Many Americans Are Upside-Down On Their Homes Due to Home Equity Loans
The rapidly increasing housing market from 2001 to 2006 enabled many Americans to spend more than they were making.
Most Americans who purchased their home anytime before 2005 saw the value of their investments rise dramatically post 9/11. Rather than sell their homes to realize the increased value of their investment, many Americans decided to use their house as an ATM machine. As the value of their homes rose, they would apply for readily available home equity loans that would allow them to extract money from their investments without having to sell.
Here is how it worked. Let's say that you bought a home in 2001 for $300k. Two years go by, and the home is now worth $450k. Instead of selling the home and realizing a $150k profit, many chose to instead go the home equity loan route. Banks and other lenders would take the appraised value of the home, subtract all outstanding mortgage and home equity loans, and allow the owner to borrow up to 100% of the remaining amount. So instead of a $300k mortgage on a $450k home, many Americans would now have a $450k mortgage on a $450k home.
Many people who initially tapped the equity in their homes became addicted. Their home values would increase on an annual basis, and they would seek an increase in their home equity loan. These home equity loans enabled many Americans to increase their expenditures while running a deficit every month. Oftentimes, these loans would be used to finance non-essential purchases, such as a new luxury vehicle, expensive vacations or maybe even a down payment on a new vacation home.
$700 billion in home equity withdrawals in 2005. That is money that found its way directly into the US economy and enabled the country to remain fairly strong economically.
Now that money is basically gone. $700 billion to $24 billion dollars is a massive drop. That represents $676 billion dollars that is no longer being spent on vehicles, home improvements and second homes. The impact to the economy has been dramatic, and has forced many Americans to completely change their consumption habits. Less shopping. Less vehicles. Less vacations. Less renovations. All stemming from less credit.
These numbers likely won't change anytime soon. Many Americans are upside-down and underwater on their home investments, due to either buying at the top of the market or frequently borrowing against the equity in their homes.
Many Americans turned to credit cards to finance their overzealous lifestyles. Now, not only do they face outrageous interest rate charges that they have a very hard time paying, but companies are starting to pare down their available credit as they want to hedge their own risk.
So not only is there less home equity credit available, but there is less unsecured credit available as well. This will result in a dramatic change in the consumption habits of many Americans, and a big reason why the American economy will very likely remain stagnant for a considerable period of time.
Filed under: The Economic Meltdown | General Knowledge