Homeowners Owning "Less Home"

Homeowners own less of their homes than ever before. OK, strange statement -- but by it I mean that the equity in their houses is at an all-time low, and the "bank ownership" is at an all-time high. (For another take on these numbers, please see Eric Rothmann's recent blog.)

This can be seen clearly in the graph below (from http://www.calculatedriskblog.com/). At the end of the first quarter, the equity portion in houses was just 41.4% of their total value. In other words, the mortgages outstanding on all houses in the country were 58.6% of their total value.

When you buy a house with a mortgage, the amount of the mortgage declines slowly over time (unless it is an option ARM, in which case it can rise quickly during the early years). Housing equity is the amount of the downpayment plus any appreciation in the house (or minus any depreciation).

OK, even though it is at a record low, at first glance 41.4% does not sound so bad. But wait, 31% of all houses in the country have no mortgages at all outstanding on them. Those are, for the most part, the houses owned by little old ladies who had a mortgage burning party years ago. Granted, on average these houses are smaller and tend to be worth less than the average house, but still it means that for people with mortgages, the equity in their houses is very low.

If we make a rough adjustment for this, and assume that the 31% of homes with no mortgage represent 25% of the total value of houses in the country (in other words, on average, a free and clear home is worth 80.6% of what an average house with a mortgage is worth) then the equity of those with mortgages is just 16.4%. This includes people who have been living in their houses with the original 30 year mortgage for 29 years, as well as people who just bought their houses. More to the point, it also includes all those people who have seen the value of their house plunge and are now underwater. These are the people who are most likely to default or be foreclosed upon, particularly if they run into any cash-flow problems, like becoming unemployed, for example.

Foreclosures will continue to be a big problem for major banks with big residential mortgage books like Wells Fargo (WFC - Analyst Report) and Bank of America (BAC - Analyst Report). Also, retirement plans that were based on using the home equity as part of the nest egg will need to be reconsidered. The same is true for paying for Junior’s college education.

What I find very significant about this graph is that there was no appreciable rise in it during the bubble years. If the amount of the mortgage is fixed to declining slowly (very slowly at first and picking up steam in later years of the mortgage) and housing prices are going up like crazy, then the equity percentage should have been headed up almost vertically. Instead, it was horizontal.

This means that the equity was being siphoned off during the boom years in the form of the Housing ATM. People would run up their credit card bills and then refinance their houses taking out extra cash to pay them off. The home ATM allowed consumption in the early years of the decade to far exceed what it naturally would have been. Consumption going forward is going to have to be based on wages and salaries, and the growth of consumption will have to be based on the increase in wages and salaries, not on asset appreciation.

Actually, given the need to rebuild savings, consumption growth will have to lag wage and income growth. With unemployment high and rising, there is little likelihood that people are going to be getting significant raises anytime soon.

This will be a drag on all discretionary purchases. It will hurt a broad range of companies, ranging from durable goods retailers like La-Z-Boy (LZB - Snapshot Report) to hotel firms like Marriott (MAR - Analyst Report) to makers of high-priced toys like Harley Davidson (HOG - Snapshot Report). This is not just a short-term effect for this year’s earnings, but a long-term drag on their growth potential. As such, it should affect not only current earnings but the multiple investors are willing to pay for those earnings.