'Overpriced' homes become debt traps

Just when your stock portfolio hits a new bumpy trough of performance, those friendly folks at the local bank are offering a soft pillow of relief.

Need a little extra cash to fix up the house? Sign up for a home-equity loan.

Going on vacation? Don't put it on a credit card. Open a line of credit instead.

Not only do you get a low rate – sometimes 4.75 percent or less for the best customers – it's also usually tax-deductible.

Now, some experts are raising warning flags about housing values. Their advice: Don't bank on your house continuing to rise in value. Depending on where you live, it may be overpriced already.

Consumers should approach low-cost home loans and lines of credit with caution, credit counselors say. Although they can help lower monthly payments if used judiciously, those tempting offers can also lead to more burdensome mortgage debt. And unfortunately, an increasing number of Americans appear to be taking on larger and larger amounts.

They're buying bigger homes and taking on bigger mortgages. According to new census statistics, the fastest-growing segment of homeowners during the 1990s was the group carrying the heaviest mortgage debt load. And as many Americans have found out – often from bitter experience – you can't always count on rising housing prices to bail you out.

Consider Connecticut. Hit by recession in the early '90s and the downturn in post-cold-war defense spending, the state saw housing prices swoon. As a result, people carrying huge mortgages suddenly found themselves in deep trouble.

"We had folks coming through the door that owed more on their house than the house was worth," recalls Ron Ramos, director of counseling for the Consumer Credit Counseling Service of Southern New England.

And getting them out of debt meant making stark choices: giving up a luxury car, private school for the children, even sometimes the house itself with no cash to show for it.

By 1999, Connecticut's housing market still hadn't clawed its way back. According to census figures, the typical single-family home (not including condos and other kinds of houses) actually was worth $133,000 – $500 less than in 1989.

Factor in inflation, and 11 states saw their housing values fall during the period, including California, Hawaii, and a swath of East Coast states from Maryland all the way up to Maine.

More recent evidence suggests property values in many of these areas have gone back up. What economists are debating now is whether other states are ripe for a bubble-bursting swoon.

Optimists say it's unlikely. For one thing, housing markets don't operate like stock markets. They are local and less liquid. So a real-estate boom in, say, Florida, has little if any effect in Illinois. Thus, any impact from a sudden collapse in housing values would probably be limited to a specific metropolitan region.

"There is absolutely no housing bubble on a national basis," says David Berson, vice president and chief economist with Fannie Mae, the nation's largest provider of mortgage funds, based in Washington, D.C. There are only a few places where a bubble might exist, he adds.

The big question: how many of those places there actually are.

Mr. Berson points to surveys from the Federal Housing Finance Board showing that home buyers have pulled back somewhat from putting little money down for real estate.

In the mid-1990s, the average downpayment was just under 20 percent. Today, it has risen above 23 percent. And while it's true many people are refinancing and pulling cash out of their existing homes, Fannie Mae's internal data suggests that on average they still have more equity than when they bought the property.

Other analysts are more skeptical. "There are a lot of markets that are in a housing bubble," says Ingo Winzer, president of Local Market Monitor in Wellesley, Mass.

Mr. Winzer tracks the relationship of income to housing prices in 120 local markets. And right now, he says, 45 percent of them are overpriced – a record.

"People right now apparently are willing to go into debt more than ever to buy a house and other stuff," he adds. Among his top overpriced markets: Boston, San Diego, Detroit, and Denver.

In a recent report, Ian Morris of HSBC Securities in New York warned that housing prices had reached new highs. For every dollar of disposable personal income in the United States, there's $1.62 worth of residential real estate. The disparity hasn't been that wide in at least 50 years, Mr. Morris warns.

This willingness to accept higher levels of debt has been building for some time. And some of the biggest rises in mortgage debt this past decade came in states that experienced the largest boosts in real-estate prices.

Take Utah. Between 1989 and 1999, it saw the price of a typical single-family home rise by 64 percent even after accounting for inflation. Meanwhile, its number of heavily indebted homeowners more than doubled. By the end of the decade, almost 1 in 6 of its homeowners spent at least 35 percent of his or her monthly income on mortgage payments, real-estate taxes, and utilities.

In Washington State, 1 in 3 homeowners fell into the 35 percent and over category.

"That's actually pretty high," says Ed Pearce, executive director of Consumer Credit Counseling Service of Columbia in Columbia, S.C.

Until the past few years, the rule of thumb had been that housing costs should not exceed one-quarter of one's monthly paycheck. "What we're seeing is a lot of people attempting to live above their means," Mr. Pearce says.

In half the states, the fastest-growing type of house during the '90s was also the largest: nine rooms or more.

The rise in housing prices and sizes won't disturb the economy as long as people have jobs that allow them to afford these homes, mortgage experts say.

Unfortunately, these experts are far more adept at projecting mortgage payments 30 years into the future than in forecasting the next quarter's unemployment trends.

How to avoid becoming 'house poor'

When home-equity offers come in the mail, Larry Quandt throws them away unopened. "Once in awhile you take a look, but you usually find a 'gotcha' line in there," says the retired southern Illinois farmer.

Farmers know about "gotcha."

After loading up on rapidly appreciating farmland in the 1970s, many had to sell out in the '80s when land values fell 60 percent and more.

Do today's homeowners face similar dangers?

First, the good news. The value of the average American home has never fallen in any year since at least the late '60s (and, quite possibly, not since the Great Depression). And demand isn't drying up. The National Association of Realtors expects sales of new and existing homes to set records this year.

While housing prices have dipped from time to time in some local markets, it takes some external shock – usually massive layoffs – to send prices tumbling. High or rapidly rising housing prices don't necessarily foretell trouble.

Unfortunately, there's no sure-fire method to predict the next recession. So the best way to avoid a nasty surprise is to ensure you're not taking on too much house debt. If you're spending more than a quarter of your gross household income on mortgage payments, real-estate taxes, and utilities, then it's probably time to take stock.

Feeling squeezed? Do debts keep building? If so, credit counselor Ron Ramos has two words for you: "Stop borrowing."

"Clearly, the refinancing of your mortgage is a great quick fix," says Mr. Ramos, director of counseling for the Consumer Credit Counseling Service of Southern New England. "But have you cured the challenges that have gotten you into this?"

One way to find out is through professional help. Seek an accredited credit-counseling organization that doesn't charge big fees. "If it's in excess of $100, take a closer look," says Ramos, whose Boston-based outfit is accredited by the nonprofit National Foundation for Credit Counseling.

Counselors typically analyze current spending habits then find areas that could be cut. If necessary, they design a debt-reduction plan. Creating a realistic budget and sticking to it will go a long way toward curing bad habits. Increasingly, Americans are carrying heavy mortgage burdens. But a few common-sense steps can keep your home from becoming a crushing load.

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