Long term wealth
Owning a home is one of the best ways to build long-term wealth, providing both equity accumulation and tax benefits over time. Though there are some fluctuations in the housing market in the short term, an investment in a home is proven to be worthwhile in the long term, as the value of homes increase significantly over time.
The seven year appreciation rate (2002-2009) for New Jersey homeowners is 37.1 percent, more than five times the national rate of 7.1 percent. Homeownership is how many American families begin to accumulate wealth. According to the Federal Reserve Board, the average homeowner nationally has a net worth of $184,000, while the average renter’s net worth is $4,000.
Dollar for dollar, the rate of return on an individual’s cash downpayment on a house is substantial. Home buyers typically use their own money to cover only a small portion of the purchase price, but the home appreciation they realize is based on the total value of the property.
Housing is not a quick-in, quick-out investment. When purchased for the long term, housing is one of the safest investments consumers can make. In addition to the savings accumulated through a buildup of equity and tax advantages, a home provides shelter.
According to Harvard University’s Joint Center for Housing Studies, the rate of return on a housing investment dramatically increases the longer it is held. For instance, an owner whose home appreciates at a typical annual rate of 5 percent and who made a cash downpayment of 10 percent generally will receive a 94 percent return on that cash after owning the home only three years. After owning for five years, a homeowner can expect a rate of return on the downpayment to increase to 225 percent; after 10 years, the rate of return jumps to 623 percent.
The stock market has experienced wide swings in value over the past 20 years. During that time, overall home values have continued to rise steadily and contribute significantly to household wealth and spending patterns. Over 10 years, a $10,000 investment in the stock market at a normal 10 percent market rate of return would yield $23,600. The same investment as a down payment on a $200,000 home at a normal appreciation rate of 5 percent would return nearly 5 times the stock market return, at $110,300.
The majority of a homeowner’s wealth accumulates in equity, which is generated by making mortgage payments on the home. In the future, homeowners can use the home equity they have built up to get cash for emergencies as well as for the purchase of big-ticket items, and have more confidence in housing wealth gains than stock gains that could be unsustainable.
The favorable treatment the IRS gives homeowners should be a major factor in your decision. Learn more about tax deductions you can make on interest, deductions you can make on real estate taxes, and the capital gain exclusion for sellers.
Your purchase and deductions on interest
Homeowners who itemize their federal income tax deductions can reduce their taxable income by the annual amount of mortgage interest paid on a first and second home for up to $1 million. Most of your monthly payment will be interest in the first few years of your loan, so this can be a significant amount of money. Click here for more information directly from the IRS on mortgage interest deduction.
Also, in most cases, loan discount points and origination fees are tax deductible to the buyer, even if the seller pays for your closing costs. Check lines 801 and 802 of your settlement statement to see how this affects you.
Deductions on real estate taxes
Itemizing homeowners may also deduct state and local real estate taxes paid on an owner-occupied home. Note — Many counties also impose property taxes for local improvements to property, and these taxes cannot be deducted. Local property taxes are deductible only if they are for maintenance or repair.
Your sale and the capital gain exclusion
When selling your home, as long as you have occupied it as a principal residence for at least two of the past five years, you can also be excluded from capital gains taxation on the proceeds of the sale.
- There is a limit on this exclusion: $500,000 of gain for married homeowners and $250,000 for single homeowners.
- This exclusion is available even if you’ve used it before. In fact, you can do this as often as two years for the rest of your life.
Mortgage Insurance may be deductible
In general, if you itemize deductions, you may deduct premiums paid for mortgage insurance provided by the Department of Veterans Affairs (VA), the Federal Housing Administration (FHA), the Rural Housing Service (Rural Housing), or private mortgage insurers in connection with a mortgage for the purchase of your main home. The amount you may deduct is limited if your adjusted gross income is more than $100,000 ($50,000 if married filing separately). No deduction is allowed if your adjusted gross income is more than $109,000 ($54,500 if married filing separately).