By: Laura Walton AFC®
A recent radio ad for Cash Call Mortgage exclaimed “Your house is your bank!” Have we learned nothing?
Investing in stocks is inherently risky; the same goes for real estate. Values boom and bust and then we quickly forget. To help us remember, here’s a quote from the second quarter of 2005:
“Phoenix real estate recorded a 55.2 percent increase in house prices over the past 12 months, according to the latest data from the National Association of Realtors.”
As home values soared, homeowners started tapping into their equity. Average spending per homeowner on home improvements increased by 36% from 2003 to 2007. It seemed like everyone was doing a kitchen or bath remodel! Pool companies, landscape architects and furniture stores were doing a landslide business. I remember – I was selling lots of full-page, 4-color glossy ads to high-end retailers. Brisk advertising sales are a good sign that business is good, very good.
With year-over-year increases in the value of our homes, we forgot they can also lose value. Here’s the wakeup call from the first quarter of 2009 for home values in Phoenix:
Using “your house as your bank” by taking out a home equity loan based on the increased value of your home isn’t very different from trading stocks on margin. Using the value of your margin account, you can buy stocks with borrowed funds (just like financing a new kitchen with an equity loan). The rub comes when the value of the stocks drop and you’re asked to make up the shortage – you get a margin call. Or, in the real estate example, the value of your house drops and you realize that it’s not worth the total of your mortgage and home equity loan.
This conjures up mental images from the Great Depression of ruined investors jumping to their deaths from office windows. It seems this might have been exaggerated – suicides were not statistically higher during that time – but one quote from a suicide note sums up the day’s sentiments: “My body should go to science, my soul to Andrew W. Mellon, and sympathy to my creditors.”
Taking on debt is always a risk. Using an asset with a fluctuating value to secure that debt further increases the risk. Let’s not learn that lesson over again.