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Protecting Yourself From a Real Estate Bubble

As any stock investor can tell you, it is no fun to be in a bubble when it bursts. While there is still considerable debate about whether or not the recent run up in home prices represents a true bubble, it is certainly prudent for those in the real estate market, whether as homeowners, investors, or both, to take the necessary steps to protect themselves against a downturn in housing prices.

Avoid borrowing the home equity

First important strategy for avoiding the pain of a real estate bubble burst is to leave the equity in your home where it is. It can be tempting to tap the home equity to pay off credit card bills, put the kids through college, or even take that dream vacation. It is best, however, to allow the equity to do what it was designed to do help you actually own your home.

Borrowing against the equity in a home could leave you in the uncomfortable and untenable position of owing more on the home than it is worth. Many lenders today will allow homeowners to borrow 100%, or even more, of the value of the home. If home prices tick down even a couple of percentage points, the borrower could easily find him or herself owing more than the current value of the home.

Focus on principal repayment

Closely related to the need to leave built up equity alone is to build up additional equity. The more equity you have built up in your home the more protection you will have in the event that housing prices stagnate or decline. Building equity through additional principal payments is the fastest and easiest way to put as much money in your home as possible.

While this repayment of principal is important for every home buyer, it is particularly essential for those people who succumbed to the wave of interest only and option ARM mortgages. Interest only mortgages can be particularly dangerous in a down market, and making advance payments on principal is the only way these mortgage holders have to protect themselves.

Abandon risky mortgage loan

Dumping those adjustable rate mortgages for the predictability of a fixed rate loan is another important way to protect yourself from the bursting of the housing bubble. It can be difficult to maintain good progress paying down a loan if the interest rate is constantly rising. As mortgage rate is expected to rise slowly, get a fixed rate loan (15- or 30- year loan) now and make sure you can afford the payments.

Think of it this way - there are few situations more terrible than facing rising monthly mortgage payments at the same time the value of the home is declining. If you hold an adjustable rate mortgage when interest rates are rising, you could find yourself in just such a situation. And since rising interest rates are likely to be one of the triggers that deflates the housing bubble, this possibility is all too real.

Commit larger home down payment

First time home buyers can be particularly at risk when there is a downturn in the housing market. That is because many of the mortgage loans being written today are being written with minimal down payments, or sometimes none at all. This means that these first time home buyers have no equity at all in their homes, and if housing prices decline they could end up owing more than the home is worth. That is why it is important for all first time home buyers to try to muster at least a 10% down payment on the home they buy. If first time buyer can't afford a large home down payment (see how to find money for your home down payment here) or a fixed-rate mortgage, the advice is don't buy and continue renting.

Long term investment

The last step, and this is quite important, is to take a step back from the view that real estate is always a great investment. While it is true that homes have been a stellar investment in the past few years, this is not always the case. Viewing real estate as just another investment, like the hot internet stocks of yesterday, can lead buyers to repeat their past mistakes.

The last tip for surviving a potential bursting of the housing bubble is to think of your home first and foremost as a place to live, not as an investment to retire on. If you think of your home as a long term commitment, you will be more likely to protect that investment by taking the other steps listed in this article, such as paying down principal, avoiding interest only and adjustable rate loans and leaving the equity in the home untapped.

In short, it is extremely difficult to time the real estate market. The bottom line for home buyers to protect themselves from any potential housing bubble is to get a fixed rate loan, stay away from tapping the home equity and enjoy living in your house for a long time.



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