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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