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The housing market has exploded in the last five years,
and homeowners are finding that the equity in their
homes is greater than it has ever been. The equity in
a home is the difference between the market value of
the home and the amount still owed on it. As home prices
increase, so does the equity for those who own their
homes. In parts of California, home values have tripled
during the last five years, and homeowners are doing
increasingly risky things with their newfound “wealth.”
Anyone considering borrowing against their home’s
equity should carefully consider the possible pitfalls
of doing so.
Traditionally,
most home equity lending was done for purposes of home
additions or remodels. These have been considered low-risk
loans, as the house is collateral for a loan that improves
the house itself. As a bonus, the improvement usually
increases the value of the home, making the loan even
safer for the lending company. Occasionally, homeowners
default on such loans, but the foreclosed property can
easily be sold to recoup the loss. Times have changed,
and many, if not most, home equity borrowers are now
using the money for different, and riskier purposes.
Thousands
of people who have suddenly found themselves with hundreds
of thousands of dollars of equity in their homes are
treating that value as a windfall of cash. Instead of
traditional uses, such as home improvements, borrowers
are using their equity to buy more real estate to use
as rental property. There are cases of individuals with
homes valued at several hundred thousand dollars who
have borrowed against their equity, bought more property,
borrowed against that equity, and repeated this process
six, seven, ten or more times, attempting to build up
an empire of rental property. It’s hard enough
for most people to manage one mortgage, but some people
who are caught up in the “equity frenzy”
are now managing ten or more of them! On the surface,
it may appear that these intrepid individuals are simply
taking advantage of an opportunity, turning several
hundred thousand dollars worth of equity into millions
of dollars worth of rental property. On the other hand,
these “investors” may be inviting disaster.
As more
and more people buy real estate on speculation, the
equilibrium of the real estate market is affected. The
additional competition among buyers, fueled by the real
estate speculators, is causing prices to go up even
more. Eventually, the market is going to peak. Buyers
who need a home to actually live there can only pay
so much for them before the homes simply become unaffordable.
And not every speculator can own ten rental properties,
as the market can only support so many rental properties
before the market becomes saturated. Once that happens,
prices will fall. And when they do, all of these buyers
who purchased their homes using their own home’s
equity will find themselves under a mountain of debt.
It’s
nice to have some equity in your home. It’s also
nice to be able to borrow against that equity for home
improvements or debt consolidation. Using your equity
as though it was cash you can freely spend is dangerous,
as many speculators will soon learn.
Compare
refinance and home equity loan offers from up to
four competing lenders in under a minute.
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About
the Author
©Copyright 2005 by Retro Marketing. Charles Essmeier
is the owner of Retro Marketing, a firm devoted to informational
Websites, including End-Your-Debt.com, a Website devoted
to debt consolidation and credit counseling information
and HomeEquityHelp.net, a site devoted to information
on mortgages and home equity loans.
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