NEW YORK (CNN/Money) -
So much for the American dream.
As more and more people have rushed to be homeowners, they actually own less of their homes than they have in decades...adding another risk factor to the overheated real estate market.
On average, homeowners have 56.3 percent equity in their homes, according to Demos, a public-interest research group. In 1973, equity averaged 68.3 percent; in the 1950s, it was upwards of 80 percent.
Two main factors are at work:
- Homeowners are starting off further behind. In the past, the standard downpayment was 20 percent. A 2003 National Association of Realtors survey reported than less than half of all home buyers now put that much down; many obtain 100 percent, even 103 percent, financing.
- Homeowners are yanking out cash. From 2001 through 2004, Americans took $330 billion in equity out of their homes, according Freddie Mac. In 2005 alone, they'll pull out as much as $160 billion.
Demos's senior research associate and author of A House of Cards: Refinancing the American Dream, Javier Silva, said that, even in the absence of a real estate crash, many families "are facing a financial crisis," partially because they've taken on more mortgage debt.
Already, the average American's financial obligations ratio (FOR) -- all your regular bills you must pay each month compared with income -- has expanded to 18.45 percent. That's up from about 15.5 percent in the early 1980s, and among the highest since the Federal Reserve began calculating the statistic.
Put to new uses
Until recently, according to Silva, homeowners cashed out home equity to pay for home renovations, college tuition, or maybe to start new businesses, all of which are reasonable motives.
Today, though, Silva says, many mortgage brokers have convinced consumers to cash out equity to buy new cars, boats, or other big ticket items.
But using home equity that way, he says, "is extremely risky. You're pulling equity out of your home – that's your family's security. And you're mixing bad credit with good."
He means that instead of paying off, say, a car loan in three or four years, paying for it by cashing out home equity adds the car cost to your mortgage. With interest rates so low, that may sound tempting.
But over a 30-year, six percent mortgage, that $20,000 car will cost more than $43,000, including interest, and you can still be paying for it long after it has hit the scrap heap.
Retiring bad debt
Some are also using home equity to pay off credit card debt.
Gerri Detweiler, author of The Ultimate Credit Handbook, has mixed feelings about cashing out home equity to pay off plastic. "Done properly, it can be beneficial," she said.
Before cashing out, though, Detweiler says your other financial fundamentals should be on solid ground -- don't take this step if you just got hit with a big pay cut -- and make sure you can handle the bigger mortgage payment.
And just because you can pay off it high-interest debt with low-interest debt, doesn't mean you shouldn't address why you're racking up debt in the first place.
If you just keep spending, you'll be worse off, because you won't have as much home-equity cushion.
Silva worries that if housing prices flatten out or decline, some newer homeowners who have built up little equity, could find themselves "upside down" -- owing more than their houses are worth.
And, if interest rates rise, homeowners with adjustable rate mortgages may not be able to keep up higher payments or sell the house for what they paid. Foreclosures could spike and the supply of homes for sale soar. That could send real estate market into a tumble.
"That's the scenario I'm most afraid of," said Silva, "and it's one that few economists acknowledge."
The thinking is that houses will maintain their value, as they have in the past, when housing never fell much more than 10 percent to 15 percent. "But prices are much higher than before in many markets," said Silva. Overinflated real estate, potentially, has a lot further to fall.
For more on cashing out on home equity, click here.
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