Chart: Home Equity, and Why You Shouldn’t Bank On It

Last week, many in the media covered the nascent rise in home equity among U.S. homeowners. Nationally, home equity rose to $6.7 trillion during the first quarter of 2012. That marks the highest level since 2008, just before the bubble burst.

This is welcomed news to the millions of homeowners who have lost equity since the housing collapse. Indeed, it will put many of them in a position to borrow from their equity once again. And that’s good for the economy, right?

Let’s not forget the lessons we learned over the last few years. The biggest lesson was this: You can’t rely on home equity for long-term wealth. For decades, it was widely assumed that home prices would always rise. This was seen as a financial and mathematical truism, much like two plus two equaling four. A house is the best investment you can make, because the value always goes up. The chart below shows the flaw in this line of thinking.

Definition: Home equity is the monetary difference between a home’s current value, and the amount the homeowner currently owes on the mortgage loan. “Current” is the key word here. If my house is worth $300,000 in the current real estate market, and I currently owe $200,000 on my mortgage, then I have $100,000 worth of equity in the property, or roughly 33%.

Home Equity Losses Since 2006

In the interest of preventing selective recall, I want to share a chart from the most recent “Housing Scorecard.” The scorecard is published each month and includes data compiled by the Department of Housing and Urban Development (HUD) and the Department of Treasury.

Home Equity Losses
Home equity losses between 2006 and 2011

This chart comes from the May 2012 Housing Scorecard, which was released on June 6, 2012. The left axis shows the total level of home equity in the United States, measured in trillions of dollars. The data go from the beginning of 2006 (before the housing collapse) to the end of 2011, just a few months ago. As you can see, home equity among U.S. homeowners plummeted from nearly $14 trillion in 2006 to about $6 trillion in 2011.

The $6.7 trillion worth of home equity that made headlines last week sounds impressive at first glance. But it loses its shine when viewed in a broader context. The nation had more than $13 trillion of home equity in 2006. Now we’re back to $6.7 trillion. Is this cause to celebrate? Or is it a reminder of a harsh lesson?

Americans have long used homeownership as buying power. Equity, measured as the amount of financial ownership you have in your house, can be used as a sort of piggybank. Homeowners use home equity lines of credit (HELOCs) as a source of ongoing funds, much like a credit card. Home equity loans can provide lump-sum payments to cover the cost of college tuition, remodeling projects and other major expenses.

Older Americans often rely on real estate appreciation as a source of retirement income down the road. But this too is a high-risk financial strategy. Just look where we are right now. According to the AARP, about 32% of U.S. homeowners over the age of 50 have lost a significant amount of home equity since the housing market tanked. Many of them relied too heavily on their equity for retirement income, and will now have to work well into their golden years to compensate for their losses.

According to Jay Butler, associate professor of real estate at ASU: “Nobody sees rapid appreciation in home values over the next 10 years [and as a result] a lot of folks will postpone retirement.”

History is an excellent teacher, but only if we pay attention to it. Our recent history has shown us that equity should not be banked on over the long haul. We used to think of it as an unshakeable foundation upon which we could build our wealth. In truth, it’s about as unshakeable as a hovel in a hurricane. Thus, it should not be the centerpiece of any long-term investment strategy or retirement plans.

A home is a place to live. It offers value in the form of protection, security and happiness. But it shouldn’t be viewed as a strategy for building long-term wealth and financial stability. History shows us the folly of such thinking — and so does the chart above.

Related Articles on This Website

How Much Home Equity Do I Have?
Equity is the difference between the current value of your house and the amount you owe on your mortgage loan(s). Subtract the outstanding balance from the value, and you have your equity. Of course, if you owe more than the house is worth, you are in a negative-equity situation (a.k.a. underwater or upside down). This article explains how it all works.

How to Get a Home Equity Loan
Homeowners use home equity loans (HELs) to finance a variety of expenses, such as college tuition and remodeling projects. They can also be used to consolidate and pay off other forms of high-interest debt, such as credit cards. This article explains the steps you’ll need to take in order to obtain HEL financing, starting with the current value of your home.