Monday, November 12, 2007
Tapping in to your best investment
One of the real estate news sources that I regularly read had two articles today about home values. One was titled “Real Estate Continues to be THE best Long Term Investment” and the other “Home Owners Still “Cashing Out” Billions of Equity Via Refis”. The juxtaposition of those two articles in this news feed sort of sums up a good part of the mentality that led to the financial mess that we’re in right now in real estate.
I certainly buy into the first story that real estate is a great investment. The author made the case very convincingly that, even in downturns like we are in, with falling values in the short term; property values are still up over the long term. He also notes that a large portion of what dictates the inherent value of a house is the replacement cost to rebuild it and that is not likely to go down over time.
The second article documented the rise in the use of refinancing of homes to pull equity out as a means of sustaining a lifestyle. The author found that 87% of refi’s today involved extraction of equity verses only 33% in 2003. It would certainly be foolhardy to think that all of that equity is being extracted to cover the cost of updates to the house, which would at least add some value. Today, much of the money taken out in refi’s is used to cover the Visa bill or to pay off other debts that we keep ringing up.
While it is not necessarily bad to tap your home piggy bank for some equity to cover an emergency need, it is the pattern of doing so regularly that got many home owners into trouble, when home values went down. If you’ve always been hovering around the 100% financed mark on your home, it doesn’t take much of a drop in values to put you upside down on the house. Then when you go to that well for another drink of equity, you discover that it is not only dry, but that you owe more than the house is worth.
If refi’s have become the only way that you can sustain a lifestyle, then you are in trouble. That habit likely contributed greatly to the current foreclosure rate that we are seeing. So the caution is to use the equity in your home wisely. Left alone, it will turn out to be a great investment, but tapped too often, it can become a powerful narcotic that can get you into trouble.