If there's one thing American investors love, it's an over-inflated market. Which is why they keep buying houses and new ones keep coming onto the market. According to the latest data, housing starts rose an annualized 3.4% in September, matching a 17-year high. Whoo-ha! Go, baby go.
I wonder if the people buying these houses, for ever-rising prices, are the same people who couldn't get enough Amazon.com stock at $100 or Lucent shares for $75? Having been burned in the stock market, I guess they decided to re-invest what was left in their homes. Are we in a housing bubble? I don't know, but I suspect that we are, at least in some areas of the country.
Don't misunderstand me, now. I own a home, and I think home ownership is one of the great freedoms we enjoy in this country. I get nervous about the people who are pulling all the equity out of their homes with new mortgages. I suspect that most of these people are spending the equity, not investing it. What they're left with is a larger mortgage, and a bunch of worthless Chinese made goods.
The current low-interest rate environment is a once-in-a-lifetime chance to lock in a cheap 30-year mortgage on your home. If you refinance the balance of your current mortgage, you've won. If you refinance, and max out on your equity, you're probably hurting yourself. You might say that by refinancing the equity in your home, you're just cashing in on your home's rise in value. Well, not exactly.
What you're really doing is collateralizing the portion of the house that you own to get a cash loan, with the intention of paying back the loan at a later date. You've really transferred ownership of the equity in your house to your lender, not cashed it out. If you want to cash out your equity, you have to sell your house, plain and simple.
For those who are buying new homes, the low interest environment is a double-edged sword. On the one hand, you can get a tremendous rate on a 30-year mortgage, the likes of which you see once in a lifetime. On the other hand, because we live in a world where the monthly payment is all that matters, lower interest rate mean higher home prices. The monthly payment stays the same, but now you've got a much higher mortgage balance, which could turn around to bite you in the future.
The dangers of refinancing the equity out of your home are readily apparent, but why shouldn't you buy a home in the current environment?
I'm not saying you shouldn't. What I'm saying is you have to be careful. Most real estate professionals understand that the monthly payment matters, not the price of the house, when selling a house. Therefore, the lower interest rates fall, the more money can be charged for a house. If you're a home buyer, with a set amount of money for a downpayment, the price of the house will determine how much equity you start with. And, it determines whether you get a conventional mortgage, with 20% down, or some other form with less downpayment. That equity percentage will determine whether you'll be paying for the great rip-off known as Private Mortgage Insurance (PMI). Trust me, it's just another monthly payout that goes down a giant rat-hole. There's no value in PMI, and you don't want to pay it.
For the sake of argument, let's assume that you won't be paying any PMI. Now, let's compare two neighbors, with identical houses, who have the same monthly payments on thirty year mortgages. The first neighbor has a $100,000 mortgage at 10% interest, the second has a $146,000 mortgage at 6%. You may think this is extreme, but I can tell you that this is what has happened in my neighborhood over the last 5-7 years. The type of house I'm living in retailed for under $100,000 in 1999, and retails now in the $130,000's.
Back to our example. Both of our neighbors are paying about $875 per month on their mortgage. Now let's suppose that both of them decide to pay extra on their mortgages, upping their payments to $1,100 per month. Both neighbors are reducing their principal balances by $225 more per month, and here's where the first neighbor has the advantage. The balance on the $100,000 mortgage goes down much quicker than the $146,000 mortgage, such that while the first neighbor is paying more in interest every month than the second neighbor, by sometime in the seventh year, neighbor one is actually paying less in total interest. Neighbor one will pay his house off in a little over 14 years, while neighbor two will take about 18 years to pay off.
In this example, we don't even take into account the possibility that neighbor one could refinance the balance on his mortgage when interest rates decline. This would lower his required payment, and allow him to pay off his house even faster. In the meantime, the "market value" of his house has risen to about what neighbor two paid ($146,000). When neighbor one decides to sell his house, he'll walk away with a lot more cash.
Obviously, this is a simplified example, but one that has been occurring over and over again in the last few years. I know that it's expensive right now to buy a house, no matter where you go. What do you do in this situation? I recommend looking for, and buying, a home that needs some work. You should look for houses that are selling at about 80% of the average market value in a neighborhood. These houses will generally need only cosmetic work, and maybe a few minor repairs, but you'll save on the price of the house and have extra equity right off the bat. Stay away from houses that need plumbing or electrical work, unless you know someone that will fix it for free. Those fixes cost big bucks, and will eat up much of the savings on the price of the house.
Buy the house, make the cosmetic changes, then have it re-appraised. You'll be surprised at how much the "value" of the house has gone up. (I put value in quotes because the only real way to judge the value of a house is to sell it. An appraisal is simply an estimate of value.) This will also help you get rid of the PMI, if you didn't have the 20% downpayment, because once the balance of your mortgage falls below 80% of your appraised value, you can petition to get rid of the PMI. Houses can be investments, and like any investment it takes a work to find good value. But it can be done.
About The Author
Chris Mallon is the editor and publisher of the Undervalued Weekly, a free personal finance and investment newsletter dedicated to creating smarter investors.
I love what Trump says about the business of real... Read More
Many homes remain unsold for a long time because they're... Read More
This info is very important for both new and experienced... Read More
Finding a rent-to-own house is one of the many ways... Read More
In last week's article, we discussed how substantial profits could... Read More
Owning a house is part of the American Dream. Depending... Read More
Getting your real estate website more traffic is easy if... Read More
They say that the whole process of selling up, buying... Read More
Did you know that it's a proven fact that a... Read More
In Real Estate "Time" is a Wealth Development ToolsReal estate... Read More
For the first time "want-to-be" homeowner, purchasing an unfinished new... Read More
Equity is the value of your home minus what you... Read More
Most people get involved in Real Estate investing to make... Read More
Property Investing Secrets:How To Work With Agents And Get What... Read More
Here's the gripping story...You are the landlord of a small... Read More
If you're thinking about buying a home but have declared... Read More
How the heck do you find a "motivated seller?"The motivated... Read More
A lakeside vacation or second home can be a quiet... Read More
How much do you really know about investment property? Accurate... Read More
Did you know that the sales flyer is the most... Read More
Condos have become an increasingly attractive home ownership option for... Read More
Fourteen Top Tips for Overseas Property Investment:1. Buy what you... Read More
Finding a professional Monticello Realtor in Illinois is the best... Read More
Buying and selling property is not as easy as you... Read More
Boston real estate is a hot topic. Daily newspaper articles... Read More
If you are thinking of selling your home, there are... Read More
As a Professional Real Estate Inspector I get to see... Read More
On October 22, 2004, President Bush signed tax legislation that... Read More
For the first time "want-to-be" homeowner, purchasing an unfinished new... Read More
Typical log home company advertisements in popular log home magazines... Read More
Selling your home? Here are some suggestions to help you... Read More
Purchasing Florida Investment PropertyConsidering researching the purchase of Florida Investment... Read More
Negotiation is the process of communication back and forth in... Read More
Babyboomers whose children have left home, commonly known as "empty-nesters"... Read More
Identity theft has been a hot topic in the news... Read More
I might upset some folks with this one, but that's... Read More
STEP#1. First you have to recognize that in order to... Read More
Today we discuss escalation clauses because much of the country... Read More
European tax haven Andorra enjoys the same fiscal benefits as... Read More
What if you want better cash flow from your rental... Read More
Lease Purchasing affords wonderful benefits and opportunities to sellers, buyers,... Read More
Many folks dream of becoming real estate investors, but not... Read More
I hope you had a spectacular weekend!Things have been going... Read More
You'd like to buy a vacation home, but you're not... Read More
Many are taking advantage of this year's low mortgage rates... Read More
Buying a house is the best way you can create... Read More
How would you like to start a bidding war for... Read More
There are many expenses that come with buying a home.... Read More
We have been studying a trend of new home buyers... Read More
So you're thinking of getting into a bigger house. You... Read More
Real Estate Real Estate