Historically real estate has been one of the few tried, tested, and proven methods for a person to accumulate both short term and long term wealth depending on their tactics. The average appreciation or growth of house values conservatively have been around 3.5-3.8% on an annual basis. These numbers don’t take into account location or economic condition. In 2020 alone the average appreciation nationwide in the U.S was roughly 8.5%. Now you might be thinking “well I could get that by investing in the S&P”, while this may be true I will go further into detail how the appreciation of your investment isn’t based on the money you put in but on the house’s value as a whole.
If you are anything like my younger self you might think “I’ll just rent forever there’s no point in spending all my hard earned money”, you wouldn’t be wrong . Typically real estate does in fact have a large barrier to entry with the typical down payment on residential properties being 3.5-25% of the homes selling price, as well as other barriers.
The first barrier I will mention is credit. A good quote I once read says “if you take good care of your credit your credit will take good care of you”. Credit is one of the primary barriers to real estate. If you have bad credit the lenders will typically not give you a loan, if you have ok credit you might get a loan but maybe a bad interest rate.
DTI or debt to income ratio is one of the most important things lenders look at even more so than credit. Debt to income ratio is simply your monthly debt payments (credit card debt, vehicle debt, house payment if you already have one and are looking to get another etc..) divided by your monthly income. For example let’s say you have no debt except for a car payment of 250 dollars, and the new houses mortgage payment, insurance, and taxes are 890.your hypothetical monthly income is 3500, in this case we would take 1,140/3,500=.32 then we just move the decimal over to the right two places and get 32% so in this case your DTI ratio would be 32%. Generally a DTI of 43% is the maximum you could have and be approved for a mortgage but ideally they want you to be under 36%.
Down payment is a big one. As I mentioned before the average down payment is 3.5-25% depending on the loan type. If one is to get a loan under 20% they will be required to pay an additional fee for PMI or private mortgage insurance. PMI is coverage for the lender in the case you default on the loan. You can avoid this payment by putting down at least 20% of the house’s sale price.
The last barrier to entry I will mention is job history, typically lenders like to see you in a nice solid career and at the same job for 6 months while also requiring 2 years total of work history.
In some cases renting makes more sense than owning when factoring in the state you’re in, the amount of money you have saved, or long term plans like whether you want to move out of state or not. There are great resources for helping you to decide this just google “rent or buy calculator”. If you have the money saved, decent credit and a low DTI and it lines up with your future plans, owning a house is great not only as a place to live but as an investment too!
I look at owning a home like having a forced savings account. Your mortgage payment is not given to the landlord but instead added to your principal amount or “money you have paid off from the mortgage”. This can be great for accumulating long term wealth. In the beginning of this article I mentioned that you could make a larger percent investing in stocks but in this case the appreciation of the house is not based on what you invested but rather what the home is worth. If your home is worth $200,000 and prices go up 5% your home would be worth $210,000. Now unless you have $200,000 in cash to invest you wouldn’t make the same with stocks. If you have $10,000 in a REIT and that goes up 5% you would only have $500 profit. But stocks are by far way more liquid or easier to sell.
There are tons of ways to make money with real estate and I’ll touch on a few. Principal pay down is one I mentioned earlier and this is utilized when you sell the property, or when you do a cash out refinance. When you sell a home they take the loan amount minus the principal/appreciation then they take closing costs and realtor fees and the remains are your profits .Renting your home is a great way to make money since you can gain wealth in 3 ways house value appreciation , your renters paying down the mortgage principal, and whatever the difference there is between the mortgage payment and what you are charging for rent . The last one I will talk about is “fix and flipping homes’’. This is done by buying an undervalued home and fixing it up to turn around and resell it for a profit.
If you are able to save up for a down payment and meet all the other requirements you might find yourself in the position of buying your first home just remember to not get yourself into anything you can’t afford and to do your best to live below your means. There are a lot of people that buy really expensive houses and find themselves unable to save money or invest in stocks because their mortgage payment takes up a majority of their income. Lifestyle inflation is a real thing. Many people fall into this trap in an attempt of “keeping up with the Joneses”. Real estate can be a great investment or a stressful burden depending on your situation.
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