If Prices Fall: Keeping
A Roof Over Your Head
Chicken little may be right. But don't worry about it.
The housing market is getting a little wild, with folks trading condominiums like they are individual stocks, one Florida market soaring 46% over the past year and buyers resorting to interest-only mortgages to purchase homes they couldn't otherwise afford.
Danger ahead? A slump in property prices might hurt speculators. But if you are an ordinary homeowner, I wouldn't be overly concerned -- provided you have enough money for your next down payment. Here's why:
Moving Markets
Despite all the talk of a housing bubble, many places have enjoyed only modest gains over the past five years, as you can see from the accompanying chart.
"The housing markets are not that crazy," contends Chris Mayer, director of Columbia University's Milstein Center for Real Estate. "I think it's a very narrow group of people who should be worried. It's high-end properties in New York, Florida and a couple of California cities. Outside of that, I don't think there's a bubble."
Still, suppose you live in one of these markets, you are convinced property prices will crash, and you want to protect yourself. What are you going to do, sell your home, move the family into a rental and buy again in a couple of years? Even if property prices tumble, you might be out of pocket, once you figure in rental and moving costs and the expense of buying and selling real estate.
And if prices do slide, there could be a silver lining. Let's say you plan to stay in the same area, but you want to trade up to a bigger home. True, if prices drop, you will lose on your current house. In all likelihood, however, the price of more expensive homes will suffer an even steeper dollar decline, so trading up will be less of a stretch.
On the other hand, if you own a house in, say, highflying Los Angeles and plan to retire to the muted Dallas market within the next few years, a California property collapse could really sting. Should you sell your Los Angeles home now and rent until you move? It could be a smart strategy. But it could also be a lot of hassle.
Mortgaging Your Future
It isn't just skyrocketing home prices that have people worried. There's also been much hand-wringing over ballooning mortgage debt. But if you have a hefty mortgage, it won't necessarily hurt you during a market decline.
Imagine that you and the elderly couple next door both own $300,000 homes. They are debt-free, but you still owe $240,000 to the bank. If the price of both homes declines to $240,000, your home equity would be wiped out. Nonetheless, your $60,000 loss is no larger than that of your neighbors.
In fact, the elderly couple may have suffered more. Many folks believe the biggest threat to the housing market is higher interest rates, which would damp demand by making mortgages more expensive.
Under that scenario, your elderly neighbors might suffer a double whammy, with the value of both their home and their bond portfolio getting battered. By contrast, you probably don't own a whole lot of bonds. Instead, you are a big-time borrower, thanks to your mortgage. As Prof. Mayer notes, that mortgage is now more valuable, because you have yourself a loan with a below-market interest rate.
This, of course, assumes you have a fixed-rate mortgage. What if you have an adjustable-rate loan? Higher interest rates will mean bigger monthly mortgage payments. But the news may not be all bad: If the spike in rates was driven by rising inflation, you may find your income is also rising -- and thus the larger monthly payments are entirely manageable.
Next Time Around
In truth, the above scenario isn't quite as rosy as I depict. Granted, if falling property prices wipe out your home equity, you may be fine as long as you stay put. But what if you need to move?
Sure, you might be looking at selling one depressed property and buying another, so it seems like a wash. Problem is, to purchase your next house, you will need to cobble together a whole new down payment, because you don't have any equity in your current home. In fact, once you figure in the brokerage commission to sell, you might be underwater.
To protect yourself, you could try a few oddball strategies. For instance, if you foresee moving, you might hedge against a home-price decline at www.hedgestreet.com, an online exchange that lets you bet on the direction of home prices in six local markets. Similarly, you could hedge against rising interest rates by buying funds such as Potomac ContraBond, ProFunds Rising Rates Opportunity and Rydex Juno. Unlike most bond funds, these are designed to climb in value when interest rates rise.
But this stuff strikes me as being a tad too clever. Instead, to ensure you have plenty of home equity when you sell, you might simply pay down your mortgage more quickly by making extra principal payments. Alternatively, you could take the precaution of amassing a pot of "future down payment" money in your taxable account.
Think carefully about how you invest this money. You want to avoid any investment that could get hit hard by rising interest rates or falling property prices, notably longer-term bonds and real-estate investment trusts. Instead, for your future down-payment money, your best bet is probably a low-cost short-term bond fund, such as TIAA-CREF Short-Term Bond or Vanguard Short-Term Bond Index.
Email your comments to rjeditor@dowjones.com.