Homeowners started losing hold of their homes years before spiking foreclosures and the housing slump slammed the economy.
Piece by piece, some gave away their homes by tapping equity to take cash out to pay for cars, weddings and vacations. Others never owned one brick. During the country's most recent housing boom, the term "homeowner" became a misnomer as lenders offered 100 percent or more home financing to some buyers.
Now, slipping home prices threaten to further erode the value of many Americans' single largest asset, curbing consumer spending and jeopardizing retirement assets.
Thanks in large part to mortgage-related tax deductions and a drumbeat of advice that everyone should own their home, the U.S. homeownership rate rose steadily in recent decades. It peaked at 69.2 percent in 2004 before backing down to 68.2 percent at the end of the third quarter, according to the Census Bureau, which has collected the data since 1965.
But that small decline masks a much larger plunge in the amount of equity homeowners hold. This figure, equal to the percentage of a home's market value minus mortgage-related debt, fell to an average of 51.7 percent at the end of the second quarter, down from 62 percent at the end of 1990, the Federal Reserve reported, even as the average home value surged 139 percent during that period.
Some economists believe the home equity number will drop below 50 percent by the end of next year, marking the first time homeowners will owe more than they own since the Fed started recording the data in 1945. The central bank is set to release the third-quarter equity figure Thursday.
"Although homes increased hugely in value, homeowners were borrowing against them as fast if not faster than the appreciation," said Dean Baker, co-director for the Center for Economic and Policy Research. "And when people were buying new homes, they were getting them with as a little as 5 percent, 2 percent down, even nothing at all."
Thirteen percent of first mortgages originated in 2005 and 2006 had down payments of less than 10 percent, according to the Mortgage Bankers Association. Another 1 percent of the mortgages surpassed the value of the property.
"How much people put down on the home has always been an important variable for the performance of a loan," said Thomas Lawler, a former official at mortgage lender Fannie Mae who is now a private housing and finance consultant.
"Mortgage lenders lost sight of its importance because most of the loan level data they used came from the latter 1990s to the early 2000s when very few places in the country weren't seeing house appreciation," he said.
A recent report from online real-estate information company Zillow Inc. showed home values declining 5.7 percent year-over-year in 83 metropolitan areas. A 20 percent down payment would have provided a cushion from these price declines.
The drop in average value is particularly bad news for homeowners who treated their homes as piggy banks instead of as savings accounts. They drained $468.7 billion out of their homes in 2004 through home equity loans or cash-out refinancings, according to a report this year from former Fed Chairman Alan Greenspan and Fed senior economist James Kennedy. Fifty-eight percent of that cash went to home improvements and personal spending, while another 27 percent paid off credit card debt.
They felt confident that housing prices would continue to rise, replenishing the equity they took out.
"To deal with your single biggest asset like that is risky," said Jim Gaines, research economist at The Real Estate Center at Texas A&M University. "Those things should be paid for by current earnings, not savings, which is what your house is."
Catherine Alexander, 61, who lives near Plano, Texas, first dipped a toe into home equity before taking a plunge.
After her husband died four years ago, Alexander moved from Seattle to Texas to be closer to her children, buying $172,000 four-bedroom house with life insurance money.
For more than a year, she shredded countless home equity checks sent to her unsolicited by Beneficial, a member of HSBC Group. She finally cashed one for $6,000 to meet expenses after being unemployed for over a year. That in turn led to phone calls from Beneficial recommending a larger equity loan.
At the end of 2005, Alexander took out a $50,000 equity loan to pay for day-to-day expenses and charges related to her son's wedding. To satisfy that loan and to pay off her Ford Escort, she took out another home equity loan the next year, this time for $93,000.
Alexander, who now works for Neiman Marcus Inc., put her home on the market in May after her home and loan expenses became too costly. Even though she felt lured into the loans, she also blames herself.
"A lot of it has been my ignorance and being naive about my finances and in trusting people," she said. "I shouldn't have had a loan that size for my income and I should've been more reasonable in the house I needed."
An HSBC spokesman said in general "our real estate loans require that customers receive a reasonable, tangible net benefit." The company doesn't comment on individual customer cases.
Fortunately, Alexander will receive more than half of the proceeds from a sale if she gets her $189,900 asking price.
For other homeowners who took equity out, what remains is scant. Thirty percent of the home equity loans issued in 2005 and 2006 left homeowners with less than 10 percent of equity in their homes, the MBA said. Another 3 percent now owe more than the value of the house.
A home equity loan is another close-ended loan on top of a mortgage, whereas an equity line of credit is an open-ended loan. Both use houses as collateral. A homeowner can also refinance for more than what is owed on the current mortgage and pocket the difference.
Many of these homeowners have little savings to fall back on, making matters worse. According to Moody's Economy.com, nearly one-third of homeowners who took out home equity lines of credit had a savings rate of negative 9 percent this year. The rate hasn't been positive for this group since the turn of the decade.
Now, homeowners trapped in unmanageable mortgages with little equity can't refinance or sell their houses at a price to cover what they owe. Many of them face foreclosure.
Dropping home prices also threatens retail spending as the equity well runs dry. Homeowners won't be able to tap equity as easily for big-ticket purchases and may put more toward saving than spending as housing values fall.
The long-term ramifications could be worse. As prices continue to decline or remain flat, homeowners' total net worth could be wrecked, especially for those who sucked money out of their homes.
Residential real estate represented 39 percent of a household's total assets in 2004, according to the Fed, whereas retirement accounts made up 11.4 percent and stocks just 6.3 percent.
No type of national bailout will replace that lost equity. Those who depended on it will have to rely on meager savings and other investments. Younger homeowners have more time to replenish the equity. But for Baby Boomers who took out cash from their homes every time home prices went up, their retirement income may not cut it.
"For lower- to middle-income homeowners who are relying on their homes as a source of savings, this will be very tough with declining home values," said Mark Zandi, chief economist for Economy.com. "Particularly in context of reining in Social Security, Medicare and Medicaid. It's one more financial problem on top of mounting ones as they approach retirement."