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By Charles Essmeier
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.
©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 (http://
www.end-your-debt.com/>debt) information and HomeEquityHelp.net, a site
devoted to information on mortgages and home equity loans. (http://www.
homeequityhelp.net/>)
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