New York, NY — Across the United States, families increasingly rely on credit cards to make up for stagnant wage growth and soaring costs. In order to cope, homeowners are depleting their home's equity to pay off a growing mountain of unsecured debt. This is a financial strategy fraught with serious consequences, according to A House of Cards: Refinancing The American Dream, a new report released today by Demos, a nonpartisan public policy organization based in New York.
"Although projections that the housing bubble will burst should have homeowners concerned, many families are already facing a fiscal crisis," said Javier Silva, author of the report. "Millions of Americans have refinanced their homes in the last three years to pay off credit card debt and to cover basic living expenses, many of them with risky adjustable rate mortgages tied to the Prime Rate. Now, with stagnant wage growth and increasing expenses, families are feeling the pinch and spending their home's equity to make ends meet. If home values bust, many of these homeowners will be devastated."
The report, based on extensive analysis of government and industry data as well as academic research, provides a comprehensive analysis of the causes and impact of the mortgage refinancing boom in the United States since 2001. A House of Cards finds that, as mortgage interest rates fell to record levels during the refinance boom, many Americans cashed out home equity to pay down debt and finance living expenses — a quick-fix that only adds to the long term economic burdens of the average family. The net result: the financial well-being of many Americans is at risk as the refinancing boom has created a blurred line between good debt — debt that results in an appreciable asset, such as a house with equity — and bad debt, which does not.
Key findings from the report include:
* Households cashed out $333 billion worth of equity from homes between 2001 and 2003, the beginning of the refinancing boom — levels three times higher than any period since Freddie Mac started tracking the data in 1993.
* A majority of households that refinanced between 2001 and 2003 used cash equity from their homes to cover living expenses and pay down credit card debt, further eroding their home's 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 2002, the financial obligations ratio — the percentage of monthly income to the amount needed to manage monthly debt payments — reached 18.56 percent, a single year record since data started being collected in 1980.
* As the Federal Reserve continues to raise interest rates, a mortgaged family with an adjustable rate mortgage will experience a significant increase in their monthly mortgage payments. The combination of higher mortgage payments coupled with rising costs of basic living expenses represents a growing financial threat.
* The rise of appraisal fraud fueled inflated home prices over the last several years. Even though it is underreported, appraisal fraud was the fastest type of mortgage fraud reported by major lenders in 2000, and could leave many homeowners owing much more than the true market value of their home.
* Homeowners who reduced their home's equity during the refinance boom could suffer devastating effects if home prices begin to fall. As a result, a homeowner could owe more on their mortgage than the house is worth — known in the industry as being "upside down" in a house.
"Homeownership has been a bellwether of financial security and a firm foothold in the "American Dream," said Silva. While most Americans are by now familiar with the marketing of ready cash from easy home refinancing, few of us are truly aware that when we borrow against our home — our most important asset — we are putting our financial future at risk."
One of the most alarming findings in the report is the role that mortgage fraud, in particular appraisal fraud, plays in the refinancing process. There are growing numbers of third party brokers pressuring appraisers to inflate home values in order to "close the deal" and reap larger fees or bonuses. The consequence can be dire for homeowners who refinance and draw out more cash equity than their home is actually worth. Unfortunately, banks often spend little time investigating the appraisal process, because they normally hold the loans for a short period before they re-bundle and sell them to investment firms.
"This is another example of the unethical and often unregulated methods used to capitalize on the financial challenges facing millions. Many people are defrauded into borrowing more than the fair market value of their homes. They will find themselves in an economic crisis if and when the housing bubble bursts."
The report suggests reforms that would have immediate and long-lasting impact:
Enact a Borrower's Security Act. New legislation is required in order to ensure that borrowers are protected from the excessive rates, fees and capricious changes in account terms, which are all legal and common industry practices today.
Enact a National Usury Law. Building on the Borrower's Security Act, Congress should enact a National Usury Law that would prohibit today's penalty interest rates of 30 percent or higher.
Maintain Existing Bankruptcy Laws For Individuals In Severe Economic Distress. In 2003 nearly 1.6 million people filed for bankruptcy. Congress has considered legislation that would make it more difficult for individuals to recover from financial collapse. The growing presence of families in the bankruptcy courts should warn policymakers of the importance of safeguarding this difficult last resort for consumers.
Protect Americans from Appraisal Fraud. While Congress passed comprehensive reforms after the Savings and Loans financial crisis, further reform is needed to protect consumers from the ruinous effects of appraisal fraud. The Appraisal Institute reported that more than 7,000 appraisers have been pressured to inflate appraisals. Congress should ensure that brokers are prohibited from coercing or intimidating appraisers in order to receive a desired property appraisal value.
To view the full report, A House of Cards: Refinancing The American Dream, or for more information about Demos' economic research, visit our Debt and Assets Clearinghouse at www.demos-usa.org/debtassets. To schedule an interview, or for additional background information, contact Ellen Braune or Tim Rusch at (212) 633-1405.
Demos: A Network for Ideas & Action, is a nonprofit, nonpartisan public policy organization based in New York.