Real estate equity is coming back. If you own a home or invest the odds are that you’re very much richer than you were just a few years ago. While we don’t have a full recovery yet, there’s evidence that the housing market has become more attractive in most metro areas.
According to the Federal Reserve, homeowner equity peaked in 2005 when the value of U.S. homes — market value less debt — equaled a rosy $13.1 trillion. Unfortunately things went downhill from there as a result of the financial crisis, by 2011 homeowner equity had fallen to $6.4 trillion and millions of American homeowners saw half their real estate equity disappear.
This was not just an academic matter. Without equity, borrowers could not refinance as rates fell and they couldn’t sell without bringing cash to closing. The alternatives were short sales, foreclosures and staying in place. In the end, more than 7 million homes were lost to foreclosure.
Now the good news: Between 2011 and 2014 homeowner equity went from $6.4 trillion to $11.3 trillion. That’s an increase of $4.9 trillion. With any luck it’s not unreasonable to believe that equity as measured on a cash basis might return to 2005 levels in the next year or so.
More Equity, More Possibilities
More equity means more homeowner options. Qualified owners can now borrow against their homes, borrow more than a few years ago or do nothing and avoid additional debt.
The situation with reverse mortgages is a little different. More equity suggests that older homeowners, those above age 62, can more readily get reverse financing. However, the FHA’s rules for such loans have tightened so it takes more equity to get a loan of a given size when compared with a few years ago. This is important because nearly all reverse mortgages are originated with FHA backing.
According to RealtyTrac, May foreclosure starts were below the pre-crisis levels seen in 2005 and 2006. Part of the reason for fewer foreclosure starts is that with additional equity it’s increasingly easy to avoid foreclosure. As long as market value at least equals mortgage debt plus closing costs owners in financial trouble can just sell for a fair market price without damaging their credit.
For many borrowers home equity lines of credit — so-called HELOCs — have been a ticking time bomb, a bomb which can now be diffused in many cases because more equity is available.
A HELOC is essentially a huge credit card secured with a home, a way for owners to extract equity without selling. In general terms HELOCs have two phases: a “draw” period when cash can be taken out and a “repayment” period when borrowers must repay the debt outstanding at the end of the draw phase.
For instance, the Smiths got a $100,000 HELOC in 2005. The loan has a 10-year draw period and a five-year repayment phase. In this case Smith had a $90,000 balance at the end of the draw period and must now repay the debt over five years at 6 percent interest. This means the required monthly payment will go from zero during the draw period to $1,739.95 per month for the final five years of the loan term.
For many households such a massive and immediate additional debt is a sure route to poverty if not foreclosure. However, with additional equity many homeowners can simply refinance their current mortgage or get a second loan to replace the HELOC. If they refinance into a new loan at 4 percent and with a 30-year term, the monthly cost to finance an additional $90,000 falls to $429.67 — an expense which is far easier to absorb.
According to a recent Experian study, HELOCs originated between 2005 and 2008 and representing $265 billion “are outstanding and nearing the repayment phase.” For millions of homeowners increased equity is the key to avoiding HELOC-based foreclosures.
It’s Not All Rosy
While the great equity increase seen during the past few years is surely welcome, the housing sector remains fragile for several reasons.
First, some markets continue to struggle. The National Association of Realtors reports that in the first quarter home prices were up in 148 metro areas but down in 25.
Second, with growing equity we’re seeing more first-timers getting back into the market. NAR says in May that first-time buyers represented 32 percent of the market, up substantially from the 27 percent seen a year ago.
This is good news but not great news — historically first-timers have been about 40 percent of the market so there’s room for further growth.
“More first-time buyers are expected to enter the market in coming months, but the overall share climbing higher will depend on how fast rates and prices rise,” says Lawrence Yun, NAR’s chief economist.
And therein lies the problem: Rising prices will dampen the influx of first-time buyers — and fewer first-time buyers will make it difficult for prices to rise.
Third, cash is a flighty measure. It may or may not be worth a lot of buying power and buying power is the real measure of wealth. For instance, the Reserve Bank of Zimbabwe has just issued a $100 trillion note, a currency with a lot of zeros that has the same buying power as 40 U.S. pennies.
A decade ago American homeowners had equity worth $13.1 trillion. However, because of inflation, the Bureau of Labor Statistics says it takes $15.951 trillion in today’s dollars to purchase the same goods and services.
If we think about real estate equity after inflation, it means the growing equity seen in recent years is good, very good, but the financial place where we need to be to equal the heady times of 2005 is still further down the road.