"Owning a home builds wealth!" That’s advice you hear from friends, family, YouTube experts, and mortgage companies. This advice is often right. Many times, owning a home does help you build wealth and create a better future for you and your family.
But you want to think about buying a home as part of the bigger picture of your finances. Buying a home can be an important way to build wealth but it isn’t the only way to do it and depending on your situation and where you are in your life, it may or may not be the best choice for you right now.
So, think about these ideas when you want to build wealth. We believe they will help you make the right decisions for you!
1. Get out of debt
A good first step to building wealth is to pay down and pay off debts you might have from things like student loans, car loans, and credit cards. This can help you stop paying interest on these debts and leave more money in your monthly budget to invest in your future.
2. Make a budget
Seeing is believing and if you aren’t keeping track of what money comes in and what money goes out, you are running blind. Consider making a budget and tracking your housing and living expenses, clothing and transportation costs, loan payments, and the amount of money you have to spend in ways you enjoy. Spending money on things you want as well as things you need is fine but if you end up spending more money than you earn each month, it’s going to be hard for you to build wealth.
3. Start an emergency fund
Life can be full of unexpected expenses like a car repair, a copayment not covered by your medical insurance, or the cost of buying a new phone because you dropped your old one. Having an emergency fund in cash you can get to easily, like in a savings account, can keep you on track, give you peace of mind, and stop you from scrambling to find the money to pay an important bill.
4. Save for retirement
Saving for retirement is an important way to build wealth. When you are young, making even small contributions to a retirement fund can make a big difference over the long term. Saving for retirement is even more important as you get older and balancing investments in retirement and your home is generally a good idea.
5. Don’t forget about insurance
Having the right amount of health and disability insurance coverage is an important part of your personal finances. If you have a family or other people who depend on you, life insurance may make sense for you too. Think about these protections when you are making your plan.
6. Save for a down payment
It is possible to buy a house with a small down payment. If you qualify for an FHA loan, you may be able to buy a home with a down payment as low as 3.5%. If you qualify for a VA or USDA loan, you might not need a down payment at all.
Making a larger down payment has advantages however. You’ll start your life as a homeowner with home equity. For example, if you make a $50,000 down payment on a house, you start with $50,000 in equity which is the value of the "wealth" you own in the home.
A larger down payment can help you avoid paying for mortgage insurance. If you qualify for a conventional loan and make a down payment of 20% or more, you won’t have to pay for private mortgage insurance (PMI). According to Freddie Mac, PMI might cost you between $30 and $70 a month for each $100,000 you borrow.
Finally, making a large down payment lets you’ll borrow less money to buy a home, which means you will pay less money in interest over the life of the loan.
7. Buy a house you can afford
As more than one wise person has said, "When you buy a home you can’t afford, you don’t own the house. The house owns you." That’s why many financial advisors recommend you get a mortgage that is smaller than the maximum amount you might qualify for.
That’s because a smaller mortgage will leave room in your budget for other investments (like saving for retirement or saving for college if you have kids). It will leave you more money to pay for the expenses that come with owning a home, such as utilities, maintenance and upkeep, and emergency repairs.
One way to think about home affordability is to calculate your debt-to-income ratio (DTI). This is a simple formula that compares your gross monthly income to your monthly debt payments, including your mortgage payment when you have one. For example, if you have $1,000 in debt payments each month and your monthly income is $5,000, then your DTI is 20%. (That is, $1,000 ÷ $5,000 = 0.20 or 20%.)
Your DTI is useful to know because lenders often require maximum debt-to-income ratios no higher than between 36% and 42% to approve a mortgage. Calculating your DTI can help you understand how much home you might be able to afford and whether you might qualify for a mortgage to buy it.
8. Pay down your mortgage faster than you are required
Most lenders will give you the option to make additional payments on top of your required minimum monthly payment. Making even small additional payments when you can is often a good idea, because this will help you pay less interest over the life of the loan and build your home equity faster.
Keep in mind that in the early years of your mortgage, much more of your monthly payment goes to paying interest than paying down the principal. That means that extra payments will probably make modest contributions to your wealth in the beginning. To learn more about how monthly mortgage payments work, see our article on mortgage amortization.
9. Look for the value of your home to increase
One big way owning a home builds wealth is when the value of your home increases. For example, say you bought a house three years ago for $275,000 and the house is now worth $325,000. That $50,000 increase in value adds $50,000 to your home’s equity or the “wealth” you own in it.
It is hard to guess how the value of your home might rise in the future and where your house is located can have a big impact on how much the price might change too. The Federal Housing Finance Agency (FHFA) reports average U.S. home prices increased 17.5% in November 2021 over the previous year. This is higher than longer-term averages. Since 1991, the FHFA states that home prices have increased an average of 4.3% a year.
Your wealth can increase quickly when your home value goes up fast, as it has in many places in 2021. Keep in mind that your home’s value can go down as well as up.
10. Think about other investments
The ideas we’ve discussed here are recommended by many financial advisors. Get out of debt. Make and manage your monthly budget. Have an emergency fund. Get appropriate insurance coverage. Buy a house you can afford while saving for retirement. Pay down your mortgage faster than you are required. Once you’ve got those things set, then consider other ways that might increase your wealth.
Freedom Mortgage Corporation is not a financial advisor. The ideas outlined above are for informational purposes only and are not investment or financial advice. Consult a financial advisor before making important financial decisions.
Reviewed by Freedom Mortgage Corporation, February 2022