Three Things to Know About the Housing Bubble

  • Share
  • Read Later

Federal Reserve chairman Alan Greenspan has tried to be reassuring. In a speech on Monday to an annual bankers' convention in California, Greenspan pointed out that despite the "apparent froth" in housing prices, only 5% of borrowers were very highly leveraged. But what if you're in that foolish 5%? TIME's Daniel Kadlec answers that question, and more:

Q: I'm one of the 5% of homeowners with way too much mortgage debt. I just couldn't resist the interest-only loan! Is there anything I can do now to cushion the blow if interest rates spike?

A: You have the most flexibility now, while interest rates are still fairly low. The best cushion you can build is by refinancing into a long-term fixed-rate mortgage, where your rate remains stable for up to 30 years no matter what happens with interest rates overall. But you may not have the income to qualify for such a loan. Presumably, that's why you are in an interest-only mortgage to begin with. Don't panic. With most interest-only loans you get a fixed rate for five to seven years. You're okay until that term expires. But after that, you'll get hit with the double whammy of a higher rate and required payment of principal. Your monthly payments could soar. So start saving now. Your goal should be to get into a fixed-rate mortgage before your initial term expires.

Q: My mortgage debt looks pretty manageable, but I did take advantage of one of those cash-out refinancings a couple of years ago. Will I be affected if the value of my home falls?

A: As long as you don't have to sell and can keep making the payments it doesn't matter if the value of your house falls. Just ride out the decline and wait for the recovery. If you must sell, though, you may find that you no longer have the equity you'd need to buy another house. If you cashed out a large amount you may even find that you owe the bank at closing, though that is rare. One other thing: If you've spent a lot of your equity and don't have a 20% down payment on your next home you'll be stuck with the additional cost of private mortgage insurance.

Q: I played it pretty safe the last few years, but my home is now far and away my most valuable asset. Should I be worried if the bubble bursts?

A: If prices tumble, so will your net worth. If you've played it safe that's no big deal because you can afford to keep making the payments and wait for a recovery. But it may affect your borrowing power, say, for college tuition. It may also prompt you to rein in your spending on things you don't really need. Think of that as the upside!