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Most people aspire to own a home and believe it is very important to their financial success, however being able to articulate why is more difficult, other than a belief. There are key concepts to understand when buying a home:

  • Leverage – the reason real estate tends to create millionaires is due to leverage, leverage is using small amounts of money to control a larger asset – leverage amplifies the return on any asset.  With $50,000 you can buy a $800,000 home or invest in stocks and bonds for $50,000. If the $800,000 house goes up 10% you made $80,000, whereas the same 10% in stocks got you $5000.  You need both in the end, but leverage is why real estate works – if you had to pay cash for a home – the world would look very different!
  • Equity– is the amount of money you put into buying a home, the down payment, the principal payments, and the market appreciation are all equity.  Equity is the difference between the value of the asset and the debt on that asset.  Equity adds to your net worth and looks good on a balance sheet but fails in a few key areas.  Equity is not liquid and does not earn a rate of return. Once you understand that a big portion of your net worth (wealth) is not easily accessible and does not earn you anything, you may start to approach the equity decision differently.
  • Cash flow – your home tends to consume the largest portion of your income, somewhere between 30-50% for most families.  Living paycheck to paycheck is not the way to build financial security.  Looking for ways to improve your cash flow, should be a focus of much of your financial planning.  Reducing expenses is the obvious place to start, but also understand that income tends to increase over time.  The challenge is that our expenses and cash flow tend to follow our incomes up over time. The Holy Grail of cash flow management is to both reduce expense and increase income until you are in a position where your assets pay your expenses and working for money becomes optional!
  • Taxes– owning real estate carries with it tax implications from property taxes, capital gains taxes, inheritance taxes as well as the tax code that helps homeowners reduce income and other Federal and State taxes.  Since the tax code is constantly changing and being adapted to the government’s priorities, it is crucial to pay attention to both the expense and potential benefits of the tax laws. Hiring professionals to help manage and mitigate tax strategies is usually very worthwhile. The more tax you pay owning real estate, the less the real estate will build financial security for you and your family.
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