A House of Cards Update
Refinancing the American Dream
November 14, 2006

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In response to ever-increasing financial pressures, families have come to depend on high-cost credit as a way to bridge the gap between stagnant or decreasing incomes and rising costs. How are families coping with their new burden? To hang on to the American Dream, to be part of the ownership society, homeowners are depleting their homes' equity to pay off a growing mountain of unsecured debt -- a financial strategy fraught with serious consequences. As mortgage interest rates fell to record levels during the refinance boom, it became more appealing to cash out home equity during the refinancing process to pay down credit card debt and finance current living expenses -- a short-term solution that fails to address the long-term economic realities faced by the average family. As the housing bubble deflates and interest rates on risky adjustable-rate mortgages have risen, more and more homeowners are feeling the pinch. Refinancing for a second or third time is becoming a common band-aid. Defaults are also increasing, particularly for subprime mortgages. The added burden of missing a mortgage payment results in putting at risk your homeyour family's most important asset. All of these factors lead to a crisis in personal finance: a blurred line between good debt -- debt that results in appreciable asset -- and bad debt, which does not.

Key Findings

• Households cashed out $715 billion worth of home equity between 2001 and 2005.  In the three years between 2003 and 2005, owners extracted $150 billion more in equity from their homes than they did in the previous eight -- a level three times higher than any other three-year period since Freddie Mac started tracking such data in 1993.
• Households have used cash equity from their homes to cover living expenses and pay down credit card debt, further eroding their homes' cash value, which many families rely on for economic security.
• Between 1973 and 2004, homeowner's equity actually fell--from 68.3 percent to 55 percent. In other words, Americans own less of their homes today than they did in the 1970s and early 1980s.
• In 2006, the financial obligations ratio -- the percentage of monthly income to the amount needed to manage monthly debt payments -- has surpassed 19 percent, a record since data started being collected in 1980.
• About $400 billion worth of adjustable-rate mortgages (ARMs), representing about 5 percent of all outstanding mortgage debt, are set to readjust this year for the first time. Another $1 trillion in loans are set to readjust next year. 
• Adjustable-rate mortgages made up 31 percent of mortgages in 2005.  Interest-only loans, which were uncommon just two years ago, made up about 20 percent of loans. 
• In current conditions, a typical borrower with a $200,000 ARM could feasibly see their interest rate climb from 4.5 percent to 6.5 percent, resulting in a 25 percent increase in their monthly payment.
• Rising foreclosures signal many homeowners are already buckling as interest rates rise and home values soften, trends that will continue as more mortgages adjust. According to RealtyTrac, foreclosures in the third quarter of 2006 were up 17 percent from the previous quarter, a 43 percent yearly increase from the third quarter of 2005.