Home loans getting tougher as more homes are overvalued

New study shows nearly one home in three is overvalued

A recent study by National City Corporation looked at home prices throughout the United States. This study took all sorts of trends into account in determining whether or not housing prices in the country are fair, too low or too high. The result? Nearly one in three homes is overvalued, some by as much as 69%. This will not come as a surprise to anyone who has been trying to purchase a home in California, New York, Florida or Massachusetts, but the entire study, which looked at 299 cities, showed that 100 cities had homes that are overpriced by nearly 20 percent.

Home prices have increased during the last five years as investors have sought other places to put money besides the stock market. The increase in real estate speculation has helped drive prices to record levels and that, combined with low growth in jobs and salaries, has made many markets unaffordable. The worst was Santa Barbara, California, which was judged to be overvalued by nearly 70%. At the other extreme were many towns in Texas, where prices were actually undervalued by an average of 10 percent.

The huge increase in prices and tendencies towards overvaluation have contributed to what many are referring to as a housing “bubble” and fears that the housing market may collapse. A total collapse isn’t likely, as many people actually live in the properties they own, and they are unlikely to sell them just because the value decreases. On the other hand, the huge overvaluation has forced the hands of many buyers, leading them towards dangerous interest-only loans and other risky loans, such as the Option ARM. These loans, which still leave the owners with huge monthly payments, generally do not help reduce the principal of the loan. Instead, for the first few years of payments, the buyer only pays interest or, in the case of the Option ARM, and amount that doesn’t even cover the interest. This has worked out in recent years, as home prices have increased and given the owners equity in their properties despite their failure to pay anything towards their principal. With home prices nearing a ceiling, that may stop, and many homeowners may find themselves with properties they cannot afford to pay for. Worse, they may not be able to sell the property for the amount of the debt they owe upon it.

What this means for the average buyer is that caution should be exercised when buying a home. The automatic assumption made during the last five years that paying the principal doesn’t matter because the value will soon go up doesn’t hold true anymore. Values may go up, but they will just as likely stay the same or go down. Buyers should keep this in mind and purchase a home that they know they can afford, with a mortgage that allows them to reduce the principal of the mortgage and pay it off on a 30 year schedule. That will help prevent any financial catastrophe that might be caused by a job transfer and possibly being forced to sell the home at a loss.

And no one wants that.