New York, NY — Homeowners have been tapping into their home equity to get the cash needed to pay down credit card debt incurred not for luxury expenses, but for basic needs. This strategy leaves them on precarious financial footing after two years of interest rate hikes and the largest drop in home prices in 35 years, according to House of Cards 2006 Update: Still Refinancing The American Dream, a report published today by Demos, a non-partisan public policy organization based in New York.
House of Cards 2006 is based on extensive analysis of government, industry and academic research, and provides a comprehensive analysis of the causes and impact of the mortgage refinancing boom in the United States since 2001. The report shows 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 compounds 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 blurred the line between good debt — debt that results in an appreciable asset, such as a house with equity — and bad debt, which does not.
"As the housing bubble deflates, and with interest rates on risky adjustable rate mortgages rising, more and more homeowners are feeling the pinch," said Jennifer Wheary, Senior Fellow at Demos and co-author of the report. "About $1.4 trillion in adjustable rate mortgages will reset between 2006 and the end of 2007, leaving many homeowners facing monthly payments that are 25 percent higher. Since refinancing for a second or third time has become a common band-aid to offset skyrocketing costs and delay the impact of a weaker housing market, many homeowners will find themselves making unmanageable payments on houses in which they have little or no equity, and which may no longer hold the value of the original mortgage."
"This is a dangerous time for American families," added Wheary. "About a third of home mortgages continue at an adjustable rate; previously-rare interest-only mortgages made up 20 percent of home loans in 2005; and sub-prime home loans are widespread. The evidence is clear — default rates could skyrocket in the coming years as millions of American homeowners find themselves way over their heads in these loans."
Key findings from the report include:
* Households cashed out $715 billion worth of home equity between 2001 and 2005. In the three years between 2003 and 2005, owners extracted $150 million more in equity from their homes than they did in the previous eight.
* 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 in times of emergency, to finance education, or for retirement.
* Between 1973 and 2004, average home 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 --surpassed 19 percent, a record since data started being collected in 1980.
* About $400 billion worth of adjustable-rate mortgages, 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 in 2007.
* Adjustable rate mortgages made up 31 percent of home loans in 2005. Interest-only loans, which were uncommon just two years ago, made up about 20 percent of loans.
* Industry experts predict a spike in refinancing next year as homeowners seek relief from these large increases and look to refinance for the second or third time.
* The rise of appraisal fraud has fueled inflated home prices over the last several years and could leave many homeowners "upside down" in their homes--that is, owing much more than the true market value of their home.
* Even though it is underreported, appraisal fraud was the fastest type of mortgage fraud reported by major lenders in 2000, and there is no end in sight. In 2005 more than 22,000 cases of mortgage fraud were reported to the FBI, a seven fold increase since 1999.
* With the past two years of interest rate hikes by the Federal Reserve, families with adjustable rate mortgages are experiencing significant increases in their monthly mortgage payments. The combination of higher mortgage payments coupled with rising costs of basic living expenses represents a growing financial threat and is leading many families to refinance for a second or third time.
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.
The report suggests reforms that would have immediate and long-lasting impact-to improve the financial security of America's households:
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.
Strengthen Current Bankruptcy Laws To Support Hard Working Families In Severe Economic Distress. Bankruptcy is the last resort for hard working families who find themselves in dire straits. Many middle class families are left in this situation from unforeseen circumstances such as health problems and unpredictable illness. In 2005 Congress passed sweeping changes to bankruptcy laws which removed many protections available to average families. As families' financial stability grows increasingly fragile and the safety net of home equity evaporates, these changes must be reexamined and reversed.
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.
"There's a financial crisis hitting America's families," said Tamara Draut, Director of the Economic Opportunity Program at Demos. "In order to make ends meet, Americans have been depleting the one key asset that most rely on for future financial security--their home, and now out of control lending practices are going to cause millions to teeter on the edge. There are many clear steps that Congress can take to start to protect America's households from economic ruin, and help restore the security that homeownership once promised. They can, and should, start now."
To view the full report, A House of Cards 2006 Update: Still Refinancing The American Dream, visit archive.demos.org.