July 9, 2006 at 5:14 AM #6828
I have been wondering about the ‘wealth effect’ and also, when do people taking out home equities expect to actually pay off their home? What seems to be happening, as their home’s value rises, is people keep taking out home equity loans to fund their fun or it seems in most cases to pay off other debt. I guess as long as their home’s value keeps rising, then they can keep doing this. But it appears that they are using their home’s perceived value as a way to sustain a lifestyle they can’t actually afford. What is going to happen if their home’s value goes flat or goes down? And when exactly do they plan to pay for a home? And when they decide to start paying, will they be able to actually live within their actual income? What am I missing?July 9, 2006 at 7:59 AM #27938carlislematthewParticipant
I don’t know a whole lot about it, but the article above makes it seem pretty simple.
In answer to your question about when people will actually pay back these loans, I agree with your “what the hell?” assessment of the situation. I wonder the same thing.
Rising home equity gives you the opportunity to do a few things:
1) Cash out and move to an area where prices are NOT inflated (as much).
2) Cash out, stay in town, but downsize.
3) Borrow more money!
Lots of people have taken option 3. I think a very common thread was people with credit card debt using a HELOC to pay that off, and buy a BMW while you’re at it. After all, it’s “free money” and your house will only ever go up in value so you can always sell in a pinch if you need to. Besides, the payment is only XXX a month! What a deal!
I don’t think the majority of HELOCers realized that they were only paying interest, that the interest would double in 2 years time (which it has already), and that they would actually have to pay this money back at some point!
Plus, once the HELOC is maxed out, I believe the spenders will go back to their old lifestyle of gradually accumulating credit card debt because their spending habits have not been fixed. If anything, they’re probably worse now because the infusion of cash has made them feel more wealthy than they really are (the wealth effect!) and so their lifestyle has changed. Nicer vacations, nicer restaurants, kids have a higher allowance, etc. It’s REALLY hard to go down in lifestyle, but it only take a nanosecond to go up!July 9, 2006 at 11:54 AM #27953
The government has data on the wealth effect. For every dollar of increased stock market wealth, an investor will spend x% more, and for each dollar increase in home equity he will spend y% more.
People in general believe home prices can only go up. They live for today. They do not think prices will stop rising, so they behave as if they will keep going up. The plan is to keep spending the equity. Some day, they sell the house, pay off all the equity lines and the mortgage, and use the remaining equity to fund retirement. They will either downsize or leave the area. Whereas people used to fund their retirement by saving and paying off their homes, now they are funding it by riding the wave of appreciation. In their ignorance, people believe this can go on indefinitely. They don’t think they ever need to live in their income limits.
In fairness, many people are forced into spending their equity, because wages have not kept up with inflation. Inflation is not properly measured with the CPI, and the things that are measured have downward pressure on them. Think cheap goods from China and lower wages from illegals. About half the construction industry is illegals and that keeps construction wages down. When people have an unexpected expense, out comes the credit card. Homeowners with equity will take out a HELOC to pay off that credit card.
Some spend their equity because we are a consumption nation. They are dependent on rising home prices to fund their lavish lifestyle.
Reality: prices stop rising or fall. Even if prices just stop rising, the gig is up. The MEW gig works only as long as prices keep rising. The market has peaked, and prices are falling. Within a year, MEW will be a trickle because home values are falling and people won’t have the equity to withdraw. Within 9 months after that, the last MEW money will be spent. By end 2007, early 2008, the MEW money will be out of our economy, and we will be in recession.July 9, 2006 at 1:20 PM #27960AnonymousGuest
I have asked several friends how they plan to pay off their mortages in SD. I get a lot of incredulous looks. They have no intention of ever really owning their homes.July 9, 2006 at 2:11 PM #27961anxvarietyParticipant
Nice wiki link.. Notice at the bottom they have a link to the wealth elasticity of demand… I think the elasticity concept in economics best describe what the effect and reactions to the housing deflation will be… it’s how people make decisions when they aren’t dictating the pace.. they have to be ‘flexible’, and divide their decisions into needs and wants.
I predict ‘cut your losses’ will be the phrase that replaces ‘i just refied’ phrase of the last 10 years..July 9, 2006 at 5:49 PM #27974
When I asked my neighbor of 3 years ago if he had earthquake insurance, he laughed and said, “If you knew how this house was financed you wouldn’t need insurance either”.
I didn’t know what that meant. Now I know he had an Option ARM. He was renting the house from the bank.July 9, 2006 at 6:23 PM #27978North County JimParticipant
In fairness, many people are forced into spending their equity, because wages have not kept up with inflation.
Are you saying there are no alternatives for people spending their equity? It’s not their fault?
Is anyone responsible anymore?July 9, 2006 at 7:36 PM #27981
Thanks for the replies. So I’m not the only one that thinks something crazy is going on. I am lucky enough (hopefully) to be able to watch and wonder as this housing market deflates. My wife and I own our home outright. No mortgage, no HEL (L). We are saving and if the housing market does crash we’d like to buy some realestate at a sane price.
We haven’t been without fault. We were stupid in our very young years and did the credit card thing. But we got a handle on that and these days we don’t have credit cards and pay cash for everything we want. If we don’t have the cash, we can’t afford it and so we SAVE for it. We have friends that act like we are a bit odd. Whatever. It is sure a nice feeling not having a mortgage. Actually, it is nice not having any payments except for utilities. It was hard getting to this point, but has been worth it. I’ve had friends ask about the tax write off of our home being gone. I tell them I’d much rather give the government three thousand dollars than give a bank ten thousand dollars in interest. Heck, if you want a ten thousand dollar write off, donate that money to a charity. You don’t hear banks suggest that. I don’t wish bad on anyone. It’s just that to me something bad has been happening regarding housing and borrowing. It just got my attention and I just can’t help wondering how this will play out.July 9, 2006 at 7:52 PM #27982rankandfileParticipant
I think powayseller made that comment more out of sympathy for those who are working hard trying to make it and just made some bad assumptions/decisions about how things were going to be in the future. It’s a lot better than rubbing it in and saying “I told you so” or “See, I was right”, which many of us on the outside of this bursting bubble might be inclined to do.
But the underlying premise, that wages are not keeping up with inflation, is very true. I guess that many thought their wages (or wages in general) would increase over time and they would be able to make it. But wages would have needed a rocket up their @ss to keep up with the inflated home prices.
Yes, even wages have @sses.July 9, 2006 at 8:15 PM #27986novice1027Participant
Don’t you think most of this has to do with the fact that, in gerneral, people have turned into instant gratification junkies? What ever happened to seeing something, deciding you want it, saving for it, then enjoying it, knowing how hard you worked to get it?
Maybe this big implosion will get everyone back to some sense of normalcy.
Maybe I’m just turning into my mother, lolJuly 9, 2006 at 9:55 PM #27988
rankandfile is right. Sympathy. Also some knowledge from a credit card study, the first ever, published in October 05, which I posted here last week. Summary: the majority of CC users are using their cards for basic living expenses and unexpected expenses such as medical bills and auto repairs. The image of CC debt as a result of a lavish lifestyle is not true. Wages have not kept up with the cost of health & home insurance, home ownership, tuition, gas, utilities. It’s the lower income people who use the CC to pay for rent, food, utilities, car repairs.July 9, 2006 at 10:28 PM #28000North County JimParticipant
I have sympathy for those who have been or will be hurt. However, how many are true victims (meaning circumstances clearly beyond their control)? Whether it’s credit cards to pay for groceries or home equity to finance consumption, there are alternatives.
On another thread, I related a story a hair stylist gave me about her family’s expenses. She claimed to have cut $600 in monthly expenses.
If things get as dire as you predict, the hair stylist will not be alone.July 10, 2006 at 2:29 AM #28004ybcParticipant
here is a Washington Post article on the widening gap of income (you may need to register to view the article)
Unfortunately, for some struggling at the bottom of the income spectrum, it takes very little (medical problems, job loss, etc) to disrupt their economic security. So they’d turn to home equity to tide them over. But I agree in principle that a lot of people here probably have forgot that one shall always underspend his or her income…July 10, 2006 at 1:57 PM #28024
ybc, I read the article and what comes to my mind is that those under-paid individuals need to get better jobs. I know it is easier said than done, but if a person just accepts their circumstances, then they aren’t going to improve. Back in the late 70’s, early 80’s I was working in HVAC, running service calls for a small company. I went to night school and changed my career to computers. Ended up working repairing PCs, then programming. It took a lot of hard work to make the switch. Actually took a cut in pay to get into the computer field. But now my salary is at least double, maybe triple of what I would have been making if I had stayed doing what I was doing. Nobody handed me anything. I had to work my ass off for it.
I just read an article on MSNBC about credit card use is up and refi’s are down. I’m sure that people are now using the CC’s to pay for gas to get to work and really juggling things. The local news has been reporting that pawn shops are doing more business. They interviewed someone in the shop that stated they were pawning stuff to buy gas. The state of affairs does make me nervous.
Finally, I agree with the poster that talked about the ‘want it now’ syndrome. In the past you did save for things. Now, it is extremely rare to see people saving for an item, when they can give themselves a loan right on the spot. It is so crazy. The question isn’t “how much does it cost?’, it is “how much is the payment?”.July 10, 2006 at 7:03 PM #28047
You’re an admirable man. Yet, I still have to ask you: don’t you think we need people to repair our A/Cs and potholes, sell movie theater tickets, serve our meals at restaurants, check us out at the grocery store, show us how to set up the tent at REI, put out our fires and jail our thieves, teach our kids, clean the bathrooms at the airport? Can all these jobs go exclusively to people under age 23, those who don’t expect to be married or own a home? Under the scenario you describe, police officers, teachers, book keepers, librarians, should be those who are in 2nd jobs, or providing their families part time income, or under house buying age. Not a realistic economic model….in other words, we need people to do all those jobs. Maybe people in those jobs should be content as renters and living a poverty level life style. Not everyone is entitled to everything.
I used to think $250K was a good salary, until I read about the thousands of people in New York who make over $200 million. $500 million is change for a hedge fund manager. That’s a whole different league. I bet they look down on people like us. So we shouldn’t look down on the $30K /year worker either, right?
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