I’ve been seeing a lot of headlines like this lately, including the New York Times today “Housing Slump Pinches States in Pocketbook.” But I couldn’t figure out why. We don’t pay sales tax when we buy a house, so why do local, state and federal governments care if homes for sale sit around unsold? And while homeowners pay property taxes (boy, do we!) those taxes are based on home appraisals that are figured once a decade maybe. So again, why does it hurt government budgets if home prices stagnate or fall? A mystery — until I read below the headlines.
“[H]omeowners who tapped into plentiful home equity and spent extravagantly during the real estate boom have started to cut back.” (NYT)
“Falling prices of existing houses also discourage people from borrowing against home equity. The result is lower consumer spending, and less tax revenue.” (Bloomberg)
“South Floridians are no longer using their home equity like an ATM and are worried about increasing housing costs.” (Miama Herald)
“In 2006, about 24 percent of homeowners used a home equity line of credit to purchase a car or truck, according to Synergistics Research.” (Washington Post)
I’m stunned. People have been borrowing so much money against the value of their homes, and spending it on furniture, cars, vacations, etc. that it’s actually been propping up our economy. And of course, when you buy almost anything other than houses, states get sales tax. When people stop borrowing against their house to buy more stuff with debt, apparently, the government’s budget (and our entire economy) is in jeopardy. Wow.
I’ve never, ever considered using a home equity loan, or a Home Equity Line of Credit to buy anything, because that would just give me an additional debt to pay. I can understand–maybe–taking a loan to upgrade one’s house, perhaps a nicer kitchen or adding on a room, since that’s actually part of the house, and would be expected to help the house appreciate in value over time. And sure, you can deduct interest from a loan on your home from your taxable income.
But 24% of homeowners used home equity to buy a vehicle?!? The Post further states that 8% of homeowners in 2006 took out a second mortgage specifically to buy a vehicle. Are you crazy?!?
First off, a basic rule of wealth and assets: invest in things that appreciate over time (like real estate, stocks, an education). Don’t invest in things that lose value over time (like clothing, cars, and other consumables). Borrowing against an asset that can appreciate, to buy something consumable, is hurting you over the long term. It’s frittering away your long term financial power (equity) for something transitory.
Secondly, a home equity loan is usually for a 10-year period (it could even be 30 years). A car loan is, at most, 5 years (and I prefer 3 years). The extra years makes the home equity loan much, much more expensive. Michelle Singletary at the Post does the math for us, in terms of the extra interest you pay over ten years.
“Let’s look at one example of an auto loan versus a home equity loan in which you finance $30,000. If you took out a five-year car loan at 7.76 percent (the national average, according to Bankrate.com), your monthly payment would be $604.85. Over the 60 months of the loan you would pay $6,291.11 in interest…However, [with the 10-year home equity loan], you end up paying $13,450 in interest, a difference of $7,158.89.”
My third and final objection: when you use a home equity loan or HELOC, you are putting something precious–your home–at risk. When you use an auto loan to buy a car, and you can’t pay your bills, they can come and take your car. So then you carpool or take the bus. When you use a home equity loan to buy the car, and you can’t pay your bills, the bank can come and take your home!
We seriously need to break our habit of short term desires messing up our long term plans. This is hard! Like avoiding the big dessert to achieve our long term health goals, we are faced with constant temptation. But maybe now that home prices are no longer skyrocketing (and maybe even declining), we will face less temptation to use our homes as ATMs. In fact, maybe the housing slump is an opportunity to size up our financial situation and make defensive moves.
In “Protecting Yourself From a Housing Slump” Business Week advises the following steps:
–Make sure you can cover your mortgage payments and other unavoidable expenses for six months even if the main breadwinner is laid off. That will save you from having to sell your house to raise cash in a down market.
–Save more and borrow less. Americans’ personal savings rate [is now negative]. Many people feel they don’t need to save money because zooming house prices are doing their saving for them. But much of that paper wealth could be blown away if house prices fall. So people need to save the old-fashioned way — by not spending.
–Treat the housing market as a risk, not an opportunity. If you’re thinking of selling when prices have already soared, don’t hold off in hopes that prices will soon go even higher. List your home this coming March or April, as soon as house-hunting weather improves, suggests Julie Garton-Good, an author and expert on residential real estate.
–Get ready to ride out a downturn. If you were planning to move next year, keep your options open in case the market softens and you no longer want to sell. As long as you can sit tight until prices bounce back, you can afford to ignore a decline in the market value of your house. Says Yale University economist William N. Goetzmann: “The paper loss is not going to affect your life too much” because you’re not losing actual cash.