Our economy depends on Ponzi borrowing to the point that the government actually encourages this behavior despite the fact that millions lost their homes because of it. The ability to freely access and spend home equity creates moral hazard. It encourages over-borrowing and overpaying. It was one of the primary contributors to the housing bubble. The desire for HELOC booty motivated the foolishness.
Many people run up $10,000 to $15,000 per year in credit card debt because they are fiscally irresponsible and fail to live within their means. During the bubble, loan owners would go to the housing ATM machine, pull out a year’s worth of irresponsible spending, and pay off their credit card debt. After two or three years of this, they come to rely on this yearly cash infusion. Rather than seeing their annual $10,000 to $15,000 spending as irresponsible, they see their house as another breadwinner, and the yearly ATM visit becomes an entitlement. The connection is lost between the foolish action — spending their home equity on consumer goods — and the consequences of their actions — being broke and losing their homes.
Those of us that chose not to borrow this stupidly are being forced to pay for the foolish mistakes of others, and to make matters worse, the bailouts we are funding will encourage more of this foolish behavior in the future. The powers-that-be even coined a polite euphemism, the wealth effect, to make this idiocy sound reasonable and respectable. For the first time in our history, parties to private contracts now have direct access to our pocketbooks through our taxpayer funded bailouts.
Housing’s Wealth Effect to Nudge U.S. Spending: Economy
By Alex Kowalski and Elizabeth Dexheimer – Sep 18, 2012 3:52 PM PT
For the first time since the recession, there’s potential for rising U.S. property values to boost consumer spending and give the economy a nudge.
Housing’s so-called wealth effect has been a drag on household purchases since 2008. A projected 2 percent gain in home values next year will start to lift consumer spending in the second half of 2013, according to Michelle Meyer, senior economist at Bank of America Corp. in New York.
Mortgage equity withdrawal is a stimulus we can do without. Financing consumer spending with 30-year debt is not a good idea and should not be encouraged in any way.
Meyer predicts the wealth effect will add 0.1 percentage point to spending per quarter, swinging from a 0.9 percentage point drag at the height of the housing crisis in the first quarter of 2009. The contribution represents a long-awaited turning point at a time when a struggling labor market impedes wage growth and manufacturing provides less support for the three-year expansion.
“There are a lot of encouraging signs in the housing market,” Meyer said. “It will still be a gradual recovery unless you see the overall economy turn stronger, but price data continues to come in strong even into the summer and early fall. I definitely have gotten more convinced of the turn in housing.”
I’m relieved to here she’s convinced, aren’t you? Her statement about price data coming in stronger is not true everywhere: Home Prices Drop in August: Zillow.
Home prices in the second quarter increased 2.2 percent from the previous three months, the best performance since the fourth quarter of 2005, according to S&P/Case-Shiller data. The lowest mortgage rates on record, a smaller inventory of available homes and a drop in distressed property sales have fostered the pickup.
Federal reserve stimulus plus bank’s slow processing of delinquent loans has engineered a bounce.
Builder Confidence
Adding to signs of a recovery: confidence among U.S. homebuilders climbed in September to the highest level in more than six years, according to the National Association of Home Builders/Wells Fargo builder sentiment index released today. …
Removing the competing REO supply from the market is making the builders very happy.
Rule of Thumb
Rising home values stimulate household spending through a channel economists call the wealth effect,
A phenomenon I call HELOC abuse.
which posits that homeowners lift spending in proportion to anticipated changes in wealth over time. A common rule of thumb is that for every dollar increase in housing wealth, consumers will purchase an average of 4 cents more, according to Meyer.
That description doesn’t capture the mechanism involved. People are not staring at their pile of their secure liquid savings and suddenly deciding to spend some of it. They are increasing the debts held against their properties to obtain this spending money. There is a world of difference between the two. Spending liquid savings has an opportunity cost in lowered investment income, but no real out-of-pocket expense. By contrast HELOC abuse increases the spenders monthly debt service obligations, and once those obligations pile up, they are very difficult to expunge.
Among those getting a boost from rising property values is Kyle Perkinson, 42, who bought a home in Concord, North Carolina for $204,000 in May. Since then, he said, its value has increased to $220,000.
New Jeep
Perkinson, who works for Electrolux AB, said the gain was one reason why he decided to buy a new Jeep.
“I felt comfortable that the economy is starting to turn and there are brighter times in the future,” he said. “I’m going to continue to upgrade my property with landscaping and new visual accents, like a rocking chair on the front porch.”
If an improved economy inspires people to spend their savings, that’s fine, but if they thing it’s a good idea to increase their 30-year debt obligations, that’s foolish. If people haven’t learned the perils of that form of borrowing, we will have another housing bubble and another huge credit crunch when the bills overwhelm people.
Kathy Brill, who lives in Mechanicsburg, Pennsylvania, is also responding to the improving real-estate market. After seeing the value of her home increase, Brill said she plans to use a home equity line of credit to invest in a new apartment in Washington, where she works.
“We feel great about the economy,” said Brill, 56, executive director of the non-profit Parent to Parent USA, which recently opened an office in Washington.
Stupid is as stupid does. If the investment is cashflow positive after all her costs, then perhaps it will work, but based on her apparent level of financial sophistication, I question whether she can accurately determine if this is a good investment or not.
Spending Lag
At the same time, it will take time for the full impact of the recovery in housing to show up in consumer spending. Rising home prices spur spending with a lag, meaning the wealth effect won’t show up this year, Meyer said.
Patrick Campbell, a homeowner in the Capitol Hill neighborhood of Washington, is only now beginning to consider spending more. The 48-year-old said he is more optimistic about spending since learning his home value has increased 12 percent after falling below his purchase price during the recession.
“I have less anxiety,” said Campbell, who said he’s entertaining a big purchase, like taking a vacation. “I don’t have a working plan, but I still don’t mind surfing for ideas now.”
Surfing for ideas might lead him astray.
The reversal will provide “meaningful support” to growth, lifting consumer spending by as much as 0.5 percentage point at an annual rate, according to the UBS economists. That could help the world’s largest economy expand by 2.1 percent this year and 2.3 percent in 2013, they wrote.
Let’s hope they are wrong.
“Rising home prices also lead people to consider investing more in homes,” Matus said. “Very few people actually get in early in a rally, so price increases could potentially be more encouraging for people to join.”
If people start jumping on the bandwagon with enthusiasm, we all know where that leads. Perhaps we will skip the despair stage and go right back to building another housing bubble.
Borrowing against one’s home, nonetheless, is harder for many people in the wake of the recession, damping some of the wealth effect, Meyer said.
Good. It should be harder, particularly considering how much money the banks lost on the HELOCs they gave out last time.
Only one of the 58 senior loan officers surveyed by the Fed said standards for home equity lines of credit, one way housing wealth can stoke spending, were easier in July than they were in 2005. Forty said they were tighter.
“The credit channel is an important part of the story as well,” Meyer said. “That probably made the wealth effect more powerful during the boom,
No kidding?
but I would argue that it’s going to make the wealth affect more muted now.”
We can only hope.
An example of the wealth effect gone wild
Does it seem wise to increase a $171,850 mortgage to 542,500? Isn’t that enjoying a bit too much of the wealth effect?
- Today’s featured REO was purchased for $191,000 on 4/24/1997. They used a $171,850 first mortgage and a $19,150 down payment.
- On 10/31/2001 they refinanced with a $200,000 first mortgage.
- On 8/15/2002 they obtained a $35,000 HELOC.
- On 10/16/2002 they refinanced with a $235,000 first mortgage.
- On 2/28/2003 they refinanced with a $322,700 first mortgage.
- On 2/28/2003 they obtained a $59,800 HELOC.
- On 7/3/2003 they opened a $100,000 HELOC.
- On 3/26/2004 they got a new $155,000 HELOC.
- On 2/28/2006 they refinanced with a $542,500 Option ARM with a 1.25% teaser rate.
The wealth effect? These borrowers don’t seem particularly wealthy today.
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Proprietary OC Housing News home purchase analysis
12 CAMPAMENTO Rancho Santa Margarita, CA 92688
$504,700 …….. Asking Price
$191,000 ………. Purchase Price
4/24/1997 ………. Purchase Date
$313,700 ………. Gross Gain (Loss)
($15,280) ………… Commissions and Costs at 8%
============================================
$298,420 ………. Net Gain (Loss)
============================================
164.2% ………. Gross Percent Change
156.2% ………. Net Percent Change
6.3% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$504,700 …….. Asking Price
$17,665 ………… 3.5% Down FHA Financing
3.53% …………. Mortgage Interest Rate
30 ……………… Number of Years
$487,036 …….. Mortgage
$130,842 ………. Income Requirement
$2,195 ………… Monthly Mortgage Payment
$437 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$126 ………… Homeowners Insurance at 0.3%
$507 ………… Private Mortgage Insurance
$114 ………… Homeowners Association Fees
============================================
$3,380 ………. Monthly Cash Outlays
($327) ………. Tax Savings
($762) ………. Equity Hidden in Payment
$20 ………….. Lost Income to Down Payment
$83 ………….. Maintenance and Replacement Reserves
============================================
$2,393 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$6,547 ………… Furnishing and Move In at 1% + $1,500
$6,547 ………… Closing Costs at 1% + $1,500
$4,870 ………… Interest Points
$17,665 ………… Down Payment
============================================
$35,629 ………. Total Cash Costs
$36,600 ………. Emergency Cash Reserves
============================================
$72,229 ………. Total Savings Needed
The property above is available for sale on the MLS.
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40 Responses to “Here comes the kool aid: HELOC abuse projected to rise”
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We live in a bizare culture of instant gratification: Spending money we don’t have on things we don’t need to impress people we don’t know.
Whats fascinating is that Real Estate has become the instant gratification drug delivery mechanism of choice.
Why not something else?
In other primitive cultures, it was big round stones with large holes in the middle.
Maybe those stones were made of granite?
I think it’s really sad what lenders have done to housing. Instead of being a symbol of sacrifice and the commitment to make timely payments to retire debt, it has become just another tool of consumerism. As you noted, it’s now the “instant gratification drug delivery mechanism of choice.” But for many it still has the old positive connotations it no longer warrants.
This is in full effect on HGTV when every single homebuyer comments, “This area would be great for entertaining.”
It will also be in full effect when the house provides the money to do the entertaining.
Since US wages are not indexed to inflation, HELOC’s are all you have if you want to keep-up with the Jones’s, especially here in ‘big-baller’ county.
Keeping up with the Joneses was particularly difficult during the bubble when the Joneses were freebasing on HELOC money.
Fixed Mortgage Rates Find New Lows in Wake of QE3 Announcement
The Federal Reserve’s announcement confirming a third round of quantitative easing sent long-term mortgage rates tumbling to all-new record lows this week.
Freddie Mac’s Primary Mortgage Market Survey showed a drop in both the 30-year and 15-year fixed. According to the survey, the 30-year fixed-rate mortgage (FRM) averaged 3.49 percent (0.6 point) for the week ending September 20, down from 3.55 percent the week before.
The 15-year FRM also fell this week, averaging 2.77 percent (0.6 point). The previous survey showed an average of 2.85 percent.
Adjustable-rate mortgages (ARMs) saw so slippage, however. The 1-year ARM saw no change from last week, averaging 2.61 percent (0.4 point). The 5-year ARM actually increased, rising to 2.76 percent (0.6 point) from 2.72 percent before.
The Fed’s announcement adds to the other good news the housing market has been seeing, said Frank Nothaft, VP and chief economist at Freddie Mac.
“Following the Federal Reserve’s announcement of a new bond purchase plan, yields on mortgage-backed securities fell, bringing average fixed-mortgage rates to their all-time record lows, which should aid in the ongoing housing recovery,” Nothaft said. “New construction on one-family homes rebounded in August, rising by 5.5 percent to the fastest pace since April 2010. In addition, existing home sales increased by 7.8 percent in August to its strongest pace since May 2010.”
Bankrate’s weekly survey showed drops in all categories. The 30-year fixed plummeted to 3.70 percent from 3.81 percent last week, while the 15-year fixed fell to 2.95 percent from 3.04 percent. Meanwhile, the 5/1 ARM dropped to 2.69 percent from 2.75 percent.
While the new stimulus may be good for housing, Bankrate wondered if the Fed’s plan will be able to achieve its intended goal.
“Unhappy with the pace of economic recovery or job growth, the Fed felt compelled to take additional measures, even if those measures will be more effective at boosting the stock market and reducing interest rates than the stated intentions of lifting economic output and aiding job growth,” Bankrate said in a release.
Household Net Worth Falls in Q2: Fed Report
Despite a $355 billion increase in the value of household real estate, household net worth fell $322 billion in the second quarter, the Federal Reserve reported Thursday in its quarterly Flow of Funds report.
And, while the value of owner-occupied household real estate increased in the second quarter, total residential mortgage debt fell almost $51 billion. As a result, owners’ equity increased just over $406 billion and owners’ equity as percentage of the value of the real estate rose to 43.1 percent, the highest level since Q2 2008, according to the report.
The report is the most comprehensive look at aggregate household and corporate balance sheets and income statements, a sort of blood pressure reading on the economy and its components.
The second quarter drop in mortgage debt marked the 13th straight quarterly drop. According to the report, aggregate mortgage debt at the end of the second quarter was $9.59 trillion, the lowest level in six years when homeowners owed
$9.49 trillion and their equity represented 57.9 percent of the value of their homes.
The drop in household net worth, 0.5 percent, was the first since Q3 2011 when it dropped $2.6 trillion or 4.5 percent. Net worth is the difference between assets and liabilities. A drop in net worth means debts grew faster than assets.
The decline in household net worth could have a profound effect on the economy. The economic theory of “wealth effect” holds that consumers tend to spend more if they “feel” wealthier, even if income drops and conversely.
Indeed, the total value of household assets fell $304 billion in the second quarter, while household liabilities rose $17 billion. The drop in assets was due to a $475 billion decline in the value of stock holdings.
The “wealth effect” theory differentiates between the growth in the value of real estate and stock market assets with the change in real estate values having a larger impact on spending.
According to the report, disposable household income increased 0.9 percent or $111.4 billion in the second quarter to $11.9 trillion, compared with a 1.5 percent increase or $178.1 billion in the first quarter. Quarterly income growth since the onset of the Great Recession in December 2007 has averaged 0.7 percent, including four quarter-quarter declines from the third quarter of 2008 through the third quarter of 2009. (Disposable personal income rose 0.3 percent in the second quarter of 2009).
The slippage in personal income growth signals another challenge to an economy heavily dependent on personal consumption spending which is more than 70 percent of the nation’s Gross Domestic Product.
“If people start jumping on the bandwagon with enthusiasm, we all know where that leads.” ~~~ If it leads to two years of free rent and a mountain of cash, I wonder how many would say no to using their house as an ATM if we could go back in time or if another bubble developed. :-\
Those are the perverse incentives the bailouts and the squatting have created. I think it will become even more pervasive this time around because so many benefited from it.
Agreed. The extent though, depends largely on the folk tales that will start circulating. Will the general “story” be:
1) “We were able to live rent-free for nearly two years and we only had to wait two years before we were able to finance another house!”
or
2) “We were able to live rent-free for nearly two years, but then we had to rent for five while rebuilding our credit and waiting-out the waiting period.”
Yes, the consequences must outweigh the benefits or moral hazard will dictate even more of the bad behavior.
” By contrast HELOC abuse increases the spenders monthly debt service obligations, and once those obligations pile up, they are very difficult to expunge.” ~~~ I’ve never taken out a HELOC, but given that credit card interests rates are double-digit vs. a loan against the home sub 5%, is there no benefit to choosing the HELOC?
Short term there is certainly a benefit. That’s why so many use HELOCs for debt consolidation. But financing consumer spending with 30-year debt is really foolish.
Basically what people are doing is pushing off their debts to someone else — the future buyer of their home. Debt consolidation is generally an admission that the borrower can’t afford to pay off the debt. If it’s a one-time event that corrects a mistake, then it’s okay, but the borrower must “sin no more.” People become dependent upon these yearly debt consolidations as supplemental income. That leads to the craziness of the housing bubble.
Irvine Renter,
Those that have credit card and pay them off on time and not HELOC’ing are view by the banks and federal govt as part of the problem for not cooperating with their income stream or voting stream. As long as there as bailouts and no personal liability, the credit bust cycles will continue.
“… must ‘sin no more’ ” has changed in the early 1960′s to Jesus saying to the woman about to be stoned “you are forgiven, sin all the more.” The people perish in their willful ignorance and lack of godly vision.
“As long as there as bailouts and no personal liability, the credit bust cycles will continue.”
Yes, and they will get worse.
Dave Ramsey would call this, “Smart math. Dumb personal finance. You need to correct the problem. The problem is not paying 18% when you could be paying 5%. The problem is the spending that got you into debt in the first place.”
Well said. He is exactly right.
The only thing I see stopping this more US credit downgrades. Enjoy it while you can, it might not exist when the US is rated A or A-, currency devaluation is here.
btw, HELOC’s were no doubt concocted as a dual-function mechanism.
1) bridge the gap between insufficient income growth vs inflation to support a broken economic model based-on consumer spending.
2) enforce debt serfdom.
Moving on….
Who will boomers, hedge funds, speculators and multitudes of amateur-hour OC flippers going to sell their SFR’s to…. and at what price??
*Mean earnings of full time workers age 25-34 with a bachelors degree only
http://www.progressivepolicy.org/wp-content/uploads/2012/09/coll-earnings1-e1348153296343.jpg?maxX=420&maxY=255
Funny, you say. When Dad flip a few home in the 1980′s, sometimes he had to carry back a small second to close the deal. It wasn’t lender, it was seller financed and it was a very interest rate.
For example, some paid him for over 15 years at 15% for a small second of $10,000. That owner finally refi’ed and paid it off. Of course, this is the extreme case.
Times have changed and I would NEVER carry back a second.
“HELOC’s were no doubt concocted as a dual-function mechanism.
1) bridge the gap between insufficient income growth vs inflation to support a broken economic model based-on consumer spending.
2) enforce debt serfdom.”
Your cynicism reflects an accurate description of what happened. I would like to think it doesn’t reflect their motivations, but it probably does.
This comment had me laughing out loud:
“I felt comfortable that the economy is starting to turn and there are brighter times in the future,” he said. “I’m going to continue to upgrade my property with landscaping and new visual accents, like a rocking chair on the front porch.”
Is he implying that a rocking chair will add thousands of dollars to his home’s value?
I didn’t know whether to laugh at his foolish thinking or get upset about the coordinated return to the errors of our past. This behavior is being encouraged by everyone who should know better.
It makes sense to me… Upgrade your home’s value with a $70 rocking chair, and parlay your wise investment into a new Jeep.
I think this underscores that most people make highly emotional decisions when making large purchases. He’s making a purchase that likely isn’t in his financial best interest, and justifying it by saying how much his home’s value has risen, which he is probably grossly overestimating.
Two (potentially related) factoids…I heard that around 2004-2006 or so about 1/3 of the new car sales in the OC were “financed” through HELOC loans. When the HELOC money dried up…there went a lot of car sales.
Arouond this time a family member married a woman who worked in the personnel department of a larger company in the OC. She knew pretty much what people earned at that company and she was astonished at how many of them owned BMW’s, Lexii (plural of Lexus?), Infinitis, etc. She couldn’t figure it out. She and her husband drove, respectively, a little Toyota and a small pick-up truck and they thought buying new cars at that time (or even leasing them) was a dumb idea. But her co-workers kept driving into the lot in shiny new luxury cars.
I can say with confidence that people are still buying vehicles out of their league thanks to the “miracle” of cheap financing. I have pretty good insight into what people are making where I work and I’m constantly amazed at how many of them are buying German and spending close to a year’s wages to do so.
I guess I was raised differently, but I’m content with my two paid off vehicles, 10 and 5 years old, respectively. I’m also getting close to buying another investment property, which this type of frugal living has made possible.
My vehicles are both paid off, and it’s been a saving grace over the last five years of up and down income. A huge car payment, or worse a huge lease payment, is a huge financial cancer than never gets better.
If the borrower can pay for the car payment, how are they going to pay for the gas and insurance?
Live simple so that others can simply live.
The bank-lending crisis was and is just another redistribution. Transfer wealth from the middle class to the wealth and illresponsible. Continued instant gratification (fees, bonus, cash from the loan), plus no long-term return of the ill gotten gains (no claw back for the loan officers and banksters). That a receipe for continued financial melt downs and transfer of weath from the workers to the banksters.
PONZI DAYS ARE HERE AGAIN! WHAT A MISERABLE 5 YEARS OF WORKING HARD, SAVING AND INVESTING INTELLIGENTLY! F THAT NOISE, EVERYBODY GETS A CAR! YOU GET A CAR AND YOU GET A CAR! WHOOOOOOO!
I imagine Ponzis everywhere will be relieved they no longer have to work hard, save, and invest intelligently. All they have to do is buy a house and turn on the ATM machine.
And before you go placing the blame of rising prices on appraisers, just look at what the government is doing….
An acquaintance of our who hasn’t paid his mortgage on his 2.4 mil home now for more than six months told me the bank isn’t even talking to him. He also said, with enough time squatting (although he doesn’t call it that) he’ll recover his equity which evaporated in the bust… And more.
Where’s the negative consequences that will make him think twice next time?
“Brill said she plans to use a home equity line of credit to invest in a new apartment in Washington, where she works.”
Seriously, how in the hell did we ever arrive back at this same destination. And we’re somehow twice as stupid as when we left?
We really are the wasted generation.
I completely agree, I call us the ADDemographic…..is that a video of a monkey flinging poo at a tourist? Did you hear that ScarJo picked corn out of her teeth with her car key? ewwww OMG, OOOOH a shiny new Iphone! where are my ritalin pills?
A lot of well informed comments today.
I always enjoy when the comments are plentiful and insightful.
What a coincidence. Never got an email from my credit union before. Today I get my first one and it’s all about HELOC.
“Get the Cash You Need Without Breaking the Bank!
Introductory HELOC Rate of Just 1.99% APR* and NO Closing Costs!
Open a new Home Equity Line of Credit (HELOC) and get a rate of 1.99% APR for the first 12 months! After 12 months, the rate adjusts to the current Prime Rate or 4.00% APR—whichever is higher.
A HELOC Offers Many Great Features
A HELOC is a great loan source for members with good credit who are looking for ongoing access to funds for home improvements, education, bill consolidation or a dream vacation! Benefits include:
Borrow up to 80% of your home’s appraised value
NO application fee
NO points, closing costs or prepayment penalties
Tax deductible (consult your tax advisor)
Easy access to funds—online or phone transfer, check or in person
Personal Loans as Low as 10.24% APR***
Borrow up to $15,000 with terms up to 60 months for anything you need, including a new computer, new furniture, electronics, or a summer getaway!”
The only good thing I read in that whole spiel was “Borrow up to 80% of your home’s appraised value.” The ad in this post which came from the bubble was for 125% of appraised value.
I wonder how long it will take for lenders to go from 80% to 125%?
We have learned nothing.