While the hope is that your real estate holdings will go up in price, every investment carries the risk of losing value. Just because your real estate's price goes down doesn't mean that it will impact you in any way, though. The key consideration is whether or not you need to tap into the value before it recovers. The amount of money you owe on your property also determines how a loss of value can affect you.
Asset values fluctuate up and down on a regular basis. However, many of these fluctuations don't matter. Your house still provides you and your family with shelter regardless of whether it is worth $550,000 or $150,000. An investment property's ROI also won't change just because its market value changes. Since many investors, as opposed to flippers, look at real estate as an asset to be held over the long term, you might not need to worry about a drop in value if you don't plan to sell the property and realize the loss.
When you owe money on your real estate, it can increase the impact of a loss of value. When a $550,000 house goes down to $450,000, it has lost 18.2 percent of its value. However, if you have a $400,000 loan on the property, your equity will go from $150,000 to $50,000 -- a loss of 67 percent of your equity. This is the downside of leverage -- it magnifies market swings in both the upward and the downward direction.
Refinances and Balloons
A decrease in value can impact your ability to refinance your property. This is problematic for owners that have adjustable rate loans that they want to lock by refinancing into a fixed rate loan, since it could prevent them from having enough equity to qualify. It's especially dangerous if you have a balloon mortgage that has a large final payment and needs to be refinanced. If your loss in value prevents you from refinancing your balloon, you can end up in foreclosure and lose your house.
Personal Net Worth
When your real estate value decreases, it impacts your personal net worth, which is calculated by subtracting all of your debts from the value of all of your assets. Your personal net worth is important if you are applying for certain types of loans. In addition, some investment opportunities, like the purchase of many franchises, are tied to your net worth and if you don't meet the threshold, you won't be able to invest. On the other hand, the Securities and Exchange Commission's standard for becoming an "accredited investor" uses net worth but excludes your personal residence, so you should still be able to invest in unregistered securities if the only real estate that you own that lost value is your house.
- BetterExplained: Understanding Debt, Risk and Leverage
- The Mortgage Professor: On Balloon Mortgages Coming Due In the Post-Crisis Market
- Michigan First Credit Union: Personal Net Worth
- Franchising.com: How To Calculate Your Personal Net Worth
- US Securities and Exchange Commission: "Accredited Investor" Net Worth Standard
- DaveManuel: Definition of Paper Loss
- New York Times: An Investor Adjusts His Ambitions
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