Billowing appreciation rates have been the hot news in home real estate for much of the past three years. But now, with many of the most effervescent local markets in a cool-down phase, the focus is turning to something much more fundamental: homeowners’ equity stakes.
The popular image is that America’s homeowners are turning into debt junkies, hocking their houses to the hilt, and are banking on double-digit appreciation rates to bail them out. But a comprehensive new analysis of home equity holdings nationwide suggests that the reality is much more nuanced. On the one hand, it is true that a surprisingly large percentage of recent home buyers are sitting with minimal — even negative — equity levels. On the other hand, most homeowners have substantial net equity holdings — a record $11 trillion, almost double what they had just five years ago.
The study tapped into proprietary mortgage and real estate valuation databases maintained by subsidiaries of First American Corp., a giant national title insurance, credit, and settlement services company. Christopher Cagan, director of research and analytics for First American Real Estate Solutions, was the primary investigator. The data included appraisal or valuation information on 26 million homes in 36 states and the District of Columbia as of September 2005, plus loan file data on nearly 20 million active mortgages originated from 2004 to 2005. Some of the findings appear to support the stretched-to-the-limit, debt-binging image critics ascribe to today’s homeowners and borrowers.
Among 2004-2005 borrowers:
Nearly one out of 10 was in a zero or negative equity position as of last September. Five percent were in negative territory by more than 10 percent. That is, their combined mortgage debts exceeded their home values by more than 10 percent.
Nearly 30 percent had equity cushions of less than 20 percent. Forty-four percent had less than a 30 percent cushion.
State-by-state net equity holdings were sobering in some cases. More than 28 percent of Colorado buyers or refinancers had less than 5 percent equity in their properties. Nearly 24 percent of Ohio owners were in the same situation, as were 13 percent in Washington, D.C., and around 11 percent in California and Florida. Data wasn’t readily available for New York.
Equity levels are important measures of household financial health and a key component of net worth. Low equity makes owners more vulnerable to economic shocks and rising interest rates. If they had to sell in a pinch, they could find themselves walking away with little or nothing at the end of the transaction. If property values declined even modestly, large numbers of recent buyers with minimal equity stakes could slip to the negative side.
But overall, the state of the nation’s home equity holdings is hardly so dire. The First American study cites Federal Reserve research which found that, contrary to some critics’ assumptions, most of America’s homeowners have plenty of equity — 57 percent stakes on average as of the third quarter of 2005.
Not surprisingly, households’ equity positions vary by the age of their mortgages, among other factors. Eight out of 10 people who took out their mortgages in 1985 have equity stakes of 75 percent to 80 percent, thanks to paydowns of principal and price inflation. Sixty-five percent of borrowers whose loans date to 1990 now have 50 percent to 55 percent equity positions. Roughly half of 2001 buyers and refinancers have seen their equity stakes grow to 25 percent to 30 percent.
By contrast, the most recent borrowers tend to be thin on equity, thanks to high housing prices, low down payments, “piggyback” second loan programs, plus widespread use of interest-only and “payment option” plans that cut monthly payments dramatically, but may add to principal debt.
Nearly 30 percent of 2005’s borrowers have zero to negative 5 percent equity positions. Some of those low-equity homeowners who face hefty payment “resets” on interest-only and negative-amortization loans in the coming two to three years will end up in hot water, Cagan forecasts.
But most will not. And need not. The upshot: If you’ve got a low-equity mortgage that’s heading for a reset, plan ahead now. Make sure you have a financial action strategy to handle what’s coming.
Ken Harney is a real estate columnist with the Washington Post.