How The Average American Family Builds Wealth

Photo Credit: "Credit Law Center"

You may or may not have the “American Dream” of owning your own home, but building wealth is a sure way to invest in anything that matters to you. Your wealth building goal may be to secure things that you really want to own, or in order give towards some philanthropic effort. We all know that owning your home is the average person’s first step in wealth building. How? When you purchase a home at or below the appraisal value, the value of your home in most circumstances will rise over time. How quickly it rises, depends on the economy and the market. Unlike cars and other types of possessions which depreciate in material value, real estate generally appreciates over time. Appreciation simply means that your home will be worth more than you paid for it, as time goes on. This value is known as equity. The appraisal value of a home differs from the market value, though both values grow. Market value is typically higher than the appraisal value. Appraisal value is based on the value of the actual construction of the home, in comparison to similar homes in the area. Whereas market value is determined by how much the average buyer may be willing to spend on a home, considering its individual features and improvements. Banks will only finance a portion of a home based on the appraisal value, but buyers within a market who may be willing to pay more money out of their own pocket for a home they really want, dictate the market value.

Successful Homeowners When you do not own your home, the goal should be to prepare to own one. The time you have when you are renting is incredibly valuable time. This is the time needed to get educated on home ownership, how to build your credit, and how to save up a down payment. The average renter will rent between 2-5 years, while they are waiting to purchase. This preparation time can set you up for success. Unsuccessful homeowners will likely purchase homes that they will struggle to maintain or repay, eventually resulting in having trouble within their Homeowner’s Associations (HOAs) or going into the dreaded foreclosure. Successful homeowners buy homes with existing equity or can stay in their homes for the necessary years that it takes to build equity. They can afford to repay their mortgage loan, according to the agreed upon terms or they may own their homes free and clear.

How do you prepare? Your goal, as a renter, is to build your credit score so that it will rise as high as possible by the time you are ready to buy. You will also want to begin to save at least 6% of the approximate value of the home you may want to purchase. Typically, a portion of that savings will be used as a down payment, while the rest covers a fee known as “closing costs”. In the most perfect circumstance, a renter who wants to become a buyer will have a score of 720+, and 10% to put down. The amount of money you put down on a home determines what your principal balance will be. Your principal balance is the remainder of money owed that you would need the bank to finance. The higher the principal balance, the higher your mortgage payments will be.

Keep in mind that having a score lower than 700 or less than 10% to put down will not disqualify you, as there are a variety of lenders who can work with you. And if you have not reached your goal, buying is always best, so long as you can afford your mortgage. I always recommend that you purchase a home only when you have an emergency fund in place just in case something breaks in your home or you fall on hard times. Remember, when you own your home, you also own the problems. But having an emergency fund is a good practice, even when you are renting. If you attempt to purchase a home and your credit score is lower than 640, you may be denied altogether. If your score is acceptable, but still lower than the average buyer’s, consequently your interest rate will be higher. The higher the interest rate is on your home loan, the higher your mortgage payments will be. Banks do offer refinancing to lower your mortgage payments when your credit and finances improve, which extends the loan term. However, you can always choose to sell your home at any time.

Your agent should help you prepare to be in the best position when purchasing your home. The most qualified buyers often find that their home loans are not only very affordable, but that they are usually approved for the homes that they really want. No settling for less. Sellers also prefer to work with the most qualified buyers (conventional loan buyers and cash byers), because they know that those buyers usually make it to closing, with the fewest obstacles. Unless you buy your home in cash, you will be financing your home with the bank.

Leasing vs Financing Explained Let me use an example that most of us are probably familiar with. When it comes to securing a home loan, you can almost compare the process with securing a car loan. If you have ever purchased a car, you likely gave the car dealer a down payment (deposit) for the car, understanding that there is still a balance owed to the lender. The lender agreed to take the risk of paying the seller or the seller’s lender, all the money that you owe up front, for you to take sole possession of the car. In exchange you agree to repay the lender that money. That was clearly a risk that they took. In most cases the lender will not know you personally and is assuming the risk that you may not to repay them at all or within the timeframe laid out in your agreement. The level of risk they take, determines your interest rate. When paying on your mortgage loan, the interest is paid first.

Do not be fooled though, the risk is mutual. If you stop making your payments, the lender can step in to repossess your vehicle, or in the case of home loan financing, the bank can step in and “foreclose” on your home. Foreclosure can absolutely ruin your credit and make it impossible to purchase, and even difficult to rent, for many years to come. To summarize, the difference between leasing and is that when you lease, the true owner is only temporarily allowing you to have possession of their property. But when you buy or finance, you are being given permanent possession of the property, so long as you abide by your repayment agreement and repay your loan in full.

When Can You Use Your Equity? If it has never been explained to you then you are probably wondering who can wait 30 years to build wealth! After all, isn’t that the average home loan term? Remember, a home’s value will naturally appreciate so long as it is kept in living condition. So, how does a homeowner get to use this value however they choose? Well, the average person will choose to live in their first or even second home for only a few years. But afterwards, they will choose to sell that home to another buyer, placing a portion of the money down on a new house, and placing the difference in their bank to save or invest it. This is how the average American begins to build wealth through homeownership.

Wishing you and your family a piece of the "American Dream"

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