What does movie meteorologist Todd Gross say when weather patterns foreshadow an unlikely set of circumstances in The Perfect Storm? "It would be a disaster of epic proportions. It would be...the perfect storm." The U.S. housing crisis has been called a perfect storm in its own right, and home equity's changing image has played a starring role.
According to The New York Times, the value of home equity loans outstanding rose from $1 billion to $1 trillion between the early-1980s and late-2008. This explosive growth is somewhat shocking, particularly because home equity debt was once considered an embarrassment -- a tool reserved for the most desperate of situations. Clearly, home equity remade its rogue image, and became a best friend to property owners. The factors that ushered in this change came from various sources, including Congress, financial advisors, and homeowners themselves.
Home equity promotion
In 1986, Congress eliminated the tax deduction for credit card interest payments, but left the mortgage interest deduction in force. In the years that followed, financial advisors spread the word that smart consumers could use home equity to consolidate debt while increasing their tax deductions. Homeowners responded to the advice. According to a U.S. Census Bureau report, the number of home equity loans used for debt consolidation rose significantly between 1991 and 2001.
Starting in the 1980s, banks and financial institutions launched aggressive ad campaigns promoting home equity debt. Slogans like Citibank's "Live Richly" and Wells Fargo's "Seize your someday," painted a picture of untold wealth and luxury for homeowners. Accompanying these ads was a movement to make home equity lines of credit more convenient. Homeowners were given 24/7 access through credit cards and electronic fund transfers. In practice, the only obstacles to using home equity debt were credit limits and willpower.
Between 1996 and 2005, housing values demonstrated unprecedented growth. Homeowners, in turn, watched their home equity and borrowing power expand, as well. As home equity increased, many homeowners tapped it repeatedly, continuing to "live richly," and funding the fun with debt.
A historic decline in interest rates between the mid-1980s and our present day also helped characterize home equity as a friendly financial resource. In 1985, average mortgage rates fluctuated around 13 percent. In 2005, homeowners could access cash for less than 7 percent. On a $50,000 debt balance, this change amounts to a savings of more than $200 monthly.
Leveraging of consumers
Consumers, in general, have demonstrated a growing acceptance of debt usage since the early 1980s. The Federal Reserve reports that total consumer debt outstanding, not including mortgage debt, rose from $524 billion in 1985 to a peak of $2.58 trillion in 2008. As consumers borrowed more and more, home equity became increasingly attractive as a cheap, tax-deductible, and seemingly abundant source of cash.
In the wake of the housing crisis storm, home equity still retains some of its best qualities. It delivers inexpensive and tax-deductible borrowing power, but it no longer offers the free flowing cash of the boom years. In hindsight, home equity is probably a better friend to homeowners now than it ever was.