Debt games could sink homeowners

Published January 19, 2005

Many American homeowners are addicted to a money game akin to "hot potato" that will end when too many consumers get financially burned.

The game is real and could easily be called "Extreme Household Debt." Here's how it's played:

The income of the average U.S. household, adjusted for inflation, has declined in recent years. To meet the fast-rising expenses of health care, education, gas and insurance - and, yes, often just to afford the next cool gadget - households have relied increasingly on credit card spending. When credit card debt becomes too big, households rush to refinance their homes at seemingly attractive, low mortgage rates. In the process, they borrow extra money to pay off their credit card debts.

Now saddled with a larger mortgage, households start anew to build up fresh debt on their higher-rate credit cards. At some point, debt becomes overwhelming. The game ends badly.

"At some point, when your income does not keep up with your expenses, it is called bankruptcy," says Javier Silva, a senior researcher at the Demos think tank in New York.

That's the short version of a new and disturbing study by Silva called "House of Cards: Refinancing the American Dream." It shows how millions of U.S. households are falling into a vicious cycle of tapping their credit cards and then refinancing their mortgages to extract needed cash from the equity in their homes.

What's driving this cycle? Households are using debt to bridge the financial gap between their incomes and expenses.

It's a seductive game. The appreciation of homes in most metro areas - certainly here in the Tampa Bay area - has been skyrocketing, adding equity for homeowners at a dizzying pace. And leveraging that new-found wealth is encouraged by a daily barrage of credit card and low-rate home refinancing solicitations, by Federal Reserve Chairman Alan Greenspan's "no worries" remarks in speeches and even by the deficit-prone Bush administration's go-spend-your-tax-cuts appeals.

"Part of the problem is people want to buy lots of things," Silva says. "But with stagnant wage growth and increasing expenses, families are feeling the pinch and mostly spending their home's equity to make ends meet."

If home values go bust - and who has not wondered in recent years about a housing bubble? - many homeowners will be devastated.

Silva's numbers are worrisome, focusing on the period since 2001 when low mortgage rates created a refinancing boom at the same time the economy was stagnating. During that period, households refinanced trillions in mortgage debt, but also cashed out a startling $458-billion in equity from their homes. That pace of cashing out equity is three times higher than any similar period since Freddie Mac started tracking such data 12 years ago.

A slim majority (51 percent) of households that refinanced between 2001 and 2003 used the cash equity from their homes just to cover living expenses and pay down credit card debt.

To many homeowners, swapping high-interest-rate credit card debt for a new low-rate mortgage seems like smart money management. And it is for some U.S. households - especially when mortgage interest is tax deductible and credit card interest is not. But it can be bad news for many other households, Silva explains.

Many homeowners are getting cash out of the equity built up in their homes while taking on larger mortgages. That makes households more vulnerable to emergencies like an illness or job loss, when a home's equity can act as a financial cushion of last resort.

Spending cash from equity also perpetuates bad habits by encouraging more consumption based on debt. This is no small matter with the U.S. household savings rate so close to zero.

Swapping unsecured credit card debt for secured mortgage debt is potentially dangerous. If problems arise in paying the new mortgage debt, the lender can seize your home as collateral. Credit card debt, in contrast, is not secured by your home.

When homeowners used the equity in their homes to pay down credit card debt, it was often a temporary reprieve. Silva says credit card debt is starting to rise again as households again start depending on plastic to cover the gap between income and expenses.

Why not just cut expenses? It's a good question, Silva acknowledges. U.S. households are too quick to splurge these days. But declining income and rising costs of basics - from gasoline to health care - are the primary reason for a financial gap now filled by credit card and mortgage debt.

Between 1973 and 2004, homeowners' equity fell from an average of 68.3 percent to 55 percent, the Demos study says. That means Americans own less of their homes than they did in the 1970s and 1980s. Worse, the percentage of monthly income that households must spend to manage monthly debt payments - a key measure of financial stress - is 18.56 percent. That's the highest since data started being collected 25 years ago.

Sound precarious? Sure does to me, especially at the start of a new year in which the Fed seems gung-ho to continue raising interest rates. Those are the same rates that will increase the cost of credit card debt and bump up adjustable-rate mortgages in short order.

In New York this week at a gathering of national retailers, St. Petersburg Times staff writer Mark Albright reports that economists are forecasting a weak year in which the "consumer may be tapped out."

Bingo. That's what happens in the game of Extreme Household Debt.

Robert Trigaux can be reached at trigaux@sptimes.com or 727 893-8405.


By refinancing, households cashed out $458-billion from homes in four years:

2001: $86-billion 2002: $108-billion 2003: $139-billion 2004: $125-billion *estimated

Source: Joint Center for Housing Studies, Harvard University, Demos


Use of money from refinancing, 2001-02:

Repayment of other debts: 51 percent Home improvements: 43 percent Consumer expenditures: 25 percent Stock market, real estate, taxes: 22 percent NOTE: Percentages add up to more than 100 because some loans used for multiple purposes.

Source: Federal Reserve System


Home ownership is up, but homeowner equity is down:

Year Home ownershipEquity as a percentage percent of home 1973 64.4 percent 68.1 percent 1980 65.8 percent 67.5 percent 1990 64.1 percent 61.3 percent 2000 67.7 percent 57.1 percent 2004 69.0 percent 55.0 percent

Source: Federal Reserve System, U.S. Census Bureau