Five Ways to Lock Home Profits
The Basics
5 ways to lock in home profits
If you’re sitting on a pile of equity and nervous about your area’s housing market, you can take your gains -- and your chances.
By Liz Pulliam Weston
Walla Walla isn't the first place you think of when you hear the words "housing bubble." But Jeremy Gonzalez has been watching prices escalate in his Eastern Washington town, and he wonders how much longer this can go on.
"To give you an idea, my wife and I bought a house for $124,000 and in just three years sold it for $163,000, and it only took two weeks to sell," Gonzales said. "That same house could probably sell now -- just six months later -- for $175,000. It's crazy."
As the housing boom spreads to more markets, plenty of people are wondering how long the party can last -- and if they should do something to protect their equity should prices fall.
Here are five options to consider:
Downsize to a more modest home
It's not just for empty-nesters anymore.
Plenty of people are saddled with too much house. They're getting killed by soaring utility bills, ever-rising property taxes or ongoing maintenance and repair costs. They may be struggling with massive mortgage payments, or -- if they have interest-only, option or variable-rate loans -- worried about the payment increases to come.
If you can live with less house, you should consider the possibility of putting the manse up for sale and buying something more affordable (and easier to maintain). Selling and moving will cost you about 10% of your home's value, but you may be able to recoup that cost fairly quickly in lowered expenses on your new, more modest home.
If you buy in the same hot market, you still will have some equity at risk. But downsizing allows you to lock in at least part of your profits.
Move to wide-open spaces
You don't have to settle for smaller quarters, however. You could protect your equity and end up with a lot more domicile -- if you're willing to move.
For what you'd pay for a 550-square-foot studio apartment in a not-so-fashionable neighborhood in Manhattan (around $300,000), for example, you could buy a five-bedroom, two-bath single-family home on a big lot in Manhattan, Kan.
And Kansas cities may be less vulnerable to falling real-estate prices simply because they haven't experienced the wild, double-digit growth seen elsewhere. Home values in the greater Topeka area, for example, have risen just 30% in the past five years, compared to 80% in New York City and nearly 120% in Los Angeles.
The downside: Cheaper markets may not give you as much future appreciation as if you'd stayed put (although that's not always the case; see “ The next hot housing markets” But if your goal is to protect your equity rather than grow it further, taking your home profits to a less frenzied market can work.
Bail out and rent
Of all your options, this is by far the riskiest. Why? Because home prices may never drop, and if they keep climbing, you could find yourself priced out of your preferred market.
Even if prices do drop, you may have locked in less of your profits than you think. You'll have to shell out cash to a landlord rather than using the money to continue building equity. Then there are the transaction costs: 6% or so in real-estate commissions to sell your current home, plus double the moving costs (to your rental, and eventually out of it), plus closing costs on the new place.
If interest rates rise in the meantime, you'll also be faced with a more expensive mortgage or forced to buy less house.
Even if you plan to leave your area in a year or two, you might rethink the idea of selling now unless prices are already falling in your area. Otherwise, you could be bailing prematurely. Housing prices don't collapse overnight; the air tends to come out of real-estate bubbles gradually, which should give you time to get your home sold before it loses too much value.
Another cautionary note: If prices do decline, you may not have the guts to jump back in. It's psychologically tough to buy while others are selling and values are in a free fall. That's why most people are probably better off not trying to time the market.
Throw your home in reverse
This is an idea for older folks who want to lock in their home profits and boost their income.
Reverse mortgages allow people who are 62 or older to tap the equity in their homes without having to repay the money during their lifetimes. (The loan is repaid when the owner dies, sells or moves out of the home permanently, usually from home-sale proceeds.) Borrowers can opt for a monthly check or, as is becoming more common, an equity line of credit they can access whenever they want, said Tom Kelly, author of “The New Reverse Mortgage Formula: How to Convert Home Equity into Tax-Free Income”
A 65-year-old Seattle resident with a $300,000 home, for example, could get a $965 monthly check for life or a $165,500 line of credit.
The amount of the loan typically is based on the current market value of the house. If the house is only worth $200,000 when the homeowner dies or sells, the lender takes the potential loss. If the house rises further in value, though, the homeowner (or the homeowner's heirs) get to keep the added gains.
Another reason to consider a reverse mortgage now: rising rates could decrease the amount of money you get.
"If you're in an appreciating market that you think is going to blow, there's no reason not to do it now rather than wait," Kelly said. "Most likely rates are going up and in some areas prices may go down."
The downside: These loans can be expensive, especially if you'll only be in the home a year or two. Reverse mortgages make much better sense if you plan to stay in the home a decade or longer so you can amortize the costs over a longer period.
Just stay put
Sometimes the best action to take is no action at all.
All of the above actions are expensive, disruptive to your family and possibly unnecessary. As Fed chief Alan Greenspan noted, the "vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices." In other words, if home values drop, most people will be able to ride out the downturn just fine. Eventually, prices should recover and (if the future is any guide) go on to new heights.