"The Home Equity Trap"by
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.