When bubbles burst, some win, some lose
When a housing bubble bursts, two things separate winners from losers: timing and the debt level.
Timing matters because the losers are those who end
up selling their homes after values fall and before prices rebound. The
winners wait longer and keep their homes until values recover. Whether
they feel like winners is another matter: Some people end up financially
trapped in their homes, wishing they could move, but unable to afford
As for the debt level: that's a plain-spoken way of referring to the debt-to-equity ratio. The higher that ratio, the deeper the trouble you can get into. It's safer to borrow 75 percent of the purchase price ($150,000 for a $200,000 house) than to borrow 90 percent ($180,000 for a $200,000 house).
Timing is partly out of your control because you can't dictate when prices collapse. Timing is partly under your control, though, because you can elect not to buy a house, if you think you would own it for only a couple of years.
While timing isn't fully under your control, you can manage your indebtedness. Imagine debt as water that's flooding your neighborhood. If you make a 20-percent down payment when you buy the house, the water is just below the eaves. In case of emergency, you can scramble onto the roof. But then you get a home equity loan worth another 10 percent of the purchase price. Now only the top of the roof is above the water. In an emergency you'll sit on the roof's peak as water laps at your toes.
The hard way
One way to avoid the pain of a burst housing bubble is to make a substantial down payment. If you put 20 percent down and the value has dropped 10 percent by the time you sell it, you'll sell the house at a loss. Bad luck, but your out-of-pocket expense, even after paying a real-estate commission, will be minimal or nonexistent. In fact, you might end up with a few bucks in cash after you sell the house, retire the mortgage and pay commissions. (This is assuming that you don't take out a home equity loan.)
On the other hand, if you put 5 percent down and have to sell the home after it has lost 10 percent of its original value, you'll have to come up with cash to satisfy the mortgage and pay any real-estate commissions. Failure to pay off the mortgage in full could result in a messed-up credit record for years.