Homing in on some painful lessons

By nearly all accounts, the housing market is back. March home prices were nearly 11% higher than a year earlier, according to the S&P/Case-Shiller home price index released last week. Not only was that gain the largest since 2006, it followed a 9%-plus gain in February.

There are other signs of optimism, such as sharp upticks in building permits, new-home construction and the stock prices of many homebuilding companies.

But here is the biggest sign: My 70-year-old mother had hardwood floors installed in her kitchen and on the stairs leading to her basement — something she had wanted to do for years but hadn’t because she couldn’t see the sense in investing in an asset that was continuously dropping in value. She is now contemplating having a gas fireplace installed in her living room.

Oh yeah, housing is back.

If history is any guide, it won’t be long before cocktail party chatter turns to “investment properties” and we are all bombarded with late-night infomercials trumpeting how anyone can flip a home without putting in a dime of their own money.

With home values on the rise, it makes sense to remind ourselves of the lessons learned after the housing bubble burst in 2009 so we can avoid making the same mistakes again.

Lesson one: If anything defined the previous housing bubble, it was that millions of homeowners dipped into home-equity loans to buy fancy cars, boats or even for down payments on second homes. Although using home equity to pay down more-expensive debt can be a solid strategy, house debt should never be used to live above one’s means.

Lesson two: Homeownership isn’t for everyone. Like every financial investment, it comes with risk — not the least of which is the fact that home prices go down as well us up. In most cases, people planning to live in a home for less than five years should seriously consider renting rather than buying.

Lesson three: Appraisers lie — or, at least, they used to. Having obtained a couple of home equity loans in the previous decade, I remember full well how the bank would establish a value that the appraisal needed to come in at, give us the name of a “good” appraiser and then we would receive an appraisal within a few thousand dollars of the bank’s projection.

I didn’t complain, even if my gut told me the appraisal was a little on the high side.

Why would I? I got my money.

Of course, by being quiet I was as complicit as the banks and the appraiser in taking advantage of a system that put homeowners at risk of taking on more debt than they could afford.

Fortunately, the Dodd-Frank Act established better firewalls between appraisers and banks to prevent conflicts of interest.

Lesson four: Potential homeowners should steer clear of mortgage loans they either don’t understand or can’t afford.

Lesson five: Avoid being “house poor.” In buying my first home back in the mid-1990s, I remember that the banks were encouraging me to buy more home than I felt I could afford, and my mother was encouraging me to buy less.

I followed her advice, and, boy, am I glad I did. There is nothing worse than being house poor — spending too much of one’s monthly income on a mortgage.

I am glad the housing market is starting to regain some of its luster. The fact that home values are climbing could offset — or at least minimize — the negative effect on the economy that may come when the Federal Reserve begins to unwind quantitative easing.

But we must not forget the lessons that we learned from the housing bubble.

Frederick P. Gabriel Jr. is the editor of InvestmentNews.