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Don’t let your own financial bubble burst

Updated: May 3, 2013 12:14PM

Originally published: July 18, 2005

It doesn’t matter if the real estate bubble bursts. It only matters if your bubble bursts. And if your personal finances are built on an adjustable rate mortgage, or an interest-only mortgage, or a floating rate home-equity loan, not to mention credit card debt, it’s very likely that your bubble will burst regardless of what happens to real estate prices.

You probably thought you paid a fair price for your home when you purchased it. Unless you’re a real estate speculator, the reason you bought the home was to live in it.

Though you may take some mental satisfaction in knowing your house is worth more now than what you paid for it, it’s still the same 2-bedroom, 2-bath condo or 4-bedroom two-story house, plus the cost of whatever improvements you’ve made.

Before you get too self-satisfied about the increase in your real estate values, take a look at how much more you’re paying for everything else, from medical services to college tuition to groceries.

Yes, home prices have outstripped basic consumer price inflation in recent years, but you can’t spend that excess until you sell your home. And then you may have to pay taxes on part of the gain: anything over $250,000 on a single return, or $500,000 on a joint return.

Where’s the bubble?

There’s no doubt that home ownership has been a good investment, even a spectacular one in parts of the country. From March 2004 through March 2005, 20 housing markets around the country posted gains of more than 20 percent. Many cities in Florida -- Bradenton, Sarasota, West Palm Beach, Ft. Lauderdale, Orlando, Melbourne -- scored gains of 30 percent or more. California and Las Vegas had similarly hot housing markets.

But the national rate of gain, according to the National Association of Realtors, was 9.7 percent for the same one-year period.

What’s fueling rising housing prices? Plenty of demand and capital that’s easily available at cheap mortgage rates. Plus, in spite of recent stock market gains, a lot of that cheap money was moved into housing by investors who fear another stock market crash.

That’s because the stock market decline of 2000 was so very visible. Prices printed on the ticker tape and evening news and on your daily portfolio update showed just how much money you were losing.

When real estate prices fall, it’s likely to be far more subtle. All real estate is individual. And it will take a while before you hear that several houses on your block or condos in your building have sold for less than the asking price, or before you notice real estate listings that announce offerings at new low prices.

What could halt the rise in home prices or even trigger a decline? It could happen in a period of relative economic strength, if interest rates start to rise. Or it could happen in a period of economic weakness, despite low rates if people lose jobs and can’t make monthly payments.

Those with little or no equity in their homes and no way to pay the mortgage may just turn in their keys to the lender. Impossible? Not at all. It happened in Texas in the early 1990s.

Who’s vulnerable? Let’s start with first-time home buyers whose median down payment last year was 3 percent compared to 6 percent the year before, and a standard 20 percent only a decade ago. With very little invested in the property and no way to pay that monthly bill, some homeowners will realize they’re only walking away from a dream.

Adjustable-rate and interest-only loans accounted for two-thirds of all loans in the second half of 2004. Rising rates could have a dramatic impact on the budgets of those borrowers.

Monthly payments on many of those adjustable rate loans change only once a year, on the anniversary of the loan. After nine upward bumps in interest rates by the Fed in the last 18 month, those ARM rates will soon reflect higher monthly payments.

The big bump

On a $350,000 interest-only mortgage, the recent rise in rates of 2 full percentage points could push the monthly payment to $2,500 from $1,403 in one quick adjustment!

Declining housing prices shouldn’t matter to you as long as you can pay the mortgage on your home.

But just as rising prices encourage more buying, forced sales that lead to declining prices could last longer and push prices lower than many people anticipate. And that’s The Savage Truth.

Terry Savage is a registered investment adviser. Distributed by Creators Syndicate.

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