House flippers and real-estate speculators weren't the only ones who lost big when the real estate market crashed in the Great Recession. Plenty of consumers lost their down payment, their home equity and their homes.
Back then, home values dropped dramatically after an intense period of rising prices. While many market conditions are different today, some are the same, such as a surge in demand for homes, which has produced another strong surge in home prices, lifting them to record levels.
Amid suddenly higher rates, housing market conditions are changing quickly. Home sales have cooled appreciably, and home price increases have begun to flatten, and more cooling likely for a time yet. There are even some concerns that home prices may deflate in some markets that may have overheated a bit.
So it's a good time to ask the question: Is a home a good investment? Or is it only a place to live and a nice tax write-off for those who can claim the federal mortgage interest deduction?
Housing is still a way to build wealth, but that's typically only achieved over the long term, says Keith Gumbinger, vice president of HSH.com.
"You don't know what the long-term value of your home ultimately will be," says Gumbinger, "but unless home values drop to zero, odds are that at some point down the road, you'll have some stake, some equity component of your home's value."
Building equity in your home comes down to two central factors: paying down your loan balance and home price appreciation.
Building positive equity
The equity you establish in your home mainly comes from paying down your mortgage over time, even if values don't rise or even if they should decline a bit, says Gumbinger.
To explain why, Gumbinger offers this example: "If the cost of your home was $200,000 and you put no money down, you have a $200,000 mortgage. If the value of your home fell by 50 percent, you have a home worth $100,000 and a mortgage of $200,000. If you continue to make regular payments over time, and even if your home's value never increases, you'll eventually pay the mortgage down and it will pass that $100,000 level, and you'll start to build some equity."
Of course, home values do generally rise over time, but if they don't it will take some time to get the home above just to a zero equity stake. How long depends on your loan's interest rate and the term of the loan. The downside is that $100,000 of equity will be costly due to interest expense.
"Paying back $200,000 probably means you're paying almost $350,000 over the life of that loan, so you spent $350,000 to accumulate $100,000. At the end of the loan, you have saved $100,000," says Gumbinger. "However, having a pool of money to borrow against as needed or live off of later on can be hugely valuable."
Home price appreciation
Home price appreciation can add what Gumbinger describes as "a nice kicker" to your savings.
But that alone doesn't necessarily make housing a smart investment. Historically, house prices tend to rise "roughly in line with inflation and not much more than that," explains Jed Kolko, chief economist at Trulia, a real estate information website in San Francisco. That means you might -- or might not -- earn a fatter real return if you invested in other types of assets such as stocks or bonds.
Timing and location also matter because home prices tend to be cyclical over longer periods than other asset classes. That's another reason why homeownership should be perceived as a long-term investment.
One risk is that housing is relatively illiquid, meaning you typically can't convert all or part of it into cash quickly or easily.
"You can't just sell off a bedroom," Kolko says.
Plus, you can't know in advance what will happen with home values in your area, adds Gumbinger. "As many homeowners learned in the last housing bust, home values don't always increase."
Damaging your equity position
Most people move at least a few times during their lifespan, but selling your home and buying another one can damage your equity position and add to your overall costs.
"The costs related to the real estate transaction can burn up any equity you've accumulated. That's part of the reason why buying a home with a short-term window in mind is generally not prescribed," Gumbinger says.
A better strategy is to plan to stay put for as many years as you can.
"Generally, you want a window of five years or longer to allow yourself time to build up a little equity, so you don't end up in a negative circumstance because of the transaction costs, says Gumbinger.
Refinancing complicates things
If you relengthen the term of your mortgage when you refinance, you'll restart your amortization clock, making the equity-building process a lot slower.
"If you do refinance frequently or a number of times on the same property, you might never get to a point where you have accumulated all that much wealth," Gumbinger warns.
On the other hand, if you refinance and shorten the term, you can "improve your equity position and build your wealth stake faster," Gumbinger says.
"If you can't refinance, or have already refinanced and want to speed up the process, prepaying your mortgage is another way you can erase debt and build equity more quickly. Even small mortgage prepayments can add up to big savings over time.
The bottom line is that there's no absolute rule as to whether the benefits and risks of building wealth as a homeowner make sense for your personal situation. Yes, enforced savings, liquidity and investment risk are financial decisions, but as Kolko says, "they're very personal financial decisions."
"For some people, the equity they accumulate over time is crucial to their well-being when retirement comes calling," adds Gumbinger. "The opportunity to build equity and be able to extract it via a Home Equity Conversion Mortgage or a proprietary reverse mortgage can make a huge difference in your lifestyle as you grow older."
Related: Want to build wealth? Buy a home
This article was updated by Keith Gumbinger.
