Conservative Consumers more Cautious about Tapping Home Equity

The downturn in the housing market has inspired a new wave of thinking among homeowners.  In the past, it was easy to cash out a huge amount of home equity and redo a kitchen.  The drop in home values has shattered that conventional wisdom, and the cash-out refinance is fading from the financial landscape.

Easy come, easy go.  That seems to be the lesson learned from the housing bust of the last few years.  But something's changed.  Homeowners are no longer willing to obtain a cash-out refinance and access that "easy money" from their home equity.  Today, a more prudent financial approach has become the norm.  People are refinancing to lower rates, but taking a pass on tapping additional equity.

Return to fundamentals

Before people started treating home equity like monopoly money, homeowners and lenders took a more conservative approach to a typical mortgage.  A 20 percent down payment was generally required on a mortgage, and a home equity line of credit (HELOC) was for emergencies only.  

As the government tried to increase homeownership rates, and lenders tried to improve their company's stock values, they made borrowing easier than ever before.  Down payment requirements shrank to 5 percent for people with good credit, and even lower through some government programs.  Lending guidelines became looser, and more people qualified for loans.  

Added to the mix was a red-hot housing market.  Homeowners became caught up in a state of irrational exuberance, believing that the bubble would never burst.  People parlayed equity into huge amounts of cash to redo kitchens, or add additions onto their homes.  Loan principle increased instead of decreased, but no one worried.  Homeowners believed that their properties would continue to increase in value forever. The marketplace, however, had other ideas.

What goes up will come down

The housing bubble, like the tech bubble at the turn of the century, popped.  In the process, it nearly toppled the entire financial industry, as many of the questionable lending practices of the past 10 years came home to roost.  Subprime mortgages, integrated into mortgage-backed securities, suddenly became worthless, drastically devaluing the investments.  Banks got scared, and lending stopped.  The crisis ensued.

The government has done its part to stabilize the uncertain marketplace, but even as the credit freeze thaws, homeowners are reluctant to resume their old ways.  While the number of refinances has recently increased thanks to low rates, cash-out refinances are no longer popular.  Consumers now understand that their home values can decrease, and that there's always the chance that they could wind up owing more than their homes are worth.

If every cloud has a silver lining, then perhaps the revamped spending habits of homeowners could be the bright spot for the current housing crisis.  Today, consumers are beginning to spend within their means, and are taking a more rational approach to money management.  This new prudent approach may be slowing our country's economic growth, but it's what we need to avoid another financial crisis in the future.