7 Real Estate Risks: Are They Over- or Under-Estimated?

We tend to speak of the risks of various courses of action in black and white, as risky or not. But the truth is, everything in life has risks - even doing nothing! Behavioral experts, economists and my dear old Dad agree: we’re most likely to make decisions we later regret when we under- or overestimate the risks of the outcomes we hope to avoid. So, outside of extremely high-risk endeavors like base jumping and going on blind dates, the real challenge in life is not to avoid risk entirely, but to assess it accurately and manage it accordingly.

This need to assess and act on risks appropriately, neither overblowing them or blowing them off entirely, is particularly critical when it comes to real estate risks. It’s easy to let your personality determine how you view and manage real estate risks. But that’s a costly approach: if you let your personal tendency to be risk averse stop you from ever owning a home, you will also miss out on the personal and financial advantages of home ownership, and the opposite is true. If you take a devil-may-care attitude toward your real estate and mortgage matters, you’re highly likely to make some highly regrettable decisions along the way.

So, instead of going on risk assessment autopilot, let’s take a quick, yet deep, dive into seven of the real estate-related risks that come up the most often in the minds of smart buyers, sellers and owners like you and how you can manage each of these risks wisely.

Risk #1: The Risk of Foreclosure. The risk of losing a home has only recently moved to the front of our collective national consciousness. Foreclosure was once a very, very rare event, seen as an unlikely worst-case scenario. But it became a vivid nightmare come true for an all-time high number of home owners during the recession. The risk and fear of foreclosure is largely due to this increase in foreclosure rate over the past few years, and to the vivid, catastrophic nature of the event. Also, almost everyone knows someone who either lost a home or had serious mortgage distress, so it seems like a very common occurrence.

When we take a look at the facts behind this risk, we realize that the risk of foreclosure appears to be much higher than it truly is. There are roughly 76 million owner-occupied homes in the U.S., according to the Census Bureau. Earlier this year, real estate data firm CoreLogic revealed that there had been 3.4 million foreclosures since 2008. That would mean only about 6 percent of homes in America had been through a foreclosure - and this, through the very worst recession of most of our lives.

The more probable risk is the risk of ending up underwater, which more than 25 percent of American homes were at some point during this past 5 years.

The fact that home values rise and fall cyclically is not a risk or a probability - it’s a fact of the real estate market, and one that you can’t do anything about. Your aim should be to manage and minimize the risk of serious mortgage distress (i.e., struggling to make the payment) or foreclosure. And you have the power to manage these risks by:

• Making smart mortgage choices. Buying at a price well within what you can afford, selecting a mortgage that your household finances can sustain over time, and not overleveraging by borrowing cash against your home equity for things like cars, clothes or ready cash.
• Making smart financial moves over time, including building a cash savings cushion you can turn to if a job loss or disability interrupts your income.
• Buying a home in as desirable a location as you can afford - and in an area with strong prospects for economic and population growth.
• Making small, extra payments to bring down the principal balance on your loan, if and when you can afford to.

Risk #2: The Risk of Overextending Yourself. This is a very real risk - more real, even than the risk of actually losing a home. Home buyers can overextend themselves when they take loans that give them falsely low upfront payments;. This was common in the subprime era that many believe led to the recession, but is less likely with today’s tighter lending guidelines and narrow loan programs...
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