Real estate is the most expensive asset most people will purchase over their lifetime. It's also a major part of a person’s wealth. A newly released Statistics Canada report found that Canadians are getting richer and the key driver of this is an increase in the value of the average Canadian home. Between 2005 and 2012 the increase in value of a primary residence was 52%. This is pretty amazing considering that while you're eating breakfast your home is creating wealth for you. The other great thing about this is that when you sell your principle residence, there's no tax on the increased value! What other means of generating wealth allows you to do this without paying taxes (that's legal of course). The fact that you can buy a bricks and mortar investment and over time it increases in value, is one of the things that attracts people to real estate investing. While I can talk a lot about real estate investing I'll save that for another blog post, but as a home owner, how can you increase the wealth generated by your home?
When looking at real estate from an investment perspective, there are a few ways of generating wealth. The first, which we've covered above, is an increase in the property's value over time. I'd call this the icing on the cake, because while it is nice, it may not always be guaranteed and is not always predictable. There's lots of variables to consider to maximize your potential for value increase when purchasing a home, but I won’t go into that here.
The second way to generate wealth is cash flow. In this case you're looking to generate a rental income that covers your expenses and produces a "profit" at the end of the month. As a side note, even with positive cash flow, this only increases your wealth if you save it or reinvest. Over time as the tenant pays the mortgage down your cash flow increases, but you've also been building equity each month as the tenant pays down the mortgage principle.
As a home owner you probably don't have a tenant contributing to your mortgage, or paying for other expenses unless you have a basement apartment or live in multi-unit property. But there are other ways of building wealth that real estate investors use that any home owner can adopt.
I always try to tell my clients buying a home that mortgage rates compared to historic averages are historically low!! (check out this interactive graph to see for yourself http://bit.ly/1pEllvD) And as a buyer and homeowner this offers a unique opportunity to build wealth at an accelerated rate. Every month you make a mortgage payment part of your payment goes to the principle (the original amount you borrowed) and part goes to cover the interest on the loan. When rates are low, more of your payment goes toward paying the principle off than interest and the more principle you pay off, the more your equity grows. In this current interest rate environment you're building equity in your home at a faster rate than ever before. Just ask your parents what their interest rate was!
If you've never done it, it's a worthwhile exercise to put your mortgage details into a mortgage calculator and see how much money in interest you pay to the bank over the life of the mortgage. You might be shocked! So this brings us to the first way to increase the wealth in your home:
1) Pay your mortgage off faster: how do you do this? There's a couple of ways. The first is to decrease the amortization period. By reducing the amount of time over which the mortgage is calculated, you're payments will be slightly higher, but you'll pay your mortgage off faster and increase the amount of money you're stashing away in equity. Another option is to increase the frequency of payments from monthly to weekly, bi-weekly, or bi-monthly, with the best option being weekly. Again, this results in you paying more of the principle off at a faster rate. Thirdly, you can make lump sum payments. Banks have various ways for you to do this which includes making one time payments annually that amount to a certain percentage of the mortgage or doubling up your monthly mortgage payments over a certain period of time.
While all three of these options result in your mortgage being paid off faster, the reality is that option 1 and 2 are likely to be the most practical options. A lot of us start off with the intention of paying a chunk of our mortgage down, but are often derailed by life's expenses and end up finding it easier not to, or putting off making such a payment until the following year. When it comes to building wealth, saving money, etc., we tend to do much better when the "saving" is automatic and done for us. By reducing your amortization, increasing your payment frequency, or setting your payments higher than what they need to be, once you've made the initial arrangements, the money gets taken out of your account automatically and your equity growth plan is put on autopilot.
2) The second way to build wealth in your home is via sweat equity. If you've bought a home that is brand new or already renovated, this could be hard to do, but if you live in an older home and have the skills or time to learn how to do the various upgrades you want, then you're able to reap even more of the increase in value to your home as a result of reduced costs. This can be anything from doing the painting yourself to getting a relative with the necessary skills to help you or even working with a professional to complete certain parts of a project while you do others. Over the years I've done everything from painting, demolition (always fun), laying of floors, building a deck, tiling, and landscaping. If I can do these things I'm sure most people can.
While sweat equity is a great way to build wealth in your home, the real point of this blog post is to emphasize that mortgage rates are at historic lows (which most people know), but they will go up and when they do and it's time to refinance your mortgage, you'll be paying less of your principle and more interest. It's better to pay yourself more now while you can and take advantage of the current interest rate environment, than paying the bank in the future.