5 Steps to Safeguard Yourself from a Real Estate Bubble
As any Internet 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 against home equity
The first important strategy for avoiding the pain of a bubble
burst is to leave the equity in your home where it is. It can be
tempting to tap the equity in your home 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 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
It can be difficult to maintain good progress paying down a loan
if the interest rate is constantly rising. 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 real estate bubble.
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 deflate the real
estate bubble, this possibility is all too real.
Commit larger 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 down payment or a fixed-rate mortgage, the advice is don't
buy and continue renting.
Long term investment
The final 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
untouched.