The underwater mortgage
The new chronic problem with about 25% of US homeowners is having an “underwater” mortgage. The term means homeowners who owe more than their houses are worth. Due to the decline in home values as a result of the recession many homeowners are finding themselves in this position. Recent studies have shown that prior to the end of the recession, about 50% of homeowners will likely find themselves with an “underwater” mortgage.
The good mortgage news
There is good news though, when it comes to the overall state of mortgages today. Though the number of underwater mortgages is expected to increase, but there are a number of homeowners that are safe. A study by First American CoreLogic, is showing that about 23 million homeowners have 20% or more equity in their properties, and about 1 million more own their houses outright. Owners in this position are faced with the question of what to do with their equity. Although it’s great to have a good amount of equity in a property, there are two concerns that every homeowner needs to face:
- If homeowners borrow against their equity and home prices continue to fall, they could end up in the “underwater” position.
- If homeowners don’t borrow against equity, the cash that could have been taken out may disappear.
The general rule of thumb is to never borrow more than 80% of the value of a house. That way even if there is a decline in value, owners still have some cushion to protect them from losing too much equity.
What to do with equity
When it comes to figuring out what to do with equity, there are some options that homeowners look into. Debt consolidation, home remodeling and car purchasing are three things that many homeowners use home equity funds for. Though this may be a convenient option, looking at each deeper reveals how little advantage there really is to each one of them.
Debt consolidation. It’s no secret that many Americans are mired in debt. Many homeowners move to consolidate when they have high interest credit. It might sound like a good idea, but there’s more to the equation. When a consumer turns debt around with their home as security, they’ve secured their debt. A better move may be to file bankruptcy because that eliminates debt altogether. The only time it’s a good idea to convert equity to a loan for bills is if the total sum owed is moderately low and the reason for the debt has been identified. Homeowners should realize what brought about the debt in the first place and commit to changing their spending habits.
Home remodeling. People with high equity might also look into home remodeling. A lot of homeowners think a remodel means added value automatically, that isn’t always the case. There are some changes that will add value, but not all remodeling brings an automatic return. A good rule of thumb of home remodeling is to pay with cash, rather than take out home equity. Popular renovations are kitchen and bathroom updates. Each one can bring a return on investment if they are done cautiously, kept within a strict budget, and paid for predominantly with cash.
Car purchasing. Some homeowners might use home equity to buy a new car. One-hundred percent of the time this is a bad idea. Why? Largely thanks to cars losing value the second you buy them. A rule of thumb is to only make a purchase funded with home equity only if the value of the purchase appreciates. Cars aren’t in that category. If a car is a necessity and the only option is using a home equity loan, then the car needs to be paid off as quickly as possible.
Equity should not be taken lightly
Due to the high number of “underwater” mortgages out there, anyone who has equity in their property should guard it cautiously. Things like debt consolidation, home remodeling and car purchasing may sound like good ideas, but according to experts, they aren’t. It’s better to keep equity where it is rather than risk it.
Tags: cash out, debt consolidation, equity, First American CoreLogic, homeowners, mortgage