|
|
|
|
| The Basics | 5 risky real estate moves to avoid now
|
(Page 2) of 2
 Previous
If you stay in the home long enough, though, you'll be required to start paying down principal, and your payment can soar. Higher interest rates will affect most of these loans, as well, because few have a fixed rate. With flexible payment loans, interest rates can change as often as monthly, and your mortgage amount can actually grow over time if your payments aren't sufficient. (For more details, read "Could you handle an interest-only loan?")
Interest-only loans made up more than 45% of total lending last year in San Diego, Atlanta and San Francisco, according to BusinessWeek Online and LoanPerformance, a San Francisco-based real estate information service, and they made up a third of the loans in 10 other hot markets. (Similar figures aren't available for flexible-payment mortgages.)
That's scaring many mortgage-rating companies, such as Fitch, which fear higher interest rates will lead to a spike in foreclosures on these loans. Falling real estate values could hurt these borrowers more than others, because many of them won't have built much, if any, equity and could become "upside down" on their mortgages, owing more than their homes are worth.
Risk: Buying money-losing rentals
In most markets, it's smart to choose property that commands rents that are at least high enough to cover your out-of-pocket expenses. (For details, read "How to find good investment property.") This is especially important in bubbly markets that could burst.
Some people think rentals will be in higher demand if foreclosures rise, but history has proven otherwise. Many of those who lost their homes in previous real estate busts lost their jobs first, Conway said, since economic downturns are what triggered the drops in home prices. People without jobs tend to leave the area in search of better prospects.
Los Angeles County, for example, lost more than 200,000 jobs a year for three years in the early 1990s, which set off the state's first-ever "out-migration" where more people left the Golden State than arrived. Rents tumbled as vacancies soared; foreclosures on rental properties climbed as landlords tired of losing both money and equity.
You can give yourself some protection by making sure your investment property has positive cash flow in good times. If you have to cut your rents, you may still get enough of a tax break to stay afloat (thanks to depreciation and deductible expenses).
Risk: Draining your home equity for other investments
Financial planner Fernandez isn't dead set against using home-equity loans to buy other investments. Some of her clients have successfully built profitable real estate portfolios this way. But using home equity to supplement a stock or mutual fund portfolio is a possibility only for the most risk-tolerant investors.
What concerns her are people who are diving in without considering the potential costs, or those who are "doubling down" by buying more property in the same, highly appreciated area where they own their primary homes.
Some want to use variable-rate loans like home-equity lines of credit to fund their ventures, not realizing spiking interest rates could make the deals unprofitable. (For more, read "5 tips for wisely tapping your home equity.")
Investors need to be reasonably confident their future returns will exceed the costs of borrowing the money, Fernandez said, and that they can handle any volatility that comes.
Most people, though, are probably better off funding their investments out of current income rather than borrowing to buy more, Fernandez said. If you do decide to borrow against your home, keep a cushion of 20% equity and consider a fixed-rate loan to lower the risks.
Risk: Owner-financed second or third mortgages
Some sellers prefer not to realize their profits all at once because that can trigger a major capital-gains tax bill. (Profits exceeding $250,000 per person on a primary residence are potentially taxable, as are all profits on rental property.) Instead, these sellers become lenders, allowing the buyer to make payments to them over time. This helps sellers stretch out their tax bill over a period of years, rather than having to realize the gains all at once.
This strategy isn't incredibly risky when the seller is in "first position" on the home -- in other words, when the seller is providing the primary mortgage. At worst, the seller will get payments for a few years until the buyer defaults. The seller might have made more money selling outright, but at least he gets his home back.
Those who finance second or third mortgages, though, might not be so lucky. If the borrower defaults, the primary mortgage lender gets first crack at recouping the loan. Only if there's equity left do the lenders in second or third position get paid off. In a declining market, those lenders can be left out in the cold.
Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.
|
|
|
|
