Friday, March 25, 2005

A piggy bank, storing up money for retirement? An investment bank to purchase new assets? Or an ATM, spitting out cash for just anything?

How to Bank On Your Home
By Jane Bryant Quinn, Contributing Editor Newsweek

March 28 issue - How big a risk do you take—should you take—when you borrow against your home? With prices in most places bounding up, homeowners find themselves sitting on a fat pile of capital (your "home equity"—the cash you'd put in your pocket if you sold the house and paid off the mortgage). That makes a house more than a mere living space. It's a piggy bank, storing up money for your later age. Or an investment bank, able to finance the purchase of other assets. Or an ATM, spitting out cash for anything you want to buy. What's your best strategy today?

Homes are on everyone's mind because that's where the money is. In 2004, prices rose an average of 10.7 percent—the largest increase in 25 years, according to the Office of Federal Housing Enterprise Oversight. The return on your cash investment could have been much higher than that. With 10 percent down ($25,000) on a $250,000 house, you roughly doubled your money.

Gains varied from city to city and block to block. Topping the charts: Las Vegas, where prices soared 47.3 percent (if you're thinking of moving, the median house there costs $281,400). Other hot spots include California, southern Florida and the urban East Coast. You're out of the loop, however, in parts of the Southeast, Midwest and Southwest. Prices dropped 4.2 percent in Charleston, W.Va., where the median home sold for $107,200. Two other losers, according to the National Association of Realtors (NAR): Indianapolis (down 3.9 percent; median price, $113,400) and Austin, Texas (down 2.1 percent; median, $151,300). Americans aren't sharing equally in the property boom.

But those who have it flaunt it. Money is flying out of homes through thousands of new home-equity lines of credit. They're currently cheap: loans with variable rates (usually tax deductible) are averaging 4.2 percent for smaller lines and 3.7 percent for larger ones, according to Bankrate.com. You can borrow whenever you want and stretch your payments out for years. At Countrywide, home-equity lending jumped 60 percent from February a year ago, compared with 15.6 percent for other mortgage loans. Wells Fargo reports a 40 percent gain.

How prudent it is to borrow more money against your home depends on what you do with it and how you plan to pay it back.

The ATM option. "Destructive," says planner Ted Bush of Capital Advantage in Plano, Texas. You're living beyond your means if you're using home equity to pay credit-card debts. You feel rich, but you're throwing away any chance of becoming rich.

The investment-bank option. Here's where the action lies today. To many investors, cash left in homes is "dead equity"—earning nothing on its own. If you strip it out, you can use the money to purchase another asset, potentially adding to your wealth. But first, ask yourself two things: What are the odds of earning more than your borrowing costs, assuming that interest rates go up? And how will you repay the loan if you're downsized out of your job, the economy falters or the investment fades? After all, your home is still your safety net. Draining your equity to make another investment is "safest" for people with high and reliable incomes, substantial assets and low debts, says planner John Gay of Frisco Financial Planning in Frisco, Texas. Without a cushion, you're taking big risks.

No surprise—but this money is mostly being recycled back into real estate. Second homes made up an amazing 36 percent of houses purchased last year, the NAR reports—13 percent for vacation use and 23 percent primarily for investment.

This lemming rush into property doesn't signal a price peak to David Lereah, NAR's chief economist and author of the new book "Are You Missing the Real Estate Boom?" Price gains are slowing, he says, but there's still plenty of profit ahead, thanks to a sound economy and strong demand from boomers in their peak earning years. He sees gains, albeit slower ones, even in mania markets—provided there's no recession or "local bad event," such as Silicon Valley's tech crash five years ago. As for rising interest rates, they're modest, he says, and boomers can afford them.

Dream on, replies Yale economist Robert Shiller, who warned against the stock bubble in his popular book "Irrational Exuberance." In the late 1990s, investors believed a "new era" had lifted stocks to a permanent new level. Today, "new era" thinking applies to the high valuation of second homes. You can't tell when bubbles will end, but history isn't on the new investor's side, Shiller says. After inflation, long-term home prices hold pretty flat.

If you rent out a house or condominium you own, your rental income should (ideally) cover your costs, including repairs and a reserve for the times you find yourself between tenants. In practice, however, rents are rarely high enough. You're probably digging into your pocket to carry your mortgage loans, making it all the more important to hold personal savings in reserve.

The piggy-bank option. Speculation is a midlife game. Real-estate players should aim to cash out, mortgage-free, when their working (and earning) years conclude. With luck, you'll have double the nest egg—as long as the new era lasts.

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