Look for market trouble when taking out a home equity loan

Equity loans can leave you with too much debt if the market collapses

The news has been full of stories recently about the explosion in the US real estate market. Home prices have reached record levels and on the East and West coasts, they’ve gotten completely out of hand. In the Bay Area and Washington, D.C., home prices have nearly tripled in the last five years. Reaping the rewards of huge home appreciation, many homeowners have realized large gains in their equity, realized either through home equity loans or by selling the house outright. The market hasn’t been so kind to a lot of people who would like to buy, however, as prices are rapidly moving out of reach for many first-time borrowers.

If you are thinking about buying a home or taking out a home equity loan you should be careful, as there are signs that the market is reaching it’s peak. Should prices fall, homeowners could end up with loans that exceed the value of their home. Some signs that the market may be peaking:

In some markets, the prices are so high that few buyers can pay with traditional term mortgages. In Washington, nearly 50% of all new home loans are of the interest-only variety, where the buyer actually pays nothing on the loan principal for the first few years of the loan. The payments are lower than with a traditional mortgage, but with no money going towards the principal, a buyer is heavily leveraged in the event of a market collapse. The high percentage of interest-only mortgages in this market (and in California, where 35% of mortgages are interest-only) suggest that the prices in these markets may be near a peak.

Many in the home appraisal industry have complained that lenders expect them to meet target prices. The lenders want to lend a home’s asking price, so they expect the appraisal to match the price the seller is asking, whether the appraiser thinks that prices is realistic or not. Those appraisers that fail to deliver what is expected of them aren’t offered more work. The result of this is prices that may be artificially inflated.

The rate of home foreclosure is increasing, especially in Florida and Texas, which are two of the most populous states in the country. The rate nationwide increased this spring over the same time last year, suggesting that more buyers are discovering that they own homes they cannot afford. The Texas and Florida foreclosure rates are three times the national average. As interest rates on mortgages are currently near historic lows, the number of foreclosures will undoubtedly increase as interest rates go up.

Prospective buyers should be careful and do a fair amount of research before purchasing a home. Anyone considering purchasing a home should give considerable thought as to whether or not they can afford to make the payments, and if they are considering an interest-only mortgage whether they will still be able to make those payments if the interest rate increases. Buyers should, as always, be suspicious of home appraisals, and should ask the appraiser if he or she is being pressured by the lender to reach a predetermined value. Every buyer would like to have the home they’d like to buy appraise for the value of the loan, but the last thing anyone needs is to own a home that’s worth less than the amount they owe on it.

The market is in a delicate state at the moment, and buyers should be careful to make sure that they can afford to buy and keep their new home.