The real estate research firm Zillow.com released a sobering statistic, and it took some by surprise: more than one-third of homeowners who bought in the past five years have negative equity in their homes. Negative equity is owing more on your mortgage than the market value of your home. On the heels of the United States' greatest residential real estate boom in the modern era, how did the above occur?
Two factors, so says economist Peter Dawson.
First, many regions of the U.S., particularly the west, experienced abnormal gains during the 2003-2007 real estate boom. "Total appreciation rates over 300% were not unusual during the period. It was an amazing run, fueled by adequate national GDP growth, and low mortgage rates," Dawson said. "But as we've seen, ultimately the appreciation rates proved to be unsustainable, everywhere they occurred."
Dawson says a 7-9% annual increase in the U.S. median home price is normal, and his models label a 10% annual increase or higher as "outsized" -- a deviation from the mean that calls for a correction at some point in time. "But during the boom, it was not uncommon to see 30%, 40%, 50% annual increases over multiple years," Dawson said. "Clearly unsustainable. Downright frothy. But these conclusions were largely ignored during the boom, on the fallacy of 'what has occurred will continue.' "
Second, a financial habit shifted, Dawson said. Way, way back in the twentieth century, Dawson recalled, the biggest stigma when he grew up in a typical neighborhood in White Plains, N.Y., a suburb about an hour north of New York City, was... Not gaining acceptance at a good college? No. Not getting the hottest date for the high school senior prom? No. "We learned that the Smith's [not their real name] down the street had to take out...a second mortgage," Dawson said.
A second mortgage! "It's was neighborhood news, and it wasn't good. A second mortgage was a sign of financial distress, a last resort," Dawson said. "You would think the Russians had just invaded New Jersey. [Dawson is old enough to remember the Cold War.] It was worse than the Yankees not winning the pennant. No one ever took out a second mortgage except for a serious emergency."
But then, something changed, Dawson said. In the twenty-first century, the second mortgage -- perdition in financial terms -- suddenly became a home equity loan that the banking sector promoted as, incredibly, a second source of capital, and, in some cases, as cash flow. "Absurd. Just absurd. As soon as I saw the aggressive marketing of home equity loans, I and many other economists said 'this can only end badly,' " Dawson said. "It's not a home equity loan. It's another lien against your house."
Combine frothy home prices with home equity loans, and a market slowdown, and you get, you guessed it: a massive amount of home owners with negative equity.
What to do?
Dawson, a perpetual optimist, has the following advice for those with negative equity. If you don't have to sell now, and you see no reason to sell in the next five years, wait it out. "Housing prices should be trending up in most regions of the country in 2-3 years," Dawson said. Also, pay back a second mortgage as soon as possible.
Housing Sector / Economic Analysis: Economist Dawson also recommends: Save continually, invest, and live well below your means, for decades. Good things happen financially when you do, he says, and that's the view from here, as well.
Reader Comments (Page 1 of 1)
8-31-2008 @ 7:01PM
william lindblad said...
Partial truth. Mr Dawson grew up in White Plains, N.Y., which is also Westchester County, N.Y.which is also the highest taxed County. (except N.Y.C.) It is also an area of "keeping up with the Jones's". Yes, a second mortgage and Home Equity is pretty similar but there are two divisions within and they still have little to do with the overall value of the initial property. In fact, the "great real estate boom" is more like a stock market "bubble" - and it burst. This has happened many times before, but not on this scale and that is the main problem - size.
I have used both the 2nd mortgage note and home equity to my advantage and I see nothing wrong with them if used in a prudent fashion.
If you wish to address blame, than blame those who control the banking system, for the real cause of this dilemma was the lack of oversight and control of speculative lending.
Now who would that be? If you don't know, it's about time you made an effort to find out.
8-31-2008 @ 11:01PM
phil said...
I am schocked that highly educated financial analyst missed the entire cause of this nation's credit crisis, due entirely to credit card companies loan sharking interest rates and late payment fees that threw the budgets of most Americans so off course that nothing was left to do but simply quit. Certainly a correction to the credit habits of most people were long overdo, but, the initial cause that escalated into a financial crisis began with the credit card companies and is today the same fuel that continues to feed a fire totally out of control that will take years or decades to put out.