Monday, September 20, 2004

America's Shrinking Home Equity

More money is going out of houses than is going in. That could mean trouble.
By Oliver Ryan
FORTUNE

We may live in an ownership society, but it's a highly leveraged one. Goaded by low interest rates, rising home values, and eager lenders, homeowners have gone on a borrowing binge. In the first quarter of 2004, Americans borrowed against their homes at an annualized rate of $840.2 billion, the highest on record. Since 2000, more new mortgage debt has been issued than was issued in all of the 1990s. Total now outstanding: a stunning $6.9 trillion.

As fast as values have been rising, borrowing has grown even faster—thanks to smaller down payments and increasing use of home equity loans. As a result, Americans' equity, as a share of total home value, has been falling. In addition, over the past three years Americans have borrowed more against their homes than they've invested in them (by paying down mortgages and making home improvements), according to a study by the New York Federal Reserve. Since the 1950s that has happened only twice before, and never at this level.

All that debt puts homeowners in a precarious position. For those who put down 10% and finance the rest, it would take only a 10% price decline to wipe out their equity. That could be disastrous for someone who loses his job and is forced to sell.

And mortgage debt has helped push the debt-service ratio—the percentage of income devoted to making all loan payments—to record highs. That leaves less for spending, saving, and investing.

Ian Morris, an economist at HSBC, says that booming prices are lulling consumers into a false sense of security. "They think their houses will take care of their retirements, so they don't have to save," he says. But for highly leveraged homeowners, those "savings" are mostly an illusion.