Housing Bubbles and You

I’ve previously discussed the concept of a potential housing bubble in Canada, but apparently that speculation is also going on in a few other places such as well such as China and some fears about the US re-inflating their housing bubble again.

Regardless of if these are real bubble or not since 2008 we have collected learned that a housing bubble can send debt shock waves around the world.  Yet what does it all mean for the average person?  Well here’s my list of some common hazards to a housing bubble.

  1. Buying a House at the Peak.  This is likely the worst case event to have happen.  You get sucked into a buying a house near the peak of the market and then if the market falls you end up owning a house which has a bigger mortgage than what it is worth.  At this point that extra debt you took on at the peak can’t be gotten rid of by selling you have to eat the extra interest and principle costs.  The good news is if you don’t have to move soon you can spread out the pain over a number of years.  The bad news is you still paid too much for your house.
  2. Spread Things Around.  Yes just about every world market got nailed when the US housing bubble burst, but some specific markets in the US did a lot worse for housing prices.  So the rule of diversification still applies, you don’t want all you money in a single country or even city.  Spread things around a bit especially in your real estate investments as you likely have too much money as is in your local real estate market compared to the rest of your assets.
  3. It’s Better to be a Lender than a Borrower.  Owing debt sucks  since you are at the mercy of others for interest rates and getting credit.  Especially so when the credit markets start to cease up.  So keep your own borrowing to a modest level and keep a decent credit history they can come in handy when things get tough.  Also some fixed income investments is a good idea for just about everyone since bonds actually did well overall in 2008/2009 and so provided a nice hedge.  Just don’t forget point #2 above still applies to bonds as well.
  4. Panic.  The top risk to you in a housing bubble collapse is very simply just one thing: you.  So regardless of how bad things are looking remember to NOT PANIC.  The trick to avoiding panic is having a plan and sticking to it or even selectively ignoring the news for a few weeks.

So that’s the obvious hazards I see in housing bubbles.  As you might have noticed there isn’t a lot of difference to them to most other risks to your financial health.  What else would you add to that list?

4 thoughts on “Housing Bubbles and You”

  1. I think what most people forget is that #1 only applies if you’re buying your first home. If you’re buying your second home, you also sold your previous home at peak… It’s different if you relocate to a different region, but if you upgrade within the same region, chances are that both your previous and new house are at a peak or a low, making the size of your new mortgage pretty much the same anyways.

  2. It should also be noted that renting is not “throwing money away.” Sure you don’t own, but most of your “ownership payments” (mortgage) are interest for the first half of a mortgage. Plus, in expensive areas, most rents are well below buyers prices. If you put the difference in the market and waited 15 years in many cases you would be further ahead. Don’t fall for the realtor sponsored commercials.

  3. Regarding #1

    I don’t believe Chris’ correction is actually true:

    Selling and rebuying isn’t the only option, just because you owned a property and sold at the peak doesn’t mean you didn’t have the choice to wait and put your money to other use while renting. Buying the new property puts you in a similar situation as keeping the first except your worse off because of transactional costs (realtor/lawyer/gst/transfer tax/moving expenses)

    A very similar argument is used by people with investments who say something along the lines of “I know my investment went down, but I haven’t sold so I haven’t REALLY lost any money yet”. Buying a different property doesn’t mean you didn’t lose money when the market drops.

    As to Tim’s original argument for #1, that “extra debt you took on at the peak can’t be gotten rid” is only true if you put a very small down payment and are now underwater. If you sell, the loss is taken from whatever principal you put into the property.

    If the market really sinks then you better hope your no longer under water by the time you have to renew/refinance because you wont be able to, it’s against financing rules for anything over 95% of the assessed value. You’ll be forced to sell, realizing the loss and then be on the hook to repay the bank/lender the difference or declare bankruptcy.

  4. Sorry for the delay at my response here, I’ve been out of town.

    @ Chris,

    Excellent point. Staying in the same market makes almost no difference less your move costs in a given year. Over the long haul you can still pay too much by moving during a market peak, but if it is your second home that would be somewhat offset by the first home. Instead of over paying for the full amount you would only over pay for the upgraded amount.

    @ Chad

    Of course not buying is always an option and hell in some places it’s a damn good idea. It just depends on your situation.

    @ Jordan,

    Thanks for clearing up my point #1. You are correct I mainly aimed that statement at home buyers with low down payments. For those with 20% or more down the risk drops off significantly but still remains in the case of a large correction.

    Tim

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