In my last article I discussed how owning a home makes financial sense over renting. As I was writing that article I became curious about how long it actually takes a homeowner to financially break even. When is there more equity than there are expenses? This article will summarize the analysis that I performed to answer that question in 3 charts.
The homeowner in this example purchased a $200,000 home. They financed their purchase with a 30-year mortgage at 4%. They put 3% of the purchase price down so their mortgage was for $194,000.
Equity is determined by the current value of the house, minus the amount of the mortgage that is still owed. In the first graph I show how the equity grows over time as both the value of the house increases, and more and more of the principal is paid back. I am not showing the effect of the tax deduction for interest paid because that effect is dependent on the owner’s tax bracket and other factors.
There are a few points of interest from this chart:
• This owner starts with $6,000 in equity on day one because they made a down payment and therefore had to borrow less money.
• The value increases at the historical average of 2.5%.
• The amount of principal paid starts slowly and increases quickly the longer payments are made.
I next looked at the costs associated with ownership. These costs include the costs that you wouldn’t have if you were renting such as the buyer closing costs, the down payment, maintenance, and the costs to sell the house.
As you can see, the buying costs and the down payment are fixed. Even though both are paid one time at the beginning of ownership, they are a cost that needs to be recouped to break even. The industry standard for maintenance is 1-3% of the value of the home per year. This can vary widely based on the age and condition of your home. For this example, I used 2% or $4,000 per year.
The selling costs are only paid at the end of the home ownership. I included them in this analysis because you cannot realize the value of your equity without selling your home. It is important that they be included in any honest evaluation of the break-even point for home ownership. Again, I used the industry accepted value of 9% of the current value of the house so as the value of the house increases, so do the expected selling costs.
The final graph is a simple combination of the above to graphs to show both the increase in equity of the cost of ownership. The point where equity is equal to the cost of ownership is where the homeowner has broken even.
For this example, year 5 is where the homeowner would break even. My analysis was a bit more conservative than the industry norms, so your time to break even may be sooner or later than what is presented here. There are many ways that you can influence both the rate of equity gain and the costs of ownership, so be sure to consult with a Realtor for their guidance through the homebuying process.