With the stock market on a long march to nowhere, home owners are increasingly looking to their homes as a source of quick cash or a hedge on the retirement life-style they once believed their technology stocks would provide. Experts say tapping the equity in your home or selling it now in a white hot market to capture large gains isn’t the slam dunk decision it seems at first blush.
Traditionally, homes have been the bulwark of middle-class America’s financial stability. During the white hot bubble market of the 1990’s many counted on that stability to help them bankroll a quick leap to financial freedom by borrowing against their homes and using the cash to invest in the stock market.
In the brutal bear market of the last two years, those that haven’t lost their homes as a result of the value of their portfolios evaporating faster than corporate America’s credibility have again looked to their homes as a financial fortress.
Interest rates on home loans are at 40 year lows causing an “unprecedented” number of refinancings, according to the Mortgage Bankers Association of America. All those refinancing aren’t simply looking for a lower rate. About 10 percent of those homeowners refinancing a house last year took cash out as well, according to mortgage broker Fannie Mae. Some $1.1 trillion in refinancing occurred last year and Fannie Mae estimates that about $100 billion of that was siphoned off in cash.
A the interest worm turns
The Tax Reform Act of 1986 put an end to deductions for the interest paid on car loans, personal loans and credit card debt. But Congress allowed consumers to keep deducting another important interest payment: mortgage and home equity loans. Generally a person can deduct the interest on up to $100,000 of a home equity loan used for things other than home improvements.
Debt consolidation is a big reason for home equity loans as is financing a child’s college education.
As seductive as such a move might be, especially when other sources of cash, such as the equity market, have all but disappeared, financial advisors urge caution.
“In general we don’t recommend people take money out of their homes to do other things such as vacations, buying cars or even investing in the stock market,” said Charles Foster, a certified financial planner with Blankinship & Foster, a Del Mar, Calif.-based firm.
But Foster’s approach to such financial issues is a holistic one; he is hesitant to give any one-size fits all answer. The viability of borrowing against your home “depends on where you are in your life and what that money is going to be used for,” he says. And then he pauses, almost as if for effect and adds: “I would like to make the point that home equity sometimes appears to be a pot of gold that gets misused.”
When asked to explain that line, Foster says “it’s going backwards to take money out of the home for short term pleasures,” like car loans or vacations. And it’s especially dangerous for people that can’t control their spending habits and leads to using their home equity to routinely consolidate consumer debt only to run it up again.
“If you’re riding down a hill towards a cliff on a bicycle it feels real comfortable to be going downhill real fast until you get to the edge,” Foster said. “The attention should be paid to reducing debt rather than transferring debt,” Foster said. “So my problem with using a home equity line of credit is it allows and encourages people to increase their debt rather than reduce their debt.”
Riding the bubble
It’s elementary, but people should always keep in mind that by tapping the equity in their homes, they are at the same time putting their homes at risk, says Dean Knepper, a certified financial planner that runs Lifetime Financial Planning in Leesburg, Virginia.
“I recommend people pay off a mortgage over a shorter period of time using money that would otherwise have gone to the conservative portion of their portfolio,” Knepper said. “Especially now there isn’t anywhere else you can get a guaranteed return of say six percent which is what you’re doing by using funds to pay down your mortgage.”
Knepper also said that “it’s a really good move” for those approaching retirement, downsizing their house, especially in the sizzling real estate market of today, makes sense, “before the housing market heads down.”
Influential economists are split on the issue of whether a housing bubble exists. Those who brush aside the idea of a “housing bubble” bursting in much the same way the stock market bubble burst include Federal Reserve Chairman Alan Greenspan. Greenspan believes that the housing market is different because it’s so localized and the economic pressures of one area won’t affect the entire country.
Dean Baker, co-director of the Center for Economic and Policy Research, a Washington, D.C.-based moderate think tank, says in his paper “The Run-Up in Home Prices,” that the average ratio of homeowner’s equity to value is 55.2 percent is “near its low for the post-war period.” A drop in home prices will send that ratio “far below its previous point.”
Baker doesn’t see a nationwide bubble, but says if prices fall 10 percent nationally then it means that some regions will be hit with 20-30 percent prices drops.
“This will create a situation in which millions of families have little or no equity in their homes, Baker says in his paper. That could be disastrous what with little or no money available in the stock market and the one remaining financial wellspring, home equity, evaporated.
“This is an especially serious issue with the large baby boom cohort nearing retirement,” Baker says. “It will also lead to a surge in mortgage default rates, as many homeowners opt not to keep paying a mortgage that exceeds the value of their home. This could place serious stress on the financial system.”