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Always dreamed of being in the right place at the right time? You may be right now.

Bubble fear? Rethink your mortgage
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Even so, if values decline, but you love your home, can make the payments, and don't have to move, you'll be OK, says Jack Guttentag, professor emeritus of finance at the Wharton School and author of "The Mortgage Encyclopedia." The ones who really stand to take a hit: speculators who borrowed as much as they could and are counting on selling in a very short window.

"It has a lot to do with the mortgage product you're carrying," says Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard University. "With a fixed-rate mortgage, you have some insulation from interest rate increases." Be careful with adjustable-rate loans "in what could be a rising rate environment," he says, especially if they are "not in sync with what future earning capacity will be."

Generally speaking, decreasing home values can hurt you in one of two ways:

  • You can't sell the home for what you paid (meaning it will actually cost you money to sell); or
  • Falling values come with increasing interest rates and you can no longer afford to make the payments. Depending on how far prices have dropped and how much equity you have, you might not be able to afford to sell.

"The worst-case scenario is that you're sitting there with very little equity and an adjustable rate at the top of the market," says Schenk. And if you have more than one house, the danger is multiplied. "The more leveraged you are, the worse your position."

Equity and the danger zone
Equity is a great shock absorber. The more you've built up, the better shape you're in if prices do start to drop. For example, if you have a $300,000 home and have $200,000 in equity, that means you could sell it for $100,000, plus the selling and moving expenses, and you wouldn't pony up any money.

So how much equity does it take to insulate you from a bubble? The more the better. A lot of it depends on just how fast prices on your home could drop.

The danger zone: less than 15 percent equity, says Ilyce Glink, author of "50 Simple Steps You Can Take to Sell Your Home Faster and For More Money in Any Market." Any time you've tapped 85 percent to 90 percent of your equity, "you're a little bit at risk," she says.

Ideally, you want enough equity to cover the drop in value, so that you always have the option of selling. And you want to build in at least 10 percent to cover selling costs (real estate commissions, sales costs, moving expenses, etc.), so that you have a little margin of error.

Generally speaking, the priciest homes are the ones that suffer most when a real estate bubble bursts.

"In any correction, the people at the top of the market will be the ones to feel the most pain," says Schenk. "You always have people moving down from the top when there's a correction."

Dana Dratch is a freelance writer based in Atlanta.

-- Posted: March 1, 2006
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