With “appreciation” not found often in sentences with “home prices” these days, many homeowners are building equity the old-fashioned way – they’re paying down mortgage debt. Residential mortgage debt doubled between 2001 and 2007 but has declined by 7 percent since, pushing home equity to the highest level since 2008. Homeowner equity jumped to 41 percent of residential property value in the first quarter the largest in 60 years, according to a Bloomberg News report, based on an analysis of Federal Reserve data.
Homeowners are taking advantage of record low interest rates to refinance their mortgages, but they aren’t just reducing their monthly payments; they are also bringing money to the table to reduce their principal balance and, in increasing numbers, reducing their loan term, as well.
“The willingness of homeowners to carry housing debt has been radically altered,” Richard DeKaser, chief economist at Parthenon Group LLC and chairman of the American Bankers Association’s Economic Advisory Council told Bloomberg. During the housing boom, when home values were soaring, mortgage debt was viewed as a virtue; today it has become a four-letter word – no longer a leveraging tool but an unacceptable risk.
Fully half the refinances recorded in the fourth quarter resulted in smaller loans – another record, according to Freddie Mac.
Uncertainty about the economic outlook and concern about declining home values are driving the current trend, DeKaser said. “If they can afford it, [homeowners] are paying down their mortgages instead of buying things,” he told Bloomberg, because it makes them feel like they’ll sleep better at night.”
Slashing mortgage debt may prevent insomnia, but it’s not helping the economy. The money consumers are plowing back into their homes is money they might otherwise be spending on other goods and services – reflected in retail sales, which declined in April and May. This trend will have a negative impact on growth in the short term, Paul Miller, a managing director at FBR Capital Markets, agrees but “it is good for our economic health in the long run,” he told Bloomberg, because it indicates that people who became “overleveraged” during the housing boom “are trying to put themselves back on solid ground.”
PLUS SIDE OF NEGATIVE EQUITY
Negative equity – an affliction shared by nearly 25 percent of homeowners who have mortgages – is not entirely negative. Because underwater owners are unable or unwilling to sell their homes, the inventory of homes for sale has been declining. The 6.5 month’s supply in April represented the lowest level in more than five years, according to a CoreLogic study. And the lack of supply, coupled with stronger (although by no means robust) buyer demand, has begun to push home prices up. Prices increased by 1.1 percent in April compared with the same month last year; including distressed sales in the calculation increases the year-over-year gain to nearly 2 percent.
The positive impact is heightened for lower-priced homes, where negative equity is greater. Prices for homes at the lower end of the market increased by nearly 4.5 percent compared with a gain of only 0.6 percent for higher-end hones.
“We have transitioned from pricing dynamics driven by economic weakness and high shares of distressed sales to one of restricted supply, which will likely exist for some time to come – reason for optimism in many hard-hit markets,” the CoreLogic report concludes.
Analysts at Zillow have also found something positive to say about negative equity: Most (nearly 90 percent) are current on their mortgages. Although the number of underwater owners increased slightly in the first quarter of this year (from 31.1 percent in the fourth quarter to 31.4 percent) only 10.1 percent of those borrowers are more than 90 days delinquent, a recent Zillow report found.
“While it was disappointing to see negative equity numbers remain so high, it is important to note that negative equity remains only a paper loss for the vast majority of underwater homeowners,” Zillow’s chief economist, Stan Humphries, observed. “As home values slowly increase and these homeowners continue to pay down their principal,” he predicted.
FEELING BETTER
American households are beginning to feel a little more comfortable about their finances. The Consumer Distress Index, published by CredAbility, rose to 69.9 on this 100 point scale, which measures financial stress on a 100-point scale. The higher the reading, the lower the stress, with any reading below 70 indicating financial distress. The current reading is close to the stress range, but an improvement over 67.6 in the fourth quarter and the best reading since the third quarter of 2008.
“At long last, the average U.S. household is on the verge of moving out of financial distress,” Mark Cole, chief operating officer of CredAbility, observed in a press statement. CredAbility is a non-profit credit counseling agency. The company’s Distress Index measures financial stress in the 25 largest metropolitan areas. Tampa-St. Petersburg, Miami-Fort Lauderdale-West Palm Beach, Atlanta and Los Angeles recorded the highest stress levels; Boston, along with Washington, D.C., Minneapolis-St. Paul, Honolulu and Dallas-Fort Worth, were at the lowest end of the range.
FEELIING POORER
Consumers may be feeling less stressed about their finances, but they are also feeling poorer today – and with good reason. The “Great Recession” has erased two decades of household financial gains.
The Federal Reserve’s tri-annual “Survey of Consumer Finances,” found that the net worth of a median household – with income higher than half of families and lower than half – declined to $77,300 in 2010 from $126,400 in 2007. Median income fell to $45,800 from $49,600 during that three-year period.
Fewer families said they were saving money (52.9 percent in 2010 vs. 56.4 percent in 2007) , and those who did save were more inclined to cite “precautionary measures” and less inclined to cite retirement, education, or a down payment on a home as their primary motivation in the 2010 survey than in the 2007 edition.
The survey also found that middle-income households lost a greater share of their wealth than higher-income families. Fed economists cited two reasons for the disparity: Middle-income families were harder-hit by job losses and income declines, and they have a greater share of their wealth tied up in their homes than in investments – the primary source of wealth for higher income households. The stock market has rebounded strongly since the downturn, while the housing market still sags.
STILL PROBLEMATIC
A federal law enacted in 2010 prohibits financial institutions from automatically providing overdraft protection to customers, but it hasn’t eliminated customer confusion about that service, nor has it reduced the fees they pay for overdrafts, a survey by the Pew Charitable Trust has found.
Customers aren’t getting “clear and comprehensive” information about overdraft options and their costs, the study found, and “certain overdraft fees have increased.” The study was released by The Pew Safe Checking in the Electronic Age Project as a follow-up to a survey conducted in 2010. The title: “Still Risky: An Update on the Safety and Transparency of Checking Accounts,” reflects the study’s conclusion that disclosures and costs related to checking accounts remain problematic.
“Consumers are expected to wade through long, confusing documents and may be subject to steep, unexpected fees to access their own checking accounts, the cornerstone of household financial management,”, Susan Weinstock, the project director, said in a press statement. “Consumers must have understandable, transparent information that enables them to make educated choices when comparing one checking account’s costs and benefits to another,” she added.
The survey of the nation’s 12 largest banks and 12 largest credit unions found little improvement since the initial survey. Among the major findings:
Important policies and fee information are not summarized in a uniform, concise, and easy-to-understand format that allows customers to compare account terms and conditions. Some financial institutions use multiple terms to describe the same fee.
Currently, the median length of bank checking account disclosures is 69 pages, with some as long as 153 pages. The median for credit union disclosures is 31 pages.
The median bank overdraft fee is still $35 for banks and $25 for credit unions – unchanged from the prior survey. But some fees have increased, among them, the penalty fee for an extended overdraft, which has increased by 64 percent. Most institutions (64 percent) charge that extended penalty fee, up from 45 percent in 2010.
All 12 banks surveyed either already reorder withdrawals from high to low or reserve the right to do so at their discretion and without notice to the customer, a practice that maximizes the overdraft fees customers must pay, the report notes.
Financial institutions restrict consumers’ options for recourse in the event of a dispute.
The Consumer Federation of America (CFA) blasted financial institutions for failing to address concerns about their overdraft practices and for refusing to offer more cost-effective alternatives to overdraft protection. But banking industry executives say overdraft protection is a valuable service for which consumers are willing to pay. Industry surveys have found that between 30 percent and 70 percent of bank customers opt-in for overdraft protection.
“They can’t accept that this is a product people want,” Carol Kaplan, a spokesman for the American Bankers Association, told the Philadelphia Inquirer. "There's a need for it, and people are willing to pay for this service."
