What the subprime mess means to you

January 18, 2008

A quick review of the genesis of this financial crisis will help explain how you can avoid the growing snowball.

Key Points

Like an avalanche picking up speed, this "subprime mess" we're in the middle of can plow down most anyone in its path. A quick review of the genesis of this financial crisis will help explain how you can avoid the growing snowball.

What happened?

It all started with low interest rates, which made homes affordable for more people. In turn, demand increased and prices skyrocketed. Lenders willing to write "subprime" mortgages for borrowers with questionable credit followed. Then . . . presto! Thousands of buyers who normally wouldn't have been able to get a mortgage on their own were able to realize the American Dream.

What does it mean to you?

While many experts are predicting a full-blown recession as a result of housing market stagnation, let's talk about the immediate effect of these events. If you're looking to buy a home, you'll be in a great bargaining position if you've got excellent credit. If your credit is less than stellar, however, don't expect the underwriting process to be easy. Many hopeful borrowers will be turned away, while those who aren't will pay higher interest rates. And, if you're looking for a "jumbo" mortgage (generally, one that exceeds $417,000 for a single-family home in 2008), you'll pay an even higher premium over the rate on a smaller mortgage.

If you want to sell your primary home, don't wait for the market to turn around. I'm advising my clients to "take the hit" and sell if they need to move. But for most people, it really isn't a "hit" after all. Suppose you bought your home for $250,000 five years ago. If it was worth $600,000 last year, but fell to $500,000 this year, you're still doubling your money.

Real estate investing

Now's the time to whittle down your real estate holdings, such as REITs and homebuilder stocks. Because I expect both real estate stocks and private property values to drop further, I recommend you limit this asset class to about 2.5 percent of your total portfolio, down from the usual 5 percent.

As a value-oriented investor, I'm salivating over the prospect of eventually purchasing distressed real estate for both current income (through rents) and potential long-term gains (through sales). Over the next few years, I'll also look to buy more shares of homebuilders, like Toll Brothers, Pulte Homes, and Lennar, but only after their prices fall to half or less of their book value per share. You can find price/book ratios at http://www.Morningstar.com or Yahoo! Finance ( http://www.finance.yahoo.com).

I'll keep watching the real estate market closely and, as history has taught me, I'll buy only when people start saying "you can't make money anymore in real estate."

The author, a fee-only certified financial planner (CFP), is president of L.J. Altfest & Co. ( http://www.altfest.com), a financial planning and investment management firm in New York City, and an associate professor of finance at Pace University. The ideas expressed in this column are his alone, and do not represent the views of Medical Economics. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics, 123 Tice Blvd., Woodcliff Lake, NJ 07677-7664. You may also fax your question to 201-690-5420 or e-mail it to meinvestment@advanstar.com
.