How to Protect Your Home Investment

Of course, no one knows where real estate prices will head in the future. But no matter what real estate prices are doing in the neighborhood, for many individuals, their homes continue to be their largest asset and a major contributor to building net worth. Like all investments, you should develop strategies to manage your home asset prudently.

keys with a red "house" key chain

Here are some "Dos and Don'ts" to consider when buying a home and after you've taken the leap into home ownership:

Don't stretch to purchase the largest home you can. The reason homes have contributed significantly to the net worth of many people is that owners retain any price appreciation on their entire properties, even though they only put down 10 to 20% of the purchase price. This fact has caused many people to strain their budgets and purchase the largest home they can afford, hoping the increase in the value will more than offset the sacrifices made along the way.

Before embarking on such a strategy, be aware of all the risks. If home prices start to fall, you could end up owing more than you can sell the home for (see right-hand box). If your budget is strained to the limit, you might not have money left over to contribute to a retirement account or college savings plan. It may be better to purchase a home you can comfortably afford.

Do take into account all monthly payments before buying a home -- not just the mortgage. Include homeowner's insurance, flood insurance, mortgage insurance, utilities, garbage, cable TV, unexpected repairs, taxes and any other obligations.

Don't take equity out of your home in the form of a home-equity loan or a higher mortgage balance without careful consideration. While lower interest rates have allowed many homeowners to reduce their monthly mortgage payments, many have also opted to take equity out of their homes and stretch mortgage payments over longer periods. One of the main advantages of home ownership is that it's a forced savings plan, with part of every mortgage payment going toward equity. Resist the urge to take the equity and spend it on something else.

Do investigate refinancing when interest rates go down. Even if you refinanced a year or two ago, it can be worth looking into again.

Rule of thumb: If the rate on your mortgage is more than 1% higher than current interest rates, the cost of refinancing may be worth it.

However, there are no hard and fast rules that fit everyone. Your potential savings depend on many factors, including the new interest rate, the length of the new loan, your tax bracket, whether you refinanced in the past two years, how much you've paid down your current mortgage, how long you plan to stay in the home and a variety of up-front charges.

Review your options before selecting a mortgage. For example, should you get a fixed rate versus an adjustable rate? A 30-year mortgage versus a 15-year term? Don't be fooled by claims of no-cost loans. There are almost always up-front costs, although they may be rolled into the mortgage payments. And check with lenders to see what rate-protection options are available. It generally takes between 30 and 45 days for a refinancing transaction to be complete. If rates fall during that time, you might be able to get a lower one if you've started the transaction. Or conversely, you might be able to lock in the current rate if interest rates go up.

Do make sure you have adequate insurance. Your homeowners insurance policy should be sufficient to completely rebuild and refurnish your home in the event of a total disaster. Check the limits of your policy every year and increase them if needed. You will probably want a guaranteed replacement clause, which pays for the entire cost of rebuilding your home.

Do inventory everything in your home. You can either write down or videotape the contents. Include everything in your home, systematically working your way around each room. Keep receipts for larger items with the inventory. This will help substantiate a claim if your home and contents are ever destroyed.

Bottom line: On a long-term basis, a home is generally a good investment. By properly managing it, you can make it even better.

Appreciation Blues

Before buying a house, think hard about whether you'll have to sell in the near future. If so, the home may not have appreciated enough to cover the costs and commission of selling. That's especially true if you come up with a down payment of 10% or less.

With realtor commissions running around 6% of a home's sale price, and the seller's closing costs coming in at about one and a half percent, these costs could easily exceed the first year's appreciation. The worst scenario is that you might even have to come up with out-of-pocket cash to sell your home.

Don't Buy Too Soon

If you're moving to an unfamiliar area (say, across the country for a new job), hold off buying a house until you get your bearings. Before making a down payment, it makes sense to rent for a while until you can scope out the neighborhoods, schools and local amenities.

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