(NO) Home Equity
By: ChartingTheEconomy.Com
January 29, 2009
This week, new data came out showing that home prices in the top 20 U.S. cities declined by 18.2% year-over-year in
November 2008. This sounds bad, and it is. What does it mean for people who purchased homes during the housing
bubble? The answer is: Negative equity in many cases.
The purpose of this paper is to show under a baseline scenario the amount of home equity people who purchased
their homes during the past five years actually have. Since the most current home price data is for November 2008,
the numbers reflect home equity as of then.
To make this analysis work, it is important to first establish a baseline. To do this we base all analyses on the
purchase of a $300,000 home. Then, in each case, we assume that the home buyer takes out a 30-year fixed
mortgage at 6%. We also add the reduction in principal from all monthly mortgage payments into a home’s equity.
Finally, using the Standard & Poor’s/Case-Shiller 20-City Housing Index the price change of a home is calculated
according to the purchased date through November 2008.
Using this baseline we look at the following three scen arios: 1) homeowners who put 10% down on their purchases,
2) homeowners who put 10% down and are faced with a 6% transaction cost when their property is sold, and 3)
homeowners who put zero down and are faced with a 6% transaction cost when their property is sold. Scenario 1
shows actual home equity, however, scenarios 2 and 3 are important because they show what happens when a
property is sold. We use 6% of a home’s selling price as a proxy for realtor fees and closing costs. The inclusion of
the 6% transaction cost is important because this amount is directly subtracted from home equity when a house is
sold. Many people forget that the large transaction costs of selling a home take a big chunk of the equity they may
have. By looking at these different scenarios we see the picture is not pretty for people who purchased their homes
anytime during the past five years.
10% Down Payment
Let’s look at Chart #1. In this chart we take the baseline case (i.e. a person purchasing a $300K home with a 30-year
fixed mortgage at 6% interest). Then we assume that a 10% down payment is made on the home and add in the
principle reduction from all monthly payments. The price change for each month is calculated through November
2008. As Chart #1 shows, people who purchased homes during the top of the housing bubble (late 2005 – late 2007)
have a major home equity problem. It is also important to remember this is a 10% down payment scenario so
anything less than $30K in equity represents a loss to the homeowner.
10% Down Payment and Transaction Costs
Chart #1, however, does not show how much equity, under the same baseline, could actually be withdrawn when
selling a home. To get the accurate picture in this case we need to subtract the transaction costs of selling the home
which we assume is 6% of the sale price. This includes realtor fees and closing costs. Under this scenario as shown
in Chart #2, it becomes obvious that most homeowners who purchased their homes since late 2004 are very upside
down on their mortgages. They will be writing very large checks if they sell their homes. Also, it is important to note
that almost all homebuyers in this scenario have lost money on their purchases since they put $30K down.
Again, this is a 10% down payment scenario, so anything less than $30K in equity represents a loss to the
homeowner. As you can see from Chart #2, almost all homeowner in this scenario will take out less than their original
down payments if they sell their homes.
No Money Down and Transaction Costs
The picture is actually much worse for many who purchased homes in recent years. Charts #1 and #2 assume a 10%
down payment. Many homes purchased during the past five years had mortgages that required far less than 10%
down, and in many cases no down payment was required. With Chart #3, let’s take a look at how the situation
changes under the baseline when there is no down payment and the sellers are faced with 6% transaction fees to sell
their home.
The picture is extremely bad. In the top 20 cities in the U.S. basically all who purchased homes during the past five
years with no down payment will be facing a negative equity situation if they try to sell their homes. Under this
scenario, for many who purchased during the peak years of the housing bubble (late 2005 – late 2007), they are so
upside down on their mortgages that it is impossible for them to sell their homes. Even for the people in this situation
who actually can make their mortgage payments, they cannot sell their homes because they do not have the money
to bring to closing to make whole on the mortgage. As Chart #3 shows, people who bought a $300K home in
November 2006 with a zero down loan would have to write a check for $80K at closing if they sold their house now.
The actual picture is much worse. Why? One reason is the latest numbers are for November 2008, and home prices
are likely still falling. The other is that the above examples do not include the effects from the massive withdrawal of
home equity during the past several years. For now the actual picture is even worse given the high number of cash
back refinancing and home equity loans that were written in recent years.
Conclusion
The purpose of this paper is to show under a baseline scenario how much equity homeowners in the U.S. have in
their homes now that the housing bubble has burst. By establishing a baseline we show, based on when homeowners
purchased their home, how much equity they have as of November 2008 (the latest month for which home price data
is available).
The numbers are shown in several different scenarios. The common conclusion from each is that for many people
who purchased homes during the past five years they have little to no equity in their homes. In some cases the
negative equity is enormous. It should also be noted that we use a baseline that includes a $300K home and the
average price changes for the 20 largest cities. The negative equity situation is much worse in some areas of the
country (e.g. California, Florida) and for homeowners that purchased more expensive homes.
The above analysis clearly shows why the U.S. is having such a housing and foreclosure crisis. But there are other
problems too. For example, a massive destruction of wealth has occurred. In addition, many people will be less
mobile. Even if they can keep up with their mortgage payments they cannot afford to move because of the negative
accrued equity in their homes. For example, many people in this position who have an opportunity for a better job in
another city/state, likely will have to decline it. All of this adds up to large inefficiencies and slower growth for the U.S.
economy for years to come.
Source:
Home price data is from Standard & Poor’s/Case-Shiller 20-City Housing Index