Home equity cash flow may soon end

Rising rates mean that fewer will use their homes as a cash dispenser

In years past, buying a home was a difficult proposition. Most families had only one wage earner, and it was hard to find the cash for a 20% down payment. Once a family secured a mortgage, they usually paid it down until they owned the home free and clear. If their equity in the home appreciated in the meantime, the equity was saved, perhaps to be handed down to heirs or to be realized when the owners decided they no longer needed it.

The stock market decline of 2000 changed all the rules, as investors decided to put their money into homes instead of stocks or bonds. That led to rapidly increasing home prices, giving many homeowners equity in their property that they never imagined. Adding fuel to the fire was the drop in interest rates to the lowest levels in memory. This allowed people to withdraw seemingly endless amounts of money from their home’s equity for vacations, cars, travel or even more houses. Some homeowners have refinanced their mortgages three, four or even five times during the last five years, and each time the value of their house and the corresponding equity, increased. Their houses were, in effect, ATM machines. As long as the value kept going up, owners could take out as much cash as they wanted, and if they sold the home, they wouldn’t even have to pay it back.

That situation is rapidly changing. Interest rates are rising, and home values are flat in most of the country. The rates aren’t high by historical standards, but they are higher than they were a year or two ago. Anyone who refinances now will face higher rates than before. Furthermore, home values aren’t rising anymore. That means that the opportunities to refinance over and over have pretty much come to a halt.

It remains to be seen if home prices will actually fall; that will come in time. The people who will be hit the hardest by the changes in the market will be those speculators who took out equity from their homes to buy other houses to use as rental property. Many of these people used that money to buy these other properties using risky, interest-only mortgages, which allow them to keep their payments low. The problem is that the payments don’t contribute to paying down the mortgage, and now that the market is flat, these speculators will either have to find a way to pay down the mortgage or sell the property in a now-flat market. This may soon result in a glut of houses for sale in a market that may not be able to support that much inventory.

The results of all of these changes will probably be fully evident by mid-2006. Assuming that the economy remains fairly healthy, a nationwide real estate catastrophe will probably be avoided. But the free ride that allowed people to endlessly pull cash out of their houses is almost certainly over. Homeowners will have to return to the days of yesteryear, when a house was a place to live and not a source of funding for leisure.