Buying a home is often the largest financial commitment a person will make, but it’s also one of the most significant pathways to building wealth. Homeownership offers the unique opportunity to increase net worth through property appreciation and equity growth over time. Here, we’ll explore how owning a home can contribute to your financial future, break down key steps in the process, and examine what you should consider before making this major investment.
Understanding Home Equity and Wealth Building
Home equity is the difference between the market value of your home and the balance on your mortgage. As you pay down your loan and your home’s value appreciates, your equity—and by extension, your net worth—increases. According to recent data from CoreLogic, U.S. homeowners with mortgages held an impressive $17.6 trillion in net homeowner equity in the second quarter of 2024 alone, marking a $1.3 trillion increase from the previous year.
“It’s a way to increase your net worth over time,” says Steven LaRosa, a senior portfolio manager at Edgemoor Investment Advisors. By building equity, homeowners can accumulate wealth without additional, active investments, unlike renters who lack this potential for asset growth.
How New Homeowners Begin to Build Equity
Building equity doesn’t happen overnight, especially at the beginning of a mortgage. When you first purchase a home, your mortgage loan typically covers the majority of the cost, meaning your initial equity is primarily the down payment. For example, if you buy a $250,000 home and put down $17,500, that amount represents your initial equity.
Over time, your monthly mortgage payments will gradually increase your equity as a portion of each payment reduces the principal balance. Let’s break it down with an example: for a $400,000 mortgage with a 5% interest rate, an initial monthly payment of $2,147 would apply $480 to the principal, with the remainder going toward interest. Over time, the portion going to the principal grows, building more equity.
Factors Affecting Equity Growth:
- Down Payment: A larger down payment gives immediate equity.
- Loan Term and Interest Rate: Shorter terms and lower rates reduce principal faster.
- Property Value Appreciation: As the market value of the home increases, so does your equity.
- Credit Score: Higher scores can secure better loan terms, affecting the overall cost of the mortgage.
The Wealth-Building Advantage of Homeownership Over Renting
Homeownership acts as a “forced savings mechanism.” Every mortgage payment helps grow your net worth by building equity, unlike rent, which is purely an expense. This savings mechanism has a compounding effect on wealth: according to the Urban Institute, the wealth gap between homeowners and renters has grown by 70% over the last 33 years, with the median wealth of homeowners now $390,000 higher than renters.
“Over time, as you pay down the mortgage every month and the value of your home increases, your net worth will ultimately climb,” LaRosa explains. However, it’s essential to note that the early years of homeownership may have minimal impact on net worth as payments primarily cover interest.
What to Expect in the Initial Years of Homeownership
In the first years of owning a home, the financial benefits may seem limited due to initial costs and limited equity growth. For instance, putting down $50,000 on a $250,000 home doesn’t mean your net worth immediately reflects the full home value. Instead, your net worth reflects the down payment and any appreciation gained as your equity builds gradually.
Costs to Consider in the Short Term:
- Closing Costs: Fees such as title insurance and appraisals reduce initial net worth.
- Mortgage Payments: The first few years primarily cover interest, with only a small portion going toward the principal.
- Liquidity: Unlike cash, home equity is not readily accessible, meaning your net worth includes an illiquid asset.
“It takes time to actually build equity in the home through mortgage payments,” adds Jeffrey Hanson, partner at Traphagen Financial Group. Prospective homeowners should be prepared for limited immediate gains but can anticipate significant equity growth over the long term.
Key Takeaways for Prospective Homebuyers
Buying a home is a long-term investment in building personal wealth. Here are key takeaways to consider as you enter the housing market:
- Down Payment: A larger down payment can increase immediate equity.
- Consider Loan Terms: Shorter loans and lower rates allow faster equity growth.
- Market Research: Buy in areas with strong appreciation potential.
- Be Patient: Early gains may be minimal, but equity builds substantially over time.
Conclusion: Building a Solid Foundation for Financial Success
While buying a home involves upfront costs and time to build equity, it remains one of the most reliable ways to increase net worth. Unlike renting, where payments are purely expenses, homeownership provides a means to grow wealth passively through property appreciation and principal payments. With patience and a strategic approach, homeowners can look forward to a significant asset that supports their financial future.