What Financial Goals Does Buying a Home Achieve?
1. Building Equity
One of the most important financial goals achieved through buying a home is building equity. Equity is the difference between the value of the home and the amount owed on the mortgage. As you make your mortgage payments, you reduce the loan balance, thereby increasing your home equity. This equity can be a valuable financial asset over time.
You gain this equity in two ways: 1) if you have an amortized Loan where the payment combines interest and principal, and 2) if the area appreciates and your home value increases. Important to note, if you have an interest only loan, you will not be making principal payments on the mortgage but just paying the “interest” only portion.
Let’s look at some recent trends to get a sense of the market’s movement. As of 2023, Alameda County’s housing market was undergoing normalization after a period of mild home price declines induced by rising mortgage rates. But the cumulative appreciation rate over the past ten years for Alameda County has been impressive. The data shows a 84.04% cumulative appreciation rate for this period, which translates to an annual average appreciation rate of 6.29%. This rate is above the national average and indicates a strong growth in home values.These trends suggest that homeowners in Alameda County, including those in Rockridge and similar areas, have likely seen a notable increase in their home equity over the past decade. The market has had its ups and downs, but overall, the long-term trend has been one of growth. (Source: https://help.aalto.com/hc/en-us/articles/22921549509773-Home-price-growth-in-Alameda-County-is-normalizing-January-2024 and https://www.neighborhoodscout.com/ca/alameda/real-estate)
2. Savings
Buying a home also acts as a form of forced savings. Each mortgage payment not only pays down the loan balance but also accumulates equity, which is akin to putting money into a savings account. Over time, this can amount to a substantial sum, especially in markets with appreciating property values. Again, as long as your loan features amortization.
2024 East Bay Possible Real Estate Trends
As of 2024, the real estate market trends in NoCal, specifically in the East Bay, indicate several factors that could positively affect your home purchase.
Home Prices
According to the California Association of Realtors (C.A.R.), the median California home price is forecasted to rise by 6.2% to $860,300 in 2024, following a slight dip in 2023. This indicates a recovery in the housing market and suggests that property values are expected to increase, potentially making a home purchase a good investment.
Inventory and Demand
In the Bay Area, starting in 2023, inventory levels began to decline due to factors like higher mortgage rates, making some homeowners reluctant to list their properties. This decrease in supply, coupled with steady demand, is putting upward pressure on home prices, which could be beneficial for homebuyers looking for value appreciation.
Marketing Stability
Despite some fluctuations, the Bay Area housing market is showing signs of stability. For example, while there has been a marginal decrease of 0.3% in the average home value over the past year, the market is not experiencing a significant downturn. With a modest 1-year market forecast of -0.8%, it suggests a controlled correction rather than a drastic drop in home prices. (Source: https://www.noradarealestate.com/)
Mortgage Rates
The housing market forecast for 2024 is optimistic due to falling mortgage rates, economic expansion, and strong demand for homes. This could make it a good time for buyers to enter the market, as lower mortgage rates can increase affordability. (Source: https://managecasa.com/articles/california-housing-market-report/)
Popular Confusions
Your Mortgage is Not Just an Expense
Many people view the monthly mortgage payment as just another expense, similar to rent. However, unlike rent, a portion of each amortized mortgage payment builds equity, making it a form of investment.
Appreciation is the Same as Equity
Nope. They’re not the same, but both appreciation and principal paydown through amortization create more value. Think of it this way: Home equity is the portion of your home that you truly “own.” When you buy a home, especially if you use a mortgage, you don’t fully own the home outright. Instead, you own a portion of it, and your lender owns the rest. Your equity is essentially the value of the home minus any outstanding mortgage balance. As you make mortgage payments, you pay down the loan amount, thereby increasing your home equity.
Home Appreciation refers to the increase in the value of your home over time due to factors like market conditions, neighborhood development, inflation, and home improvements. If your home appreciates in value, your equity increases even without making mortgage payments, because the total value of your asset (your home) has grown.
Combined these two processes work together to increase your total home equity. When you make mortgage payments, you’re directly increasing your equity by reducing what you owe. And if your home’s value appreciates, your equity grows because the difference between the home’s value and the mortgage balance becomes larger. This means that over time, as you make mortgage payments and as your property value (hopefully) appreciates, you build wealth in the form of home equity. You can later leverage this asset for loans, lines of credit, or profit from selling.
Put simply, if your home is a piggy bank every mortgage payment puts money in. But home appreciation is like the piggy bank magically growing larger. The combined effect is a more valuable piggy bank over time!
How to Make the Best Use of This Information
Take the Long-Term Perspective
When buying a home, consider it a long-term financial commitment that can help build personal wealth over time. In dynamic markets like ours, home values will fluctuate; you have to take a long view on your investment. A hot potato approach to buying and selling can quickly get you into trouble. We typically advise clients to hold onto a property for 7 to 10 years to realize the benefits of appreciation, the benefits of amortization and to allow the home owner to go through an economic cycle or two looking to see higher highs, and higher lows, as the market ebbs and flows according to economic conditions, geopolitical risks, and local and federal government involvement.
Note Additional Benefits
Remember that homeownership can also provide other financial benefits like potential tax deductions and a hedge against inflation.
Think about Budget Management
I cannot emphasize enough the importance of budgeting not just for the mortgage but also other homeownership costs like property taxes, insurance, maintenance, and potential homeowners association (HOA) fees. Home maintenance is critical, and postponing or delaying needed repairs can get you into trouble. Consider maintenance of a home part of your annual expenses.
Estimate Property Taxes
Mortgage rates are set on Wall Street, not locally. I advise clients to use 1.5% of the purchase price as a rough estimate of the property tax amount, due to all the voter-approved bonded indebtedness on the tax bills.
Liquidity Considerations
While building equity is beneficial, it’s also important to note that home equity is not a liquid asset. You might be able to access equity through a home equity line of credit or a second note and deed of trust. If not, then the only way to access the equity is through a sale of the property.
Wealth Building
Because of the long view of the investment, and the ability to fix your monthly payments, homeownership is a leading way for families to build wealth and security in the United States. A locked-in interest rate means you are paying the debt off with ever lower value future dollars due to inflation. This is a wonderful hedge for your finances and secures a roof over your family’s head at the same time!
Community Stability
Home ownership can contribute to community stability and civic engagement. Homeowners tend to be more active in community groups, local schools, and political activities.
Buying a home achieves the dual financial goals of building equity and creating forced savings, making it a multifaceted financial decision. Understanding these aspects can help you appreciate the broader financial impact of homeownership well beyond the acquisition of property.