Cashing In on Home Equity
By BOB TEDESCHI
Published: July 23, 2006
NEAR-RECORD numbers of owners are still cashing in on the increased value of their homes, and they continue to use that cash for purposes that raise eyebrows among financial advisers. Yet, because the housing market has been so strong in recent years, it is unlikely that the free spending will undermine most borrowers’ long-term financial health.
According to Federal Home Loan Mortgage Corporation, the government-sponsored company known as Freddie Mac, which helps finance a large percentage of the mortgages in the United States each year, homeowners are on pace this year to take $170 billion in cash out of their home equity as they refinance their mortgages.
That figure is down from last year’s record, $244 billion, but it is still far higher than in other recent years — in fact, about 10 times higher than it was in 1996.
“Families still have a whole lot more home-equity wealth than they previously had,” said Frank Nothaft, Freddie Mac’s chief economist, “and they’re tapping into it.”
Cash-out refinancing has become so popular because house valuations have jumped 57 percent, on average, in the last four years, in many cases giving homeowners hundreds of thousands of dollars more in equity than they had when they bought.
Say, for example, that a couple’s house has a $400,000 mortgage and has grown in value to $600,000. They can now refinance the mortgage, taking out much or all of the increased equity in the process.
If they take out $100,000, the new loan is for $500,000, minus whatever principal they had paid down on the original mortgage.
Homeowners have not only completed more of these transactions in recent years than ever, but they have also grown more aggressive in how much cash they are taking out. According to Freddie Mac, more than 20 percent of each refinanced loan will be taken as cash this year, virtually the same as last year. That is more than double the average of the previous five years.
Instead of saving or investing, some of these borrowers will spend $6 of every $10 they take out in home equity, said Raphael Bostic, a professor of economics at the University of Southern California. More important, he added, consumers often spend much of the money on things like cars, furniture, vacations and home-entertainment systems.
“Households have really been leaning on their home equity in an important way,” Mr. Bostic said. “It’s one of the reasons you’ve seen the general economy continue to perform, which is good in that it’s another way for households to smooth consumption.”
But the difficult thing, Mr. Bostic added, “is when you’re consuming things where you’re repaying for a lot longer than you’re getting the service.”
As an example, he cited cars, which typically carry five-year loans.
“If you pay for that car through a house refinance,” he said, “you’re paying for that car for 30 years — long after you’ve stopped getting value from it. Talk to financial folks, and they’ll say you shouldn’t buy short-term pleasures with long-term money.”
Barring a crash in housing prices, though, such behavior should not be catastrophic for consumers.
“Even with the record volume of home-equity extraction with refinances last year, the total amount of home equity wealth in the country actually increased,’’ said Mr. Nothaft of Freddie Mac.
“I’m sure if you look hard enough you’ll find someone who’s sucking all of the equity out of their house, but that’s not typically what people are doing.”
nytimes.com |
