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Equity gains more than wiped out by equity loans


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2008 Apr 2, 1:20am   28,455 views  317 comments

by Patrick   ➕follow (55)   💰tip   ignore  

dodo

From a reader:

Americans now own less than 50% of their home for the first time in many years. What I did not hear in the press is that this percentage was reported AFTER home values had increased astronomically. That is, as home prices shot upward, many Americans chased those zooming home prices by adding debt, not by rejoicing that they now owned a larger fraction of their home. To me, the story is not that Americans now own less than 50% of their home, but that this is true after home prices have skyrocketed in recent years, outstripped by debt rising even more rapidly. Consider the implications to baby boomers who hoped to retire soon, but who have already extracted a large fraction of the true equity in their homes and spent it.

This is pretty amazing. After the biggest runup in prices ever, owners managed to blow all of that equity, and then some. And now they've got rapidly declining prices on top of that.

Patrick

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1   HARM   2008 Apr 2, 1:45am  

B-b-b-but... Ditech says "People are smart".

2   BayAreaIdiot   2008 Apr 2, 2:09am  


Marta Wolfe is one of them. She lives in Vallejo and bought a house for $215,000 a few years ago. She refinanced when it jumped to $385,000.

In the past year, with the real estate downturn, the value dropped to $310,000. That's $75,000 in lost equity.

Her lender knew this and mailed a letter that read: We regret to inform you your home equity account has been temporarily frozen. That means you'll be temporarily prohibited from making additional draws against your line of credit.

"I new the real estate market values were going down, but I had no idea they would freeze my line of credit," Wolfe said.

The money she would have been able to use to pay for landscaping, remodeling, and even basic living expenses is gone - at no fault of her own.

http://cbs5.com/seenon/consumer/Home.Equity.Loans.2.689101.html

This was a HELOC story on CBS5 a couple of days ago. However, it seems appropriate for this blog posting, since the lady in the story refinanced the house at +$170K. It's not clear how much of that she pulled out and how much she just had in her credit line. It is clear though that she considered the credit line "her money".

3   Peter P   2008 Apr 2, 2:19am  

and even basic living expenses... at no fault of her own

Huh?

4   DinOR   2008 Apr 2, 2:23am  

BAI,

Interesting to note she is already calling her lender for a loan modification! So... was her being able to "afford" the home based on her being able to draw equity OUT against the ever-appreciating home!?

Didn't most lenders put a kink in the HELOC Hose just a month or so ago? Do you mean to tell me 1 or 2 months into this and she's going into "HELOC Arrest"?

5   DennisN   2008 Apr 2, 2:27am  

Most HELOCs have a "draw" period and a "payback" period. Does anyone know the general timeframes of these? Once everyone who has been "drawing" since circa 2003 hits the end of their "draw" period, this was going to happen anyway.

This hasn't been discussed much, but won't there be a time when most of the "draw" periods will end during a relatively short time? Won't this be just one more problem?

*insert "confused" similey here*

6   DinOR   2008 Apr 2, 2:28am  

"even basic living expenses"

Well... uh, er she IS seeking "credit counseling" (which means she is going to flake out on her bills) That's an option from the "Buyer's Contingency Plan" I missed from the previous thread!

We've just given these people too many options, too much power and responsibility. I guess it's especially acute for singles where their house only qualifies as a "second" not third income.

7   DinOR   2008 Apr 2, 2:30am  

DennisN,

Yes, you can "draw" on it as long as the house is appreciating like a m@ther f*cker and when you it stops... that is known as the "payback" (and it's a b!tch)

8   DennisN   2008 Apr 2, 2:32am  

Jack Guttentag says this:

"HELOCs have a draw period, during which the borrower can use the line, and a repayment period during which it must be repaid. Draw periods are usually 5 to 10 years, during which the borrower is only required to pay interest. Repayment periods are usually 10 to 20 years, during which the borrower must make payments to principal equal to the balance at the end of the draw period divided by the number of months in the repayment period. Some HELOCs, however, require that the entire balance be repaid at the end of the draw period, so the borrower must refinance at that point."

So many of the draw periods will end in a year or two on average.

9   DennisN   2008 Apr 2, 2:37am  

I wonder what percentage of HELOCs have a balloon payment at the end?

10   DinOR   2008 Apr 2, 2:46am  

I've had a few 2nds in my day and I can honestly say I've never had one that required a ballon at the end of 5 years or whatever. Not to say it doesn't happen but they sound kind of rare.

11   BayAreaIdiot   2008 Apr 2, 2:58am  

So… was her being able to “afford” the home based on her being able to draw equity OUT against the ever-appreciating home!?

Who knows DinOR. I mean, it's entirely possible and at the same time so un-fuc*ing-believable it's almost comical.

There was a post on CR (http://calculatedrisk.blogspot.com/2008/04/vintages-revintages-and-defaults.html) which attempted to explain how this entire mess could happen without raising any flags.

I admit not all of it is easy for me to grok, but to the extent that I do grok it, it would seem those tasked with designing/creating the software which tracks everything didn't really understand the products they were tracking. It's a bit like those satellite launches we see from time to time go up and explode in 30 sec. Later we're told there was a small error in the code - harmless on its own but devastating as part of a system.

Since no-one bothered with system analysis......boom.

I think this was Greenspan's argument in the FT. It's not our fault. Our models/software are not good enough. Maybe he was right after all.

12   DinOR   2008 Apr 2, 3:20am  

It's easy to fault someone that was using their HELOC for living expenses but difficult to grasp just how much of that is due to stagnant wages and incomes? Had incomes kept pace enough to actually justify bubble prices we wouldn't be having NEAR the problems on the down side.

"Oops! Borrowed too much against my house, now I guess I got to pay it back. No biggie, where are we going for lunch?"

How many of us can say that?

13   Peter P   2008 Apr 2, 3:21am  

I think this was Greenspan’s argument in the FT. It’s not our fault. Our models/software are not good enough. Maybe he was right after all.

Again, economic "models" exist to make Astrology look respectable.

Disclaimer: I believe in Astrology

14   Peter P   2008 Apr 2, 3:28am  

Had incomes kept pace enough to actually justify bubble prices we wouldn’t be having NEAR the problems on the down side.

I doubt that trend is going to reverse:

1) real wage has been dropping for decades
2) nothing can outrun a bubble

15   DinOR   2008 Apr 2, 3:38am  

Peter P,

Perhaps a better way to word that would be to say "Nothing can keep up with a mania".

I suppose you could argue that had wages seen real increases between 1997 and 2006 the boom would have been much, much worse. I agree, expecting to see wage increases in this environment is totally unrealistic.

16   Peter P   2008 Apr 2, 3:51am  

I suppose you could argue that had wages seen real increases between 1997 and 2006 the boom would have been much, much worse.

It might have been a bit worse, but not much. The most fearsome aspect of a mania is that it feeds on itself.

There are usually multiple feedback loops in this bubble:

1) psychology and the sense of infallibility
2) collateral pricing and access to credit
3) over-regulation (programs to "improve" affordability)

17   BayAreaIdiot   2008 Apr 2, 3:51am  

It’s easy to fault someone that was using their HELOC for living expenses but difficult to grasp just how much of that is due to stagnant wages and incomes?

DinOR
if one is trapped in that situation and the numbers were an order of magnitude smaller, I would be with you all the way. e.g. my son had to have a particular surgery not fully covered by my insurance so I used the HELOC for the $20k differential. This would be capitalism at its best.

However, what I've seen happen is what Patrick describes. People realized their fake equity and instead of taking it and running or just sitting tight, they leveraged half of it into another overpriced shitbox. They used the other half for a German car, remodeling, granite counters and stainless steel appliances. And they have an Option ARM instead of fixed at historically low rates.

18   Peter P   2008 Apr 2, 3:56am  

my son had to have a particular surgery not fully covered by my insurance so I used the HELOC for the $20k differential. This would be capitalism at its best.

I believe insurance ought to cover catastrophic expenses. It is sad that our society abuses insurance for everyday care, causing the premium to skyrocket, making major medical care unaffordable.

We should promote high-deductible catastrophic insurance and medical saving accounts.

19   FuzzyMath   2008 Apr 2, 4:00am  

Again, I think alot of this talk about the irresponsible borrowers is mostly old news. The people you are describing have already foreclosed, or are in the process of.

The market has quickly flushed those people out, although congress keeps trying to push them back in.

It is amazing that the media keeps finding complete douchebag idiots to include in what are supposed to be victim stories.

20   BayAreaIdiot   2008 Apr 2, 4:08am  

The people you are describing have already foreclosed, or are in the process of.

I don't think so Fuzzy. At least here in Bay Area, even though numbers are up compared to past history, the vast majority has not been foreclosed on. I'm not really sure what's happening but people seem to be floating not sinking. Maybe lower LIBOR is helping out?

If it's the marginal buyer determining the price, perhaps tightening on new loans will reduce prices to a point where nobody can refinance. But it hasn't happened yet I don't think.

21   FuzzyMath   2008 Apr 2, 4:14am  

vast majority of what? People who took out HELOC's when they couldn't afford their main loan? I'm assuming you're using anecdotal evidence to support that?

22   DinOR   2008 Apr 2, 4:25am  

I guess we have to ask ourselves, how... would we have paid for that particular surgery, or German car or granite countertop had it not been for easy access to cheap credit?

If you paid half down on a house but the int. rate on your HELOC was 13% would we have been so eager to use it? If homes weren't appreciating at 20%+ a year would there even be that much demand for 2nd mortgages?

23   KurtS   2008 Apr 2, 4:33am  

"The 'money' she would have been able to use to pay for landscaping, remodeling, and even basic living expenses is gone - at no fault of her own."

Money?? What money?!!
So the pigs at the credit trough are upset now that they've gorged to the very bottom? My heart breaks for them.

24   FuzzyMath   2008 Apr 2, 4:34am  

DinOR,

nope. We wouldn't have.

On some level, it would be kind of stupid to turn down such cheap credit. Ask the banks who are borrowing from the TAF.

25   BayAreaIdiot   2008 Apr 2, 4:36am  

Vast majority of those who increased what they owe (in the last 7 years especially) without commensurate income increase. That would be just about everybody around here.

26   Peter P   2008 Apr 2, 4:41am  

Welcome back, Kurt!

27   DinOR   2008 Apr 2, 4:44am  

Fuzzy Math,

Very true. Also at some level borrowing right up to the max amount the bank would possibly loan you against your house must have seemed like a validation in many peoples minds!

"How do I know my house is worth $799,995? Because I bought for $600,000 and my bank loaned me the other $199,950 against it, THAT'S how!"

Which brings up the whole issue of "suitability". Just b/c you have $1 mil. w/ Merrill doesn't mean it's suitable for you to be trading on margin! Sheesh. You're in your 70's with a bum ticker for crissakes! That's what's bummed me out about the whole equity stripping thing. Just b/c your home is worth it doesn't mean it's right for everyone to borrow against it?

28   FuzzyMath   2008 Apr 2, 4:46am  

so your premise is that everyone who bought in the last 7 years in the Bay Area will foreclose?

29   FuzzyMath   2008 Apr 2, 4:51am  

DinOR,

it would seem like most of those decisions in the climate we were in were rather justified in my mind. Their houses WERE going up 20% a year, and credit was ridiculously cheap at the same time.

While now those actions are exposed for cleary being irresponsible, at that point in time it's hard for me to judge. We had the chairman of the Fed telling everyone that ARM's were a great idea for christ sake.

30   BayAreaIdiot   2008 Apr 2, 4:58am  

You’re in your 70’s with a bum ticker for crissakes!

hey maybe that's the best time to be trading on margin! if you lose you die, if you win your kids will build you a statue 10 ft tall!

31   DinOR   2008 Apr 2, 5:02am  

Fuzzy,

Oh I absolutely agree! Very much a product of the times we were in. In 2005 the only people that were clearly spooked (were posting here)

Why it was like "having a friend at the Fed!" He prints me up a fresh batch of money pretty much any time I need a little. My house? Oh you mean my bank vault, right...

32   Peter P   2008 Apr 2, 5:03am  

Greenspan said homeowners "might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade."

He did not "telling everyone that ARM’s were a great idea."

33   Peter P   2008 Apr 2, 5:03am  

Please read Greenspeaks literally. Every fluff word counts.

34   DinOR   2008 Apr 2, 5:08am  

BAI,

Well... I think we should worry that the stress of facing margin calls would be the end of you! No..?

It's so obvious (now.. as Fuzzy points out) that clearly a solid majority of these borrowers were out of their depth. Out of their league. I'm sure in a lot of cases what we're seeing is the result of greedy MB's feeding FB's the answers when it came to raises and the potential for increased income.

I really got a kick out of Bill Gross' depiction of the current situation as having "isolated cases of fraud". Pfft, what part of this whole arrangement *wasn't fraud?

35   FuzzyMath   2008 Apr 2, 5:09am  

Check out this article. For as much hate mail as she probably gets, this was a rather good call considering.

http://biz.yahoo.com/pfg/e03greenspan/

36   DinOR   2008 Apr 2, 5:10am  

Peter P,

Agreed, agreed. BUT... his sagely eyebrows were clearly raised at the time (lending credibility to the notion that this was what smart money was doing!)

37   Peter P   2008 Apr 2, 5:12am  

his sagely eyebrows were clearly raised

LOL

38   BayAreaIdiot   2008 Apr 2, 5:13am  

so your premise is that everyone who bought in the last 7 years in the Bay Area will foreclose?

no of course not! Just that the less distance between ones last purchase and 2006, the more certain one can't afford that loan were it to be fully amortized. This represents a lot of people. Certainly a lot more than have been foreclosed already (or will be in the future). However, the foreclosures we've seen so far - I believe - only represent the bottom of the barrel. The rest seem to be escaping somehow (so far)

39   BayAreaIdiot   2008 Apr 2, 5:18am  

What does it say about Greenspan that he was giving advice inferior to that of a TV personality?

40   FuzzyMath   2008 Apr 2, 5:18am  

Peter P,

point taken. Regardless, him coming out in 2004 in support of ARM's, and saying housing was looking good, is a bit ridiculous from todays perspective.

Do you expect your average american to take those comments as "we're in the biggest housing bubble ever, get the hell out while you still can?"

While I think your average American was aware that the runup was unsustainable, I don't think they were thinking about what would happen if housing dropped 40% in 2 years time. They weren't thinking that because they weren't even hearing it as a possibility. Not from the media, not from their peers, not from their financial advisors, not even from the man in charge of the entire money supply of the United States.

They didn't even get a warning!

Whille I applaud the patrick.net crew, the people really should have been hearing this stuff from more main stream channels.

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