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October 18, 2005
"The Home Equity Trap"
How's this for a scary scenario?
On paper, you're reasonably well off. You don't own many stocks or bonds, but your house is worth a lot more than you paid for it. You figure you'll sell it when you retire, move into a cheap condo somewhere, and live off your housing equity.
Then you get laid off. Your stocks and bonds carry you for only a couple of months. Next you max out your credit cards.
Well, you figure, you still have that housing wealth. So you go to your local bank for a cash-out refi. But because you're out of work and have maxed out your credit cards, your FICO score looks bad. The bank turns you down.
Humiliated, you go to a subprime lender, who gives you the money you need but at an extremely high interest rate. Or you sell the house and move out of town, tail between your legs.
Your problem: Not a lack of wealth, but a lack of liquidity. You couldn't easily get money when you needed it.
This can happen. It does happen. Most middle-income Americans have far too much of their housing wealth tied up in their homes. According to the Federal Reserve's 2001 Survey of Consumer Finances, middle-income families (40th percentile to 59th percentile, to be exact) 67% owned their primary residence, but only 16% directly owned stocks.
I came across some interesting testimony on this topic by Anthony Yezer, an economics professor at George Washington University. Last year he told a House subcommittee about what he calls "the home equity trap"--where people whose income abruptly drops can spiral downward because too much of their wealth is locked in their homes. Go to page 5 of this link.
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? Lansing: Will Home Equity Prevent the Retirement Dreams of Baby Boomers? from Pacesetter Mortgage Blog
If you have been a reader of my blog you know that I have been sounding the trumpet to Baby Boomers to rethink their investment strategy and consider their Home Equity as a part of that strategy. I just read [Read More]
Tracked on October 20, 2005 01:45 PM
This is why an equity line of credit is recommended while still working. A 6% yield on mortgage paydowns vs. a 4% yield on bonds or stock earnings yield of 5% is still better. Diversification in this instance is overrated unless price declines would significantly affect your equity.
Posted by: Lord at October 19, 2005 02:07 PM
You haven't even mentioned what happens when house values drop by 30-50% and most people are underwater!
Posted by: greg at October 19, 2005 03:22 PM
Thursday, April 28, 2005
Housing Market in California
OK! For all of us that still live in the real world, it’s time to talk realistically. The average person’s salary in California is around $40,000/year, based on info from the 2004 Occupational Employment Statistics (OES) Survey. For those who don’t know, the average salary correlates to the middle class income. Now, the average sales price for a home in California is $495,000 as of today (by the way that’s half-a-million for all you lay-people). HUH???? At the current phenomenal rate of just 5.85% interest on a 30 year loan, with property taxes included, zero money down and an adjustable rate mortgage (ARM) after 10 years, the average Californian pays a conservative $3200/mo for his 3 bedroom shack in beautiful Carson. Think about it, at the published OES average wages per year, the average Californian makes about $3,330/mo before deductions. If we subtract a really conservative 10% off of the gross income for taxes and social security, we leave the average Californian with $3000 and no money to pay his mortgage. That automatically eliminates about 50% of the state from buying homes. We might still say there’s no ridiculous bubbly type bubble in California, so let’s examine who can afford these irrationally overpriced properties. Most intelligent people know that a mortgage should take up no more than 1/3 of your monthly take home pay. We’ve already shown that the average Californian’s mortgage is 110% of his monthly take-home. Is everybody ready for some Math 101? In order to figure out the amount of take-home pay we would need to afford this mortgage, we simply multiply the monthly mortgage calculated above of $3200 by 3. The needed take-home income now becomes $9600/mo, that’s a gross income of $145,000/year. Some of you will now say, “Well, if I made $9600/mo take-home I could afford a $1,000,000 home”, which is exactly what is fueling house-inflation mania in California…people living way beyond their means. Since most of us don’t use the 1/3 rule, I will reconfigure the monthly income, such that of our virtual-income goes to the mortgage. Using of our take-home pay for the mortgage, we would need $6400/mo take-home. Lest we forget, Uncle Sam likes his money too. So adding back in our extremely conservative 10% for taxes and social security, we would need to gross $7100/mo. This equates to $85,000/year (for all of us who say, well I make $80,000 or $90,000 with my wife’s salary, that’s fine until one of us loses our job, or even worse we both do). More importantly, less than 4% of Californians fall into this group. So that eliminates the other 46% of the state from either moving into another home or buying a first time home in the current market. There is a real problem, and it’s deeper than housing bubbles or crashing stock markets. The problem lies in the fact that Californians always want the nicer car, the nicer house, the nicer boat, the nicer vacation home. For a vast majority of people living in California, it’s all about numero uno. Californians are not the only ones, most Americans are never happy unless they’re spending money on themselves. We’re always spending money we don’t have to keep up with the Jones down the street. But what happens when the interest rates go back up again, which they will, or the housing market goes through a quarter or two with almost no sales, which it will, or the dollar keeps falling in value, which it will, or buyers are pushed so far out of the market they can’t even dream of affording a decent shack…let alone a decent house, which they already can’t (they just don’t know it yet). That’s right friends and neighbors the housing market will crash faster than a 747 jumbo jet with both wings missing and the cabin on fire. Worse yet, it will bring the entire economy with it. It doesn’t take a PhD in economics to see that we’re in a horrible pandemonium, and if it doesn’t stop soon we’re going to be worrying about a lot more than the fact that our home has depreciated 50% or more. We’re going to be worrying about which bankruptcy lawyer to go to. So, you may still say there’s no housing bubble…well, if you believe that, I have some beachfront property in Burbank to sell you. Homeowners, builders, realtors, buyers and sellers believe there’s no bubble in today’s market, because they have homes to protect. But there is a bubble, and it’s getting heavier over California and it's ready to pop which will deliver another debilitating blow to the economy. Conclusion: buying a home in California is for the birds (or bird-brained).
Posted by: Taylor at October 19, 2005 05:31 PM
I agree with what Lord said yesterday. Arranging a home equity line of credit is a smart way to increase your liquidity and make sure you won't fall behind on bills if you get sick or get fired. Two keys: Arrange the line now, before you need it. And don't use the equity in your home for routine expenses.
Posted by: Peter Coy at October 20, 2005 10:19 AM
To Taylor: Your math is correct, sir, and when the bough breaks it's going to break really hard. I'm living in lovely Chicago where the price for a condo is 'ridiculous'. The city and the developers are pushing renters into condos through conversion and attractive mortgages. Already in my neighborhood I see "for sale" signs in every block where there were condo conversions & new bldgs less than 5 years ago. Owners are cashing out -- NOW! while they can.
Posted by: AnonymousChicago at October 23, 2005 02:19 PM
My husband died suddenly in our home. He had taken out a line of equity on it, in the form of a credit card. after his death, I went into a deep depression,on medication and started going to the casinos nearby.I used the card there for time to spend away from the house. After a while the card maxed out and during that time the bank never called once; not until it maxed out at 41,000 against the house. now the finance charges are all that I can pay each month. Are any of the finance charges going towards the balance? The bill shows that the balance remains the same every month.My husband had a balloon rate and a 10 year full payment due contract.I have learned all this after comming off my medication, which I cannot blame this on. It is all my own fault.Should I file bankruptsy,or let them foreclose.
Thank You, Fran
Posted by: Fran at October 30, 2006 03:15 PM
Well, this situation can be avoided if people know the basics of a Home Equity Loan.
Posted by: Steven James at November 7, 2006 01:43 AM
We have lost our job but now my husband just went back to work, we are 3 months behind in our mortgage. I want to know if foreclosure or bankrupsy is better?? The line of work we are means my husbands credit will affect his job. So what do we do bankrupsy or foreclosure? Help!
Posted by: michelle at January 6, 2007 03:54 PM