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For most people, buying a home will be the biggest financial transaction they will make.
It’s also generally considered a path to build wealth and increase your net worth, financial experts say.
In the second quarter of 2024, U.S. homeowners with mortgages had a net homeowner equity of over $17.6 trillion, according to CoreLogic. Home equity increased in the second quarter of this year by $1.3 trillion, an 8.0% growth from a year prior.
In the simplest terms, your home’s equity is the difference between how much your home is worth and how much you owe on your mortgage.
It’s a way to increase your net worth over time.
Steven LaRosa
director and senior portfolio manager at Edgemoor Investment Advisors based in Bethesda, Maryland
How new homeowners create equity
Homeowners, however, did not acquire that equity overnight.
“At the beginning of homeownership, the loan is usually quite large, and you have no equity in the house at that point,” said Steven LaRosa, director and senior portfolio manager at Edgemoor Investment Advisors based in Bethesda, Maryland. The firm ranks No. 14 on the 2024 CNBC Financial Advisor 100 list.
Homeowners can start to see their equity and net worth increase within five to 10 years. The rate at which equity grows depends on several factors, like the down payment, loan term, credit score and property value appreciation.
You can have immediate equity in a house when you make a down payment. Let’s say you buy a home priced at $250,000 and put $17,500 down. Your immediate home equity is $17,500, per Freddie Mac.
After that, the equity continues to grow as you make mortgage payments. A portion of each payment includes interest and an amount that reduces the outstanding principal that you still owe.
By way of example: In the first year of a $400,000, 30-year fixed-rate mortgage with a 5% interest rate, your monthly payment may be $2,147.29, according to LendingTree. About $480.62 would go toward the principal while interest takes up $1,666.67, the analysis found.
The money that goes toward the principal will grow over the life of the loan.
Homeownership allows you to increase your net worth because you can build equity through mortgage payments, which increases your asset value over time as the property appreciates in value, experts say. Unlike rent, which is simply a recurring expense; this essentially acts as a forced savings mechanism contributing significantly to wealth building.
To that point, over the past 33 years, the median wealth gap between homeowners and renters increased by 70% to $390,000, according to the Urban Institute.
And, as you pay down the mortgage every month and the value of your home increases, your net worth will ultimately climb in the future as well, LaRosa explained.
“It’s a way to increase your net worth over time,” LaRosa said. “But at the beginning, the first year or two after you buy it, it’s a negative for your net worth.”
Here’s what happens to your net worth after a home purchase and what factors to consider before such a major transaction, advisors say.
It takes time to actually build equity in the home through mortgage payments.
Jeffrey Hanson
partner at Traphagen Financial Group in Oradell, New Jersey
What happens in the first years of homeownership
Let’s say you buy a home for $250,000 and you put 20% down, or $50,000, says Stephen Cohn, co-founder and co-president of Sage Financial Group in West Conshohocken, Pennsylvania. The firm ranks No. 61 on the 2024 CNBC FA 100 list.
“The asset on your balance sheet is really the $50,000,” he said. “It’s not $250,000.”
What really happens is the cash you had for your down payment has now become illiquid, meaning it’s harder to access than before, said certified financial planner Shaun Williams, private wealth advisor and partner at Paragon Capital Management in Denver. The firm ranks No. 38 on the FA 100.
Additionally, upfront associated costs like closing costs and title insurance might negatively affect your net worth in the short term because you’re spending additional money, said CFP Jeffrey Hanson, a partner at Traphagen Financial Group in Oradell, New Jersey. The firm ranks No. 9 on the FA 100.
And “you’re not accumulating any equity” from the monthly mortgage payment in the first five to seven years,” Cohn told CNBC.
“It takes time to actually build equity in the home through mortgage payments,” Hanson said.
