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The recent increase in property values has a lot of people talking. Everyone seems to have seen a home in their neighbourhood sell for far more than they would have imagined a year or two ago. The high price reflects an overall increase in property values across the board. But what does this increase mean for homeowners?
Of course it means that you could sell your home for more, but what then? Because most people have a mortgage, your home is a leveraged investment. Changes in the value of your investment are magnified because you are using borrowed money for a portion of your investment.
If you are downsizing, this can be great. Say you have a home that was worth $300,000 two years ago and you have a mortgage of $150,000. Now that home is worth $600,000. Equity has risen to $450,000. If you sell your home and purchase one worth $450,000, you may have less home, but you will have no mortgage. For empty nesters or people retiring, this can be a great advantage of a rising market.
But, if you plan to upgrade, the rise in property values can make it harder. Although your property has increased in value, more expensive properties have generally increased more.
Let’s use our same example, a home that was worth $300,000 and mortgage of $150,000. We will assume you want to buy a home that is twice as nice. What would have cost $600,000 now costs $1.2 million. If you use your $450,000 equity as a down payment, you are left with a mortgage of $750,000. You may have a home that is twice as nice, but your mortgage is five times greater. Even if you can afford the mortgage payments now, will you be able to afford them if interest rates rise, as is predicted over the next few years?
If property values keep rising, you may be able to leverage your investment in your home into even greater equity. But if property values fall, if interest rates rise, or if you need to redeem your investment at a time when the market isn’t as strong, you can end up on the wrong end of the financial lever. Consider whether you are comfortable risking your home.
Even if you do not intend to move, increasing property values can lead to temptation. There is the temptation to increase your standard of living, to consider yourself richer than you were. Your income doesn’t rise just because your home is worth more, but lenders may tempt you to borrow against that increased equity. They will encourage you to pay off credit card debt with lower-rate credit lines using your increased home value as security. This isn’t necessarily a bad idea, but if it is used as a way to spend more than you earn, it can become part of a cycle. If you are not careful and regularly pay off consumer debt with equity loans, your home equity will be diminished.
Others may tempt you to use your increased equity to borrow for investment purposes. Again, this isn’t necessarily a bad idea. As with all significant financial decisions, you would want to consult your business advisor or accountant. But you must recognize that you are further leveraging yourself. If the investment works out well, it can be good. If not, your home is at risk.
So, what does the increase in property values mean? Most people have the same home and mortgage as they had before. Values for property tax purposes will go up, but generally governments don’t increase their total taxation when property values go up, they simply change the mill rate. So property taxes will stay generally the same. Increased property values give an advantage for those who want to downsize and it will make retirement planning easier. But avoid the pitfall of significantly changing your lifestyle just because your house is worth more. After all, Taking Care of Business starts at home.
By Wendy Lewis, CA. Originally published in Comox-Valley Record (April 11, 2005). For more information on this topic, please contact the MNP office nearest you or Wendy at 250.338.5464.
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