Perspectives on home equity
Welcome, friends. I hope this finds you feeling optimistic as February draws to a close and spring is around the corner.
Over the last several days, several reports and articles have been published regarding the rise in home equity held by U.S. homeowners–an average of $194,000 in equity per mortgaged property, according to CoreLogic.
In this post, we’ll look at multiple perspectives on home equity, including how we got where we are today and what it means as we move forward.
A quick look at the markets and economy
Before we get into home equity, here’s a quick recap of markets and the U.S. economy.
Suffice it to say that the markets are strong and show every sign of continued strength–although volatility is still high and growth velocity is still staggering. Pessimism comes from those who see two potential problems (Covid flare-ups notwithstanding):
Manufacturers face lingering supply-chain disruptions that slow production and can potentially cause not-insignificant increases in the cost of goods.
Many economists see inflationary pressure building as well as rising interest rates, both of which could slow the recovery’s momentum.
In my opinion, though, there would need to be very significant increases in interest rates and inflation to impact trend lines and have a stagnating or negative impact on the recovery. Happily, Federal Reserve Chair Jerome Powell seems to agree!
While we’re on the topic of inflation and about to head into home equity, here’s a quick note: in this blog, I’ve frequently mentioned that housing is normally an inflationary hedge. To best explain this concept I’ll borrow this, from HomeUnion:
As inflation refers to a decrease in your buying power, an inflation hedge—in investing—protects you from it. An inflation hedge typically involves investing in an asset expected to maintain or increase its value over a specified period of time. That’s why real estate is considered a hedge against inflation, since home values and rents typically increase during times of inflation.
Increases in housing prices have certainly been a factor in housing equity increases, and it’s worth noting that home prices, a.k.a. housing appreciation has outpaced ordinary inflation over roughly the last five decades.
Home equity valuation: What does it mean?
As noted earlier in this post, a CoreLogic report cites that Americans own an average equity of $194,000 per mortgaged home. This potentially represents an immense increase in wealth for American homeowners.
On the one hand, this is great news: it means that people have more housing security as well as cash available, should they choose to use it, to invest directly in their homes or into other assets, like stocks, or valuable undertakings, such as higher education.
On the other hand, it begs the question of who, exactly, has this equity?
Does most home equity belong to those who are already wealthy, as is the case for other assets? Or is it somewhat more equitably spread across a broader swath of middle-income households, too? It’s hard to say but, according to this BankRate study, the highest equity is found in the wealthiest states.
Time-series events and home-equity growth
In my view, it’s important to realize that huge gains in home equity are likely less about wise investing and more about the impacts of time-series events.
Prior to 2008, mortgages and home-equity loans were easy to get. Then, the cumulative impacts of subprime lending and shoddy investor practices led to millions of people taking on more housing debt than they could handle, leading to the crash of the housing market and the Great Recession. (Of note, according to the Center for American Progress, the majority of failed subprime home loans were refinances to extract home equity.)
Fast forward to 2020/2021 and the Covid-19 bubble: home prices have soared but mortgage rates have stayed low. As a result, anxious people are once again taking on significant mortgage debt to finance higher-cost homes. This, in conjunction with much higher underwriting standards (including criteria such as down payments of 20%-30%), have increased equity in a more substantive way.
It seems to me that the phenomenal growth in housing valuations–and the subsequent growth in home-equity valuation–resulted from incentives and regulations put into place following the 2008 housing crisis, the first of which were extremely low interest rates, for a very prolonged time. This led to historically low rates on 30-year mortgages, which has an extraordinary impact on home valuation and purchasing power.
According to a recent Radian Home Price Index report, the current median home price in the U.S. is about $270,000. Assuming 20% down, then:
That would have equated to a $41,300 home in 1971. With that year’s average interest rate of 7.31%, you’d have a monthly principal-and-interest (P/I) payment of $227, which is equivalent to about $1,486 today.
In 1981, when mortgage interest rates peaked at 18.45%, the monthly P/I payment for that same home (which would have had a purchase price then of about $89,500) would have been $1,105, or the equivalent of $3,335 today.
In 2021, when mortgage rates are averaging around 3% (a slight uptick from recent record lows), that same home, with a current purchase price of $270,000 would have a monthly payment P/I payment of $911 today.
Clearly, then, because mortgage rates are so low, today’s home buyers have more room in their budgets for higher-priced homes and sellers are responding accordingly.
Another factor impacting equity rise is that the average length of tenure in an owned home is around 13.4 years, which has stayed steady or risen in most areas over the last decade or so. At that point, homeowners have accumulated average equity on their homes of about 43%, simply from payments made on a 30-year mortgage. And, of course, as mortgage principal goes down and home valuations rise, the resulting equity builds and builds.
A question to ponder is whether people are holding onto homes longer because, like certain highly priced stocks now, they’re seeing the velocity and momentum of increasing values? And, as we know from previous posts and life itself, a lack of available housing inventory (even prior to the pandemic), as well as pandemic-related factors have certainly driven housing prices and accumulation of equity, too.
Is equity leading to the “stockification” of homes?
With the incredible growth in home equity are amazing opportunities, along with real-life conundrums: Are you better off cashing out some of your equity to invest in other assets, like stocks, or expenses like education? Are you better off using that money to reinvest in your home? Is there an amount of equity that’s the “right” amount to have?
There are a lot of people out there who will say that if your mortgage interest rate is lower than average stock returns, it’s worthwhile to cash out equity and buy into the markets.
There are others who say that you should never use home equity for anything other than improving your property. Otherwise, you’re putting your home–your shelter and your largest investment–at risk.
And still others say that keeping too much money in home equity means that you miss opportunities to build wealth, so aim for such-and-such a percentage of equity and beyond that, use the funds as you see fit, so long as you can comfortably pay the mortgage or home-equity loan.
To me, the right answer is whatever is best for each homeowner’s particular situation.
Many people are “house rich, cash poor,” while others have learned to leverage mortgage debt and home equity to their advantage. What I see more often now, though, is the tendency to view homes as money-making machines (something that we also saw leading up to 2008, though not for those who were victims of predatory lenders so much as with those who were rampantly leveraging home equity for more and more purchases).
And soon, I think we may see correlations between the lottery/gamification mentality that has been so pervasive in the markets and ultimately, who does what with home equity and how that works out in the end.
Using home equity to build current and future value
In several posts, I’ve talked about Plunk and how our app can help homeowners understand how improvements (necessary and otherwise) impact the value of their homes in real time, leading to better decisions about renovations and improvements. And according to this CoreLogic report, people are investing a lot in their homes.
Investing in your home is often one of the best investments you can make–it’s your major asset and the only one (for most people) over which you have total control. It’s like owning the company that you’re investing in. That said, not all home improvements are created equal. That’s where the Plunk app can help to maximize the return on equity and investment.
Still, as with nearly all AI-driven apps, what it can’t factor in is the inherent pleasure or use you’ll get out of some of the changes you make while you live in your home–and in some cases, those factors may far outweigh the lack of financial return. Sometimes, you simply have to do what you enjoy.
How equity feels
Speaking of enjoyment, one of the factors I haven’t touched on yet but that is certainly worth noting is how good it feels to build home equity.
While we can debate the merits or lack thereof of using home equity, there’s no denying the emotional satisfaction of seeing an investment do well. Figuring out the best way to leverage that financial power–whether staying the course, taking out some and reinvesting it in your home or cashing out most and taking your chances–are highly individual choices.
But there’s one thing we can all agree on: building home equity not only feels great–it’s also a wise decision.
