Understanding the Racial Wealth Gap

 KELLY O’DONNELL, PH.D. | CHIEF RESEARCH AND POLICY OFFICER, HOMEWISE 

Closing the racial homeownership gap by increasing the percentage of Black and Hispanic households that own their homes is critical to making the distribution of wealth more fairly.  In the United States, the typical Black or Hispanic household has less than one-fifth the wealth of the typical white household. The racial wealth gap is the result of many factors, most of which are rooted in our country’s enduring legacy of systemic racism.  Households of color have lower incomes on average than white households, they are also less likely to benefit from intergenerational wealth transfers (e.g. inheritances and financial gifts from parents or grandparents), and they are less likely than white households to own the home they live in.

Homeownership is the primary means by which middle-class households in the US build wealth.  It is a key strategy for closing the racial wealth gap because it substitutes mortgage payments for rent payments and thus transforms a pure outflow and a mandatory expense for most households into a savings vehicle that can generate significant returns via the mechanisms of appreciation and leverage.

 Homeownership is a savings tool. The portion of each monthly mortgage payment that goes to the principal is equity that accrues to the homeowner. Thus, homeownership serves as a form of automatic savings, adding to the homeowner’s assets as the loan is paid down each month.  Rent, in contrast, flows solely to the landlord and the renter must budget for both housing and savings separately.

Appreciation compounds the value of the savings ‘banked’ in a home’s value.  Even modest appreciation can have a powerful cumulative effect on homeowner wealth.  A $200,000 home that grows in value at an average annual rate of 2 percent will appreciate by over $20,000 in just 5 years and will grow to more than $162,000 over the course of a 30-year mortgage.

 Leverage is a third wealth-building feature of homeownership.  Although a typical homebuyer‘s down payment constitutes a relatively small fraction of a home’s value, appreciation applies to the home’s full value, including the portion ‘owned’ by the bank.  This leverage further amplifies the return on the homeowner’s initial investment.  Homeownership is likely the only opportunity most modest-income households have to achieve this kind of investment leverage.