Foreclosure, and How to Avoid It

Dear Ali:
Since house prices have dropped, I'm considering buying a home. How do I make sure I won't end up in foreclosure?
A: Fear of foreclosure is a legitimate concern, especially given news reports such as the one in BusinessWeek, from data supplied by foreclosures.com, that there were around 1 million foreclosures nationwide in 2008.

However, as you read many of the individual stories -- such as the recently publicized L.A. Times tale of a California couple who spent $63,000 for a "dollar house" -- you'll realize that many foreclosures have a few things in common. Following just three simple rules may save you a lot of heartache:

• 1. Don't spend too much money. My rule of thumb is to limit yourself to a loan balance of 2 to 3 times your annual income. People who thought that they would never own a house, and then take a mortgage of 4 or 5 times their yearly income, may find that they have a tough time holding on to it when the wind shifts.
• 2. Don't buy a home on a fixed income. Houses break, they leak, garages need fixing -- all things that are manageable if there's a raise in your future, or you have the ability to work a few weekend hours until the contractor is paid off. When you have no way to increase your income, though, every unexpected repair can be a major squeeze.
• Don't treat the equity in your home like it's found money. This is a common mistake -- the couple in the dollar home article refinanced their home after prices rose, and then gambled away their equity at various casinos. (Ouch!) This is not just a mistake of the poor and unfortunate. I once had a Hollywood client tell me that since she had a home equity line on her California home, it was like "money in the bank."
Yes, it is, but it's the bank's money -- not yours -- and if you spend it, you'll have to repay it. So don't spend it.