David Bach The Automatic Millionaire

After my last column on home ownership appeared, I got a ton of e-mails from excited and upset readers. Many suggested that it's simply too late to buy real estate.

Well, I feel that it's never too late. The secret to real estate is timing, location, and financing. So, this column tells you how to protect yourself against a real estate slowdown.

Home prices have had an amazing run. In the fourth quarter of 2005, residential property prices posted double-digit increases in 72 metropolitan areas. That's a record that the National Association of Realtors says may mark the "peak of the boom."

Even the new Federal Reserve Chairman Ben Bernanke told Congress recently that a "leveling out or a modest softening of housing activity seems more likely than a sharp contraction."

What should you do now? Fortunately, there are ways you can bubble-proof your home from these down cycles. Just follow these five steps outlined in my latest book.

1. Make sure your mortgage is affordable

Don't buy a house you can't afford. According to SMR Research, more than 70 percent of all homebuyers borrowed over 80 percent of the purchase price in 2004. One in three homebuyers took adjustable rate or interest-only mortgages. And in 2005, we saw a shockingly high number of purchasers -- 48.2 percent --buy homes with no money down.

Those can be risky tactics if real estate prices go down. When interest rates rise and home prices plummet, some homeowners suddenly can't afford their mortgage payments as payments may jump by 25 percent to 75 percent. Suddenly, their homes are worth less, and they can't sell or they'll lose money.

It's a scary dilemma.

But there are warning signs you can heed. They include putting no money down, taking an interest-only mortgage, or using an option mortgage where you're only paying the minimum allowed. Also, your savings cushion should be able to cover six months worth of mortgage payments.

There's nothing wrong with stretching to make payments. But, you need to think sensibly by considering these red flags when buying a home in a hot market.

To play it safe, you'll want to:

• Know what type of mortgage you have and when the loan comes due. That's especially true if you have an ARM (adjustable rate mortgage).
  
• Know what the ARM rate adjustments are and when it changes.
  
• Estimate whether you can afford any adjustments today. You can do this by contacting your mortgage company and asking it to run an estimate of what could happen if your rate readjusts.
  
• Lock in your mortgage rate, either with a fixed rate or 15-year or 30-year loan.
  
• Refinance while rates are still low if you have an ARM.
  
• Pay a little extra on your mortgage each month, and shrink the principal.
  
• Start paying off the principal if you have an interest-only loan.
  
• Borrow equity out of your home to build on your assets e.g. buy more real estate, improve your current home. Be careful about using your equity to pay off credit cards, buy a car, or for day-to-day expenses.

2. Think local

In the end, your real estate market is the only one that matters. Nationally, average home prices can fluctuate as much as 50 percent. But, it's more important to know what your home or condo is worth in the city, neighborhood, or even building where you live.

Stay on top of your market by reading the real estate section in your local newspaper every week. Find out if there are there lots of homes like yours for sale. Are they selling quickly or slowly? Are the same homes for sale week after week?

Also, you can drive around your neighborhood and check for "for sale" signs. Are they posted everywhere? Or are there only a few? You'll be able to tell whether homes are selling well.

Perhaps the best way to scout out the market is by attending a half-dozen open houses. You can get a quick feel for the market by talking to real estate agents and asking them questions. "How many people attended?" "How's the market?"

If your market is hot, you needn't worry. If it's deflating, you should be careful not to overextend yourself.

3. Get the facts

There are a handful of key facts you should know about your market. What's the housing inventory? Which homes are selling well? How long are homes sitting on the market? A good real estate agent who specializes in your area should be able to answer these questions quickly. Here are the key points to discuss.

• Inventory: It pays to know how many homes like yours are for sale in your neighborhood. You'll need to compare homes by size, age, quality, and style. If more than 15 percent or 20 percent are similar to yours, you may have difficulty selling for top rates.
  
• Price: Find out what homes like yours are selling for by getting "comps." If you're thinking about selling soon, have your real estate agent send you monthly updates on comparable home prices.
  
• Time on the market: Are homes moving faster or slower? Selling agents can tell you.

4. Forget trying to flip a house

Buying a new condo or building in a hot market and hoping to flip it for a quick profit can be risky. You may flop instead. A few months or years later when the housing markets cool, you could find yourself in a bind, unable to sell. We're already seeing signs of a condo slowdown in markets like Florida and Las Vegas.

And if you think you'll just rent out the property if you can't sell it, get the facts and think again. Rental markets fluctuate just like home prices. If you buy a rental property, it must be able to generate enough cash flow to cover mortgage payments, taxes, insurance, brokerage fees, management fees (if any) and maintenance. Otherwise, you could find yourself locked into a mortgage you can't afford.

Remember, when buying real estate focus on cash flow. Appreciation happens over time and can't be counted on short-term. "I'm buying this property because it's sure to go up," is not an investment strategy. In fact, it may be a recipe for financial disaster.

5. In most cases, time cures all

Over the long haul, areas that go bust generally come back. Still, every area has its bleak periods that can seem endless -- even in great cities.

For example, in 1970 the real estate market in New York City was brutal. Then it boomed again in the early 1980s. Then it went bust. And in the early 1990s, you couldn't give away a condo. One friend borrowed money from her father to buy a brand new, three-bedroom condo on the chic Upper East Side for $180,000. Today, it's worth over $2 million.

But the property didn't appreciate overnight. In fact, appreciation took nearly 15 years, and most of it happened in the last five years.

Real estate can be a great tool for building wealth over your lifetime. And, lifetime is the key word. Most people who try to get rich overnight go broke quickly. But over time, real estate will likely be the best investment you'll ever make.

What if you don't know where you'll be living in 10 years' time? It still makes sense to own your own home. Here's why: Hefty tax breaks, an automatic savings account, and a foothold in real estate. Use the "rent vs. own" calculator at BankRate.com or Yahoo! Finance to see exactly how much money you can save in just a few years.

True, real estate sometimes dips. And you have to pay fees, closing costs, and property taxes. But I've met many people who think they'll be moving in a few years -- and five years later, they're still there and have missed a chance to build wealth through home ownership. So, run the numbers for your situation -- chances are they'll tell you to stay in the game.

Just ask your parents and grandparents if they wish they'd purchased more real estate. My guess is they'll say yes.