Homeowners Hanging Upside-down

by Robert Franco

March 03, 2008



I heard this on CNN over the weekend: "More than 30 percent of U.S. homeowners who bought in the last two years owe more on their mortgage than their house is currently worth." I found that figure staggering, so I did a little research. Here are some statistics that I found.

On average, homeowners had 56.3 percent equity in their homes in 2005, according to Demos, a public-interest research group. In 2007, that dropped to 50.4 percent. In 1973, equity averaged 68.3 percent; in the 1950s, it was upwards of 80 percent.

Why? Good question! For starters, homeowners are starting off further behind than they have in the past. It was once considered standard practice to put 20 percent when buying a home. Now, however, many opt for 100 percent financing. Starting with ZERO equity is a sure way to end with less equity than generations before us. And, when home prices drop it makes it pretty darn easy to wind up upside-down.

But, starting out that way isn't the only way to tumble over - Americans are tapping their home equity like a beer keg at a Delta Tau Chi frat party. (Useless Trivia: Delta Tau Chi was the full name of the fictional Delta House fraternity from Animal House.)

U.S. property owners took out $318 billion of equity from their homes in 2006 by refinancing home loans, according to Freddie Mac, the world's second-largest mortgage buying company. Add to that $146.2 billion lent in home equity lines of credit, according to the Federal Reserve.

In all, $2.2 trillion of home equity has been liquidated since 2001, which was the first of five years of record-setting house prices and sales.
(From: Housing Slump Puts Mortgages Underwater)

It is certainly not a good trend. It is no wonder that so many Americans are loosing the American dream in foreclosure. As so many people drained the equity in their homes, or never really had any to begin with, the home price declines we have seen really began to take their toll. The old rules of requiring 20 percent down may have kept many people from being able to afford to buy a home, but it did protect them from short term lulls in the housing market - it also protected the lenders.

It really isn't surprising that Americans are using their home as their personal ATM machine to supplement their income. And, who could afford a 20 percent downpayment today? The cost of a home has increased far more than household income. Check out the Mercyman53's Weblog.

Here is the crux of the whole matter. A new house cost 1050% more in 2006 than in 1970. That means a new house in 2006 was 10 times more expensive than one in 1970. By comparison, the median household income increased 452% between 1970 and 2006. The 600% difference between income and housing expense is why there is a crisis of monumental proportions plaguing this country.

The problem we have today is a combination of people's desire to live well beyond their means and the banks' willingness to hand out money like it was printed by Parker Brothers. Because of the ease at which money could be borrowed, people could afford to pay more for homes. Like any thing else, if people can afford to pay more, the price goes up; it's supply and demand. Obviously, this couldn't go on forever. Americans ran out of equity, the banks' endless supply of money began to dry up as investors realized the risk of the mortgages they were sold, and now prices are dropping.

With falling home prices and less equity - many homeowners are upside-down. Foreclosure isn't as scary as it used to be, when people actually had equity in their homes. They don't have much of an incentive to work harder to keep it if it isn't worth what they owe. In fact, many people are actually planning to let their home go, even though they could afford to keep it.

There is no doubt that home prices were due for a correction. And, that really wouldn't be a big deal in the big scheme of things, if Americans had more equity like the generations before them. Perhaps 20 percent down is an unrealistic expectation today, but even a five or ten percent down payment would preserve some equity during minor market corrections. If people actually had some equity in their homes it would make the entire housing market more stable. That is what makes this the worst housing market ever.


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About the Author

Robert A. Franco has been in the title industry for nearly 15 years in the state of Ohio. The owner of VersaTitle, a full service abstracting and title company, and the founder and president of Source of Title, a Web site devoted to providing media and marketing services to the title industry, Franco has dedicated much of his professional career to furthering the role and significance of title examiners in the title insurance industry.  You can read more from Robert's blog or write him at rfranco@sourceoftitle.com .


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