S1EP42 – Homeownership and The Power of Leverage

Why is homeownership important in building wealth? Why do renters die broke? What are the pros and cons of homeownership? How important is the power of leverage when it comes to buying a house? In today’s episode we discuss the idea of renters die broke and why homeowners have a 44x greater net worth than those of renters.

Connect with me 👇 Jeb Smith (huntington beach Realtor/orange county real estate) DRE 01407449 Coldwell Banker Realty ➡I N S T A G R A M ➳ https://www.instagram.com/jebsmith ➡Y O U T U B E ➳https://www.youtube.com/c/JebSmith

Connect with me 👇 Josh Lewis (Huntington Beach Certified Mortgage Expert) DRE 01209148 Buywise Mortgage M:714-916-5727 E: josh@buywisemortgage.com ➡I N S T A G R A M ➳ https://www.instagram.com/borrowsmartjosh ➡Y O U T U B E ➳https://www.youtube.com/c/buywiseborrowsmart

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📩 – info@theeducatedhomebuyer.com

📝 – Home Buyer Questionnaire – https://www.theeducatedhomebuyer.com/wp-content/uploads/2022/12/BuyerQuestionnaire.pdf

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For Show Notes, See Below 👇

Jeb Smith, Huntington Beach Realtor: [00:00:00] Hey Josh, you once said something that was pretty mean and pretty nasty, and it was something along the lines of renters die broke. So I thought today we could spend a little time and actually talk about home ownership, the power of leverage, if you will. And what exactly you mean when you say renters die broke?

Josh Lewis, California Mortgage Broker: Now, I’ve never been Jeb, a big Twitter guy, but once upon a time, my Twitter handle was renter’s die broke. And it will absolutely elicit a response from people. And when I say that, when I say Renter’s die broke, it’s a factual statement. It is the genesis of that, and we’re gonna talk about this, homeowners have more than 40 times greater net worth than renters.

The average renter median net worth is $6,300. For 2022, the average funeral expense is more than $7,000. So when we say that, it is just literally a statement in that renters are not building enough wealth to pay for their own final expenses. This is not to say renters are bad or that no one should ever rent.

There’s a time and a place, we’ve talked about this, Jeb, there’s a time and a place to buy and there’s a time and a place to not be a homeowner. But what we’re gonna do today is go through the three to four biggest factors that lead to homeowners having 40 times greater net worth and why that leads 65 percent of American families to choose to be homeowners at any given time. 

We’re currently in the mid 66% range. We’ve peaked almost as high as 70. The lowest we’ve really seen after the 2008 crash was about 62%. So at any given time, two out of three American families choose to be homeowners and they end up having 40 times greater net worth than renters.

And it’s a fairly simple mathematical equation that we’re gonna go through today that explains why that is. Now, that doesn’t mean that if you’re renting, you’re a bad person, you are less than, or that you have to go out and buy a home today. It’s the reason why over a lifetime you’re going to want to become a homeowner and we’re gonna break that down.

Jeb Smith, Huntington Beach Realtor: And so those three things that we’re really gonna touch on are tax benefits. We’re gonna touch on the idea of forced savings. But the important one here is the leveraged growth in being able to buy a home. Josh, when we talk about the idea of leveraged growth in home ownership, what are we talking about and what does it mean?

For somebody out there buying a home, that probably doesn’t understand, I think they probably get the premise of it once you tell ’em what it is. But when you say leverage growth, it’s the idea of being able to come in essentially with a smaller amount of money and be able to, to multiply uh, that sum of money and, and in buying a house, for example.

And one reason you can get to that 44 times greater net worth that we talked about. So let’s give an example here of leveraged growth, what it means and help people understand.

Josh Lewis, California Mortgage Broker: When you buy a home, you are controlling 100% of that asset, but you are not putting up anywhere near 100% of the money. So let’s use a super simple example. Buy a $500,000 house and you put 5% down, that’s $25,000. So you control all $500,000 of that asset for $25,000 plus closing costs but for the simplicity of this, let’s say 5%, so that’s a 20 to 1 leverage. 

And what that means is if your $500,000 house goes up 10%, it went up $50,000, but you didn’t make 10% on your money. If you remember, you put $25,000 down the house just went up $50,000. You just made 200% on your money. That is leverage. That’s the power of leverage, and that is the biggest thing that impacts homeowners building wealth over the long haul.

Jeb Smith, Huntington Beach Realtor: It’s Important to understand that too, is that, you’re able to, in theory, go in with a much smaller amount and buy this property and come away with potential gains. But let’s come from a different perspective, Josh. Home ownership or home appreciation over the last couple of years have gone up 40%. 

We’ve seen homes go crazy over the last couple of years and there’s a lot of news out there at the moment, you know, about essentially the peak this year for most markets out there was some time around May. And since then we’ve seen home prices come off that peak and one of the latest stats that just came out from Black Knight this week that said 8% of people that purchased in 2022 are now underwater on their property.

So maybe they bought that $500,000 property, like you mentioned, they put that 5% down and now there’s a chance that maybe they’re at what, their loan amount was on that property. So when people hear this, they’re coming at you and I and saying yeah, your example is great, but it’s not always a great time to buy. So what do you say when somebody has those thoughts? Because you and I know the importance of home ownership long term. We also know it’s not always a great time to buy a house. So just dive into that just a minute.

Josh Lewis, California Mortgage Broker: The last thing you said is the most important there. [00:05:00] If you’re talking to a person who either sells real estate or sells mortgages for a living and they ever say any version of, “It’s always a great time to buy!”… just run away. That is self-serving. So what you and I have said here, Jeb, is over a lifetime, everyone should aspire to become a homeowner because it’s going to lead to greater wealth.

Does that mean that it is always a great time to buy, or that there are not better times to buy than others? That’s absolutely not the case. So probably the best example I have is a set of clients of mine. They are the parents of one of my wife’s best friends. And in 2006 they came to and said, we want to buy a house. There were some red flags, homes were at an all-time high, affordability was at an all-time low and we said, “Hey, this may not be an optimal time to buy”. 

They said, “We do not care, we’ve rented where we rent. We’ve rented this house for 20 years. When we started renting there, it was worth about $150,000. Today it’s worth about $350-400,000. We’ve paid $250,000 in rent over that time, and we are not going to rent anymore.”

So these folks had the perfect view, they said, “I don’t care what happens with home prices going forward. We are going to buy this home. We’re going to pay it off in the next 30 years. And when we come to retirement age, we’re gonna own this home free and clear”. And that is essentially what happened. That home dipped, they paid close to $600,000. At the bottom, it probably wasn’t worth $400,000.

And now today through principal reduction, they’ve paid that thing down through the years, they owe about $250,000 on the property and it’s worth a little over a million. So they bought at the absolute peak of the market, absolute wrong time. They’ve still been able to refinance three times through that process, decreasing their payment every time.

They’ve paid far less to own that property than it would’ve cost to rent it, and they’re sitting on, you know, three quarters of a million conservatively, in terms of equity and they’re probably gonna sell that house, move to Tennessee, pay $400,000 cash for a home and have another $350,000 of retirement cash available for them.

So that is probably the best example of, was that the best time to buy? No, it’s a terrible time to buy. But because they took the long view and said, “We can afford this payment. We want to be homeowners and we’re gonna live here for the long haul,”… hardly anyone has to worry. So Jeb, going back to that leverage example nationwide, over the long term home price appreciation has averaged 3.2%. 

So there’s times when it’s gone down, there’s times when it’s gone up 10, 12, 15%. Over the long haul nationwide, 3.2%. So using our example, if we had 3.2% appreciation over a 10 year period, it’s a 35 to 40% increase. So that $500,000 home goes to somewhere around $700,000 and we controlled that for a down payment of $25,000. So you’re gonna have equity of a couple hundred thousand dollars for a $25,000 investment. Over the long haul, that is the impact that leverage has on your wealth.

Jeb Smith, Huntington Beach Realtor: And another example my, my wife and I got married in 2011. Had a child in 20 12. And towards the end of 2012 she started wanting to look at properties. We were renting an apartment at that time. And, you know she came home one day, said, “Hey, look I saw this property I want to go see.”

And in my head, I wasn’t thinking about buying a property at all, right? I had been through the housing crash. I had owned property. I had to short sell property. I owned some investment property that I just you know, that I ended up selling just because it was a crazy market. I was in the trenches with everyone else at that time and honestly a little timid about the market in general, just because, like I got beat up pretty badly along with a lot of other people. Even though I made some money, I lost just as much during that period of time. So I wasn’t really thinking about the idea of buying house. But we were in a two bedroom apartment downtown Huntington Beach, no real yard in fact, no yard at all.

We just had a child. And so she wanted to go see this property and I was shy of seeing it just because again what I had been through. Long story short, we ended up buying this property. We ended up closing in December of that year. Little did I know the market would start to pick up in 2013. 

I was in the real estate business. I don’t think anybody knew that 2012 was essentially going to end up being the bottom, not the bottom of the market, but right before the tides would turn. In 2013, the market started to take off and now we’ve been in that property 10 years and that property has more than doubled. 120 -130% or so from where we bought that property. Which is a substantial gain.

Now, the reason I bring up this story is because, if we were to rent today, so my mortgage payment on that property was, is still based off the payment from when we purchased years ago because I’ve been able to refinance and actually even bring it down some. I couldn’t rent anywhere close to the price that I’m paying on that house.

And now I didn’t buy it because I thought the market was going to go up. I didn’t buy it because I thought that was the bottom in the market and this was the best time to get in. I bought because [00:10:00] my wife forced me to. No, because we were having children, we wanted a yard, we wanted to be in a different location because of family and all of these things.

So it was just kind of life events. It was the right time in our life. And for us, here we are 10 years later in a really good financial position with that house because we just made the decision based off where we were in our life. The payment made sense. Just everything that goes around that.

You know, I say this all the time, but there’s a lot of people out there at the moment too worried about tomorrow versus what’s today look like. Is it the right time for me now? And when I say worried about tomorrow, worried about what the value is tomorrow. If you don’t need to sell the property, you’re not going anywhere for like us 10 years. It doesn’t matter the value of that property. 

Now, that’s not me telling you need to go buy a house today. It’s just me trying to give you a different train of thought on owning that property. Now, with that being said, not only did we get the appreciation, but we got one of the second things that we want to talk about here, Josh, and that’s the idea of forced savings.

So every single month I’m making that mortgage payment, right? Property taxes, homeowner’s insurance, all that’s included in my mortgage payment and that’s less than I could rent anywhere at the moment. Here’s the crazy thing is, a portion of that is actually paying down the principle balance on my loan.

So every single month I make that, I’m paying down that principle balance and that’s gonna lead to that second thing that we started talking about here today, Josh, and that’s the forced savings.

Josh Lewis, California Mortgage Broker: Well, let’s use an example that, it’s not your debt on example of buying that property, but it approximates it and it matches up and pairs well with our original example there, that home was roughly $500,000 when you bought it. If you put 10% down, that’s a $450,000 loan. In 10 years, on a 30 year mortgage of making monthly payments, it would’ve gone down to $360,000.

So you went from 50,000 to $140,000 of equity just with principal reduction. And it’s important that people say, “you had to make the payment. You were putting that money into it.” When you look at your payment on a 30 year fixed mortgage, there’s a principal portion and an interest portion. The principal is basically a forced savings account that you’re putting that over there on your own.

Unless you are fortunate enough to have a family member that lets you live with them or live in a property they own rent free, you are going to have to pay to put a roof over your head. So that payment, the mortgage payment, is not going to go away if you don’t buy. So by making a payment that you would’ve had to make regardless in the form of rent, by making that to yourself and in your benefit, in that example, you would’ve built up an additional $90,000 of equity.

Now, it just so happens that timeframe of the last 10 years was, like you said, Jeb, you look like a genius in retrospect because the market had kind of bounced around the bottom between 2010, 2011, 2012, 12 was still pretty close to the bottom, and now we’re sitting here at a peak. 

So that home has doubled in the last 10 years. I would never count on that. Would never caution someone or advise someone to count on that. In our example, if we said long-term appreciation at 3.2%, that means that home should be worth $700-750,000. But even in that example, if it’s at $700k and now you owe $360k, your $50,000 down payment is now $340,000 of home equity.

That is a very difficult number to match anywhere else. And the only thing you were doing in terms of the debt service of that mortgage is paying a mortgage payment that would’ve been canceled out by a very similar rent payment over that timeline. And Jeb, that’s probably something that we should talk about. 

Jeb Smith, Huntington Beach Realtor: Let’s kind of talk about that for a moment. Say I didn’t buy and I just rented for essentially what that mortgage payment is, right? So I’ll be completely transparent with everything in taxes, insurance. I have an HOA in my community, I’m less than $3,500. But let’s just say it’s $3,500.

Over the course of 10 years, we’re talking about nearly $425,000 that I would’ve paid. That’s crazy. You don’t think about it because you’re just paying it every single month and it’s something that you have to do but when you take a step back and go, okay, 10 years, I’ve just paid nearly half a million dollars in rent that I got absolutely nothing out of.

That’s a kick. Yeah, we won’t say the rest of that statement, but it’s a feeling that you need to question a little bit and figure out how you can come out, get a solution if you will.

Josh Lewis, California Mortgage Broker: Well, Jeb, let me ask you a question here, cuz this is an important piece. I think this is almost equally important to all of the other elements of why home ownership is important over the long haul. $3,500. What would it cost to rent your home today?

Jeb Smith, Huntington Beach Realtor: Probably over $5,000.

Josh Lewis, California Mortgage Broker: Over $5,000. So it’s a $1,500 discount. So that’s a concept we wanna talk about. There is no such thing as 30 year fixed rent. 10 years ago, you might have been able to rent that property for $3,500… 35, 37, 38, somewhere in that range. And now it’s up over $5,000. 

I’ve owned my home… Next year it’ll be 20 years we’ve been in our home and I remember looking around going, [00:15:00] “Wow. This house, if we wanted to rent it, would be like $2700-$2800 a month to rent it, and now just like Jeb over $5,000 a month to rent it, which is way more than what my payment is. 

That is a critical thing to look at if you’re in Southern California, if you’re in California in general, you buy a home without a large down payment. So if you’re a first time buyer doing 3%, 5%, 10% down, the mortgage payment is likely to be higher than what it would cost to rent an equivalent property. The difference being you’re most likely to take out a 30 year fixed rate, that if you never get a refinance opportunity to go to a lower rate and payment, it is at least fixed for the next 30 years.

Yes, your taxes can go up a little bit. Yes, homeowner’s insurance can go up a little bit. Jeb has a homeowner’s association, so there’s some variable portions of that. But, in my instance, the rent in my neighborhood in the 20 years that I’ve been there has doubled. So if I had chosen to rent, I would’ve been good for two or three years and saved some money.

Saved, not really, because remember, my mortgage payment, a portion of that goes to principal. I’m just putting money over here in my equity account. But it’s very important to not be shortsighted and just look and say it is cheaper to rent. It is more affordable monthly in high cost areas today to rent but usually about five years of inflation down the line, will wipe that out.

And after 10 or 15 years, the rent is considerably more expensive than what a mortgage payment would be, even for a first time buyer with a minimal down. 

Jeb Smith, Huntington Beach Realtor: We had somebody last on the live show, lives here locally, what’d she say 9% her rent’s going up in February. Year over year. So if you just did some really, really simple math. you’re saying her rent is $2,000 a month, her rent’s gonna go up, basically what, 190 bucks? Something like that. 

 That’s considerable for a lot of people out there, especially when she also gave us the information that her wages only went up by 5%. Wages went up by five, her rent went up by nine, she’s getting caught in a really bad situation here.

Now, clearly some of that has to do with inflation and some other things going on, but that’s the reality. But let’s talk about the last thing, Josh and something that’s gonna be a little bit different for each person out there, depending on how much mortgage they have, how much income they make, how many properties they own, all of this stuff, but that’s the tax benefits.

Josh Lewis, California Mortgage Broker: we’ve always talked about the four pillars of building wealth through home ownerships. We talked about leveraged growth, we talked about principal reduction, we talked about a 30 year fixed payment. There is no 30 year fixed rent. You fix your house payment, you take advantage of leverage, and you’re making principal payment as a portion of your payment every month.

The fourth pillar was always tax benefits. Now, post 2018 whether you love him or hate him, Trump pushed through some tax changes and there were some important changes there. It increased your standard deduction. If you’re married, you have a $24,000 standard deduction. So let’s say you buy a $400,000 house at 6% interest, or you finance $400,000 to buy a house at 6% interest, that’s $24,000.

You can itemize above that and now you’re getting some tax benefits. But one of the big things that you would itemize is your property taxes. If you’re in an area like California that has high state income taxes, we can deduct state and local taxes, but there’s a limit to those of $10,000 a year. So for us in California, nearly anyone that’s bought their house in the last two, three years, you’re paying so much in state income taxes that your property taxes are not going to be deductible. So back in the day, what we’d say is figure out how much you’re paying in interest. Figure out how much your property taxes are, add those up, and you’re gonna be able to itemize and deduct those, and then compare that to the standard deduction.

So without going down the rabbit hole of all the different calculations, even at $500,000, if you are in a high state tax area, it is unlikely that you’re gonna see much of a benefit as a married couple. Now, if you’re single, it changes that because the standard deduction is much lower.

But you want to talk to a mortgage person that knows the numbers, can help you walk through this and see if there’s going to be any benefit if you’re in a higher cost area, especially with rates a little bit higher now you may see some tax benefit, but many first time home buyers that are buying homes and borrowing less than $500,000 see little to no tax benefit for a married couple. 

So it’s important that someone knows how to analyze those numbers and present them to you. It’s certainly not gonna be a negative, but it’s not the big benefit that it was in the past.

Jeb Smith, Huntington Beach Realtor: And, something also important to note, Josh is not a licensed tax advisor. He’s not a CPA. Make sure you’re talking to somebody that is in order to make sure the calculations are correct. We’re not giving tax advice here. Just wanna be clear there. just kind of rolled that out. I guess I’ve watched way too many shows where they have to do that, so I figured we would lay it out there as 

Josh Lewis, California Mortgage Broker: Even if you’re sitting across the table from me, and we’re going through those numbers, I’m gonna say, “From what I’m seeing from your tax return and the proposed mortgage, this is what your tax benefit looks like. These are the questions you wanna run by your tax preparer to [00:20:00] confirm that there’s not something about your circumstances or situation that I’m not seeing but this is our understanding.”

Jeb Smith, Huntington Beach Realtor: Absolutely. So you’ve got all of the pros, if you will. Josh kind of went over ’em uh, again, but just for another quick recap. You’ve got appreciation. You’ve home equity that you’re building that forced savings that you’re paying things down. You got the tax deductions, you got potential other deductible expenses that comes when buying a home that you’re able to write off your initial, purchase when making that property.

But Josh, there’s also some. Potential downsides, some cons, if you will, of buying a house as well.

Josh Lewis, California Mortgage Broker: One of the big things is that upfront cost. Again, using that example of a $500,000. If you got in with 3% down and have the seller pay all costs for you so that all you had to come up with was your down payment, we’re still talking $15,000. That’s a chunk. It can be hard for people to come up with that.

If you’re looking at a five or a 10% down or a higher purchase price, it can be even more. If you’re unable to get a seller or a lender contribution to cover closing costs, even more money. So it can be a big chunk. I don’t know about you, Jeb, but the people that I talk to, that’s probably the biggest hurdle.

Affordability in terms of making enough money to qualify for the price of homes in their area has become a bigger concern over the last two years. But the big one is it can be hard to come up with the down payment. We wanna look at that and some people, Jeb will say to us I could take that money and invest it and get a return.

Yes, you can. And people will say, Hey, stocks have averaged seven something percent appreciation, which is way better than the 3% appreciation you’re talking about in the house. But again, 3% leveraged at 10 or 20 to 1 is gonna be a much bigger return. Let’s say if you put 10% down, you have 10 times leverage. That 3% return is a 30% return, or four times what the stock market is going you. 

Jeb Smith, Huntington Beach Realtor: When you buy a primary home, you also get the ability when you sell that property of, some tax benefits, if you will with regards to capital gains whether you’re single and or married. Whereas when you sell a stock, You’re paying ordinary income, right? You’re paying taxes on that gain which you don’t have the ability to avoid otherwise. 

So obviously that’s, one of the pros, but another downside if you will, Josh, is the idea of depreciation on a property, if you will, like values we’ve said it don’t always go up. There are some people that purchased this year that may be a bit underwater if they needed to sell that property that could present a problem for them.

So depending on where you are in your life, that’s one thing that we often talk about here on the show is buying for the long term. Making sure you have that longer term time horizon so that you don’t have to deal with what happens in the short term because there are costs involved when selling a property, and that’s something that could potentially put you upside down.

So that could be a downside. And the other thing, Josh, is the idea of illiquidity, right? So you’re have a forced savings account. You’re paying down this balance, but your money’s tied up in the property. Yeah. There are programs. to be able to access it, cash out refis, home equity lines of credit, that sort of thing.

But there is if you’re looking at it, I guess four cons, if you’re somebody out there that’s looking for pessimistic view pessimism, if you will, these are some things that could be downsides, but the reality is home ownership is important. And I think we’ve pretty much, you given that to you on a silver platter. But with that said, Josh, anything you wanna add before we we head out?

Josh Lewis, California Mortgage Broker: Two pieces to consider there that can be considered a con. People that are pro renting and want to advocate that home ownership isn’t all it’s cracked up to be will point out that you have maintenance expenses if you rent. If Jeb rented the property he lives in, if I rented the property I live in, if the water heater goes out, I don’t have to write a check. I have to call the landlord. 

Most of the things that I see online that tick off rules of thumb of what annual maintenance and upkeep would cost are grossly overstated. But is there a cost and expense to it? Absolutely. The other piece of it would be, it’s a long-term commitment. If you buy a home today and something in your life changes in six months and you need to sell that home, absent massive appreciation like we saw during COVID, you’re going to be losing money. If you put 5% down and you sell in six months, you’re probably gonna have six or 7% of expenses to sell the property. So it needs to be a longer term commitment. You don’t have the flexibility that a renter has.

So you’re gonna be tied to that property for a while. Which leads us to two things that we always talk about and advise with our clients. Jeb is don’t spend every dime you have for your down payment and closing costs. You want to have a cushion because things can and will come up that you’ll need to spend on your home.

And do not buy a home if you cannot commit to living in at least five years. Seven to 10 would be a better timeline. And I’m not saying you have to, I’m saying you need to look at it as, worst case scenario, if I had to live here for seven years, am I cool with that? And if you can’t pretty strongly say that’s a probability that you would be comfortable with that, then maybe renting is the right thing for you in terms of your life stage.

Jeb Smith, Huntington Beach Realtor: And, And barring any life events, right? You don’t know what’s gonna happen in life but in looking at where you are in your life at the moment, looking out seven, ten years, making sure that you could see yourself in that area, in [00:25:00] that property would be ideal. And if you’re listening to this you’re just getting started in the pre-approval process.

Maybe you’ve been pre-approved looking for a real estate agent. Regardless whether you need a lender and or a real estate agent, there’s a link in the body of this podcast that’ll get you in touch with a professional that we know and trust that can guide you through that process. An expert like Josh, if you will, an expert like myself on the real estate side that can have these conversations, answer your questions and educate, empower, and really guide you through that process. So make sure you check out that. But we appreciate you listening to the Educated Home Buyer. 

Until next time, adios.

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