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Mortgage Equity Withdrawal
Mortgage Equity Withdrawal M Munro, University of Glasgow, Glasgow, UK ª 2012 Elsevier Ltd. All rights reserved.
Glossary Housing equity The amount by which the market value of an owner-occupied home exceeds any outstanding loans secured against it. Housing equity withdrawal (HEW) A process by which an owner-occupier is able to convert housing equity into cash that can be spent, increasing the debt owed on the home. Negative equity The situation in which the value of an owner-occupied house has fallen below the amount borrowed.
Housing Equity Housing is typically too expensive for households to purchase outright and so across the developed world households take out mortgage loans, often substantial and to be repaid over many years, to allow them to buy an owner-occupied house. ‘Housing equity’ is defined as the difference between the total market value of an owner-occupier’s home and the amount that they owe on a mortgage or other loan secured against it (so, e.g., a household buying a house with a market value of £100 000 which owes £60 000 on its mortgage is said to have housing equity of £40 000). For owner-occupier households, housing equity may at first glance seem to be somewhat intangible – a notional amount of money that is locked up in their home. But housing equity is a real asset which is increasingly not locked up, but can be accessed and spent. Housing equity is often a very sig nificant part of individual household’s total wealth holding and adds up to a considerable portion of the aggregate wealth that households own nationally. The three main ways in which housing equity is acquired are as follows: 1. Households will often pay some money towards the purchase of their house – a deposit (down payment) – typically from savings, gifts or loans from family, or the proceeds of selling a previous house. (Many lenders require some minimum proportion of the initial pur chase price to be provided as a down payment by the buyer as a condition of lending to them.) 2. Many mortgage loans are arranged so that over the life of the mortgage, households gradually repay their loan
364
Remortgaging A process by which an owneroccupier repays their existing mortgage by taking out a new mortgage on the same property. This may be to access a better deal (e.g., a lower interest rate) but is often used to increase the amount borrowed to provide cash for general spending or to repay other debts. Subprime lending Loans made, often by specialist lenders, to higher risk or credit impaired borrowers, typically charged at a higher interest rate reflecting the higher risk of default on the loan.
principal (the original sum borrowed), so they gradu ally accumulate housing equity (these are sometimes called self-amortised loans). Whatever the mortgage arrangement (e.g., there are interest-only mortgages where buyers do not gradually repay capital, but put money aside in other ways to repay their loan), at the end of the loan period the principal will be repaid and the household will own the property outright, so their housing equity equals the whole value of their home. 3. Importantly too, households accumulate housing equity through the effects of house price inflation: if the resale market value of the home increases, say by £10 000, the household acquires an additional £10 000 in housing equity. This last source of housing equity is a windfall gain to owner-occupiers – they accumulate this value, an increase in their net worth, simply by benefiting from prevailing market conditions. An increase in housing equity is pro duced by any increase in house prices whether nominal (i.e., where house prices are simply rising along with gen eral prices and wages in the economy as a whole) or real (i.e., where house prices rise faster than other prices, so that over time houses become relatively more valuable than other assets). House price inflation (see Price Determination in Housing Markets) has been a persistent, if highly variable, feature of many developed housing systems. In many countries there have been quite long periods where house prices have risen quite rapidly year on year. Over time, therefore, many households acquire significant amounts of housing equity simply by virtue of occupying their home and, indeed, the prospect of acces sing an asset with the potential to increase in value over
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time is argued to be a significant element of the attractive ness of house purchase compared to renting (see Economics of Housing Choice).
Housing Equity and the Advantages of Owner-Occupation Housing equity underpins the conception of owneroccupied housing as both an investment good (something worth buying to ‘make money’) and a consumption good (something that the household buys to meet a need and to enjoy using). Over particular time periods and in parti cular places, the rate of return from investing in housing may be (considerably) greater than investing in other assets (such as savings accounts, stocks and shares, or other goods), and/or it may be seen as a relatively attrac tive investment if returns are believed to be relatively low risk compared to other assets. But even if returns on housing investment are not particularly attractive, by buying a house, the household still benefits from the ability to live there – the ongoing consumption of housing services – as well as accumulating wealth and ultimately owning an asset, which can be passed on as an inheritance. Because of this dual feature of owner-occupied hous ing, households may also engage in expenditure that is deliberately targeted at increasing their house value (which is likely simultaneously to enhance their enjoy ment of living in the property). For example, extending the dwelling or making significant improvements to the fabric and fixtures of the house may bring an immediate increase in an estimated resale value and is therefore a way by which households can choose to increase their investment in housing wealth directly. (The immediate gain to the position of the household depends on the difference between that increased value and the amount spent.) Because of the longevity of much housing stock, it is difficult in practice to distinguish what spending should be classified as repairs and maintenance (that would maintain the quality and saleability of a house) and improvement (that would enhance its relative value). Activities such as updating bathroom and kitchen fittings would be examples that sit in this somewhat grey area. Internationally, different approaches are adopted as to whether expenditure on the home is deducted from esti mates of total housing equity. It should be noted explicitly that inflation-driven gains in housing equity are not an inevitable or guaranteed part of owner-occupied housing markets. Whole housing sys tems can experience long periods in which house prices remain relatively static or are falling (as in Japan in the wake of the financial crisis of the 1990s). And, of course, particular houses or particular neighbourhoods can suffer long- (or short-) term decline in their fortunes so that owners’ housing equity diminishes. A particularly
problematic aspect of this has been called ‘negative equity’. This develops where house price decline means that the value of a household’s home falls below the amount they have borrowed to buy it – which can create very real difficulties for owners and their lenders. The global finan cial crisis of 2008 onwards has seen the widespread reemergence of negative equity in many housing systems.
Housing Equity Withdrawal Housing equity withdrawal refers to the processes by which households convert some or all of their positive housing equity into cash; a liquid asset that can be spent, saved, or invested elsewhere. There are several ways in which this can be done. Traditionally, the main mechanisms were: down – buying a cheaper property than the • Trading one sold, and retaining the balance. from owner-occupation into renting – again • Moving retaining any balance from the sale. ‘last-time sellers’ – particularly referring to • So-called households that die, leaving their housing assets as an
•
inheritance for their beneficiaries, although sometimes also to households that sell their house as they move into long-term care, or another household’s home to access similar support. ‘Over-mortgaging’; when a household sells one house and buys another more expensive one, it might be possible not to put all the proceeds from the first house towards the purchase price of the new house. Instead, the household may choose to keep some of the proceeds as cash, put a smaller deposit towards the new house, and borrow a larger balance – that is, more than they strictly needed to.
It is clear that all these mechanisms involve the costly and disruptive process of selling and buying different homes. Costs include both the indirect costs of disruption to family life and time spent looking for a new home as well as the direct transaction costs of buying and selling which can be considerable (frequently including tax, as well as estate agents/realtors fees, legal costs, etc.). Not surprisingly, households are only likely to do this when they have other reasons for moving house rather than simply wanting to cash in some housing equity (trading down as a strategy to help fund retirement may be an exception). When mortgage finance is relatively tightly controlled and tied to housing transactions though, these are the only ways of extracting housing equity – indeed even the last mechan ism, of over-mortgaging, may be strictly limited (as it was in the United Kingdom when specialist building societies, and in the United States, when savings and loans organisa tions, ‘thrifts’, dominated specialist circuits of mortgage finance up until the late 1970s).
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In more liberal mortgage markets, there are, however, a range of easier financial mechanisms by which house holds may access the equity that is accumulating in their homes, without having to trade in the housing market. These have become more widely available and greatly varied and include: in situ: a household may choose to • Remortgaging borrow more when they switch from one mortgage to
•
•
another than is necessary to redeem the original mort gage. In doing this, they reduce their housing equity, releasing money that is then available to be spent. This may be the primary reason for remortgaging (for instance, a household may choose to borrow more to finance improvement expenditure or to pay off other more expensive debts (such as credit cards)). For others, it may be a more incidental opportunity offered by a decision to switch to get a better mortgage deal, such as a lower interest rate. Other secured lending or second charge lending: instead of increasing debt in a single mortgage, households may also secure other lending against the value of their home (assuming the lender judges them to have sufficient equity). For borrowers, secured lending is cheaper than unsecured lending, as the lender faces less risk of default. Households might choose to use their housing equity in this way, for instance, to make a major purchase like a car, or to put some money into a business. However, because the security to the lender is less than with a first charge mortgage, the cost of borrowing is also typically higher than first mortgages. Because of this, additional secured lending may be more prevalent among house holds in some financial difficulty, or whose credit rating is impaired. There may, though, be a trade-off in the terms of the loan, for example, a shorter repayment period, that makes second charge lending an attractive option for some households. Flexible mortgages: there is a vast and increasing range of mortgage products that are designed explicitly to allow households access to their housing equity. In the United Kingdom, these are typically called flexible mortgages (although it is too the case that an increasing number of ‘standard’ mortgages have some flexible features). In the United States, a similar explosion of ‘exotic’ mortgages include payment option mortgages and mortgages that offer home equity lines of credit (HELOCs). There is an enormous variety in the detail of these mortgages in relation to the ways in which and the limits that are placed on the extent to which bor rowers may draw down their equity (see article Mortgage Contracts: Flexible) but they share features that allow borrowers to increase their mortgage bor rowing almost or exactly as easily as repaying their loan. They may allow borrowers to slow down the rate of repayment (e.g., through payment ‘holidays’ or
•
reduced payments), another mechanism which allows households to increase current spending rather than increase housing equity. Other special mortgages have been developed to allow older, outright owners to access some of the equity in their homes (often the lender recoups the money when the house is finally sold) – called equity release or reverse mortgages.
These ways of extracting housing equity are all relatively recent developments. Until the financial market liberal isation of the early 1980s, the withdrawal of housing equity was nearly impossible except through trading down or out of owner-occupation. This created credit constraints on households that meant they had little choice but to hold more housing equity (and spend less on other things) than they would ideally desire. That is, there was previously a suppressed demand for access to housing equity. The credit market revolution created by changes in regulation, technological change, and the deepening global markets for securitized contracts and derivatives increased the availability of all kinds of loans. Highly competitive mortgage markets developed in many OECD countries that offered borrowers a range of attractive and varied mortgage deals. This rapid product innovation responded to household demand to be allowed to access housing equity. Further, lenders were keen to expand their loan portfolios and actively sought to make customers aware of the possibility of increasing their lending against the value of their home, effectively selling such loans to households who perhaps would not have thought of equity withdrawal otherwise. In these highly competitive (also described as more ‘complete’) mortgage markets, the cost of accessing equity was also reduced. With some mortgage products, households may access housing equity up to an agreed limit (which may be the whole amount of equity accumulated) at no cost at all. These quite radical changes have been argued to have created a culture change – whereby people are increasingly likely to see their housing wealth as a resource to be tapped into at will – in a routine, taken-for-granted way (housing as an ATM) – for pur chases that might be large, such as a car, or small, routine grocery shopping (Klyuev and Mills, 2007). Smith and Searle (2008) estimate that the use of such mechanisms for withdrawing equity was becoming increasingly wide spread through the early years of the new millennium. But this change in the access to and use of housing equity has raised important questions about the way in which house price rises and increasing housing equity can have significant impacts on macroeconomic relationships. Consumption fuelled by housing equity has the potential to shift long-established relationships, that link, for instance, income and interest rates to aggregate levels of saving, consumption, and investment. The significance of housing equity withdrawal is underlined by evidence
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that the propensity to spend housing equity is signifi cantly greater than that out of other types of wealth (Case et al., 2005).
Equity Withdrawal and the Macroeconomy In the United States and the United Kingdom, rising house prices have been observed to be associated with increased consumer spending and reduced savings. Economists dis pute whether this represents a ‘housing wealth’ effect (whereby households spend more as house prices rise because they feel richer (see Housing Wealth and Consumption). Muellbauer and Murphy (2008) argue per suasively that in fact this association is caused by a housing collateral effect – that is, this increase in spending asso ciated with higher house prices works via households being able to access increased credit directly on the basis of their increased housing equity. The strength of the effect is therefore different depending on national institutional arrangements – they note that where mortgage markets are less well developed, rising house prices reduce con sumption because households need to save more for a deposit to enter owner-occupation (e.g., in Italy). Economists have examined the accumulation and extraction of housing equity in terms of the standard eco nomic models for saving and find support for the predictions of these models. The life-cycle theory of saving proposes that households seek to smooth consumption over their lifetime, even though income fluctuates. They are therefore expected to borrow when they are younger and expect their incomes to rise. However, it would also predict that wealth be used up in old age – which has not been generally true of housing equity (explained by a desire of many owners to pass on their housing wealth to their children). An alternative theory of saving is the precaution ary motive. This suggests that households accumulate savings in order to be able to draw on them if they should face any financial adversity. Work by Benito and others (Benito, 2009; Benito and Power, 2004) argues that house holds use housing equity in a way that is consistent with both of these models. Based on large-scale analysis of a decade of data from the British Household Panel Survey (BHPS), they find that withdrawal of housing equity rose as households aged through their 20s and 30s, reaching a peak when households reached 40. Similarly, there is evidence that households were more likely to draw on housing equity when they experienced financial adversity, for instance, when they had experienced unemployment or a divorce during the year. In this way, housing equity appears to provide a cushion to smooth household expenditure in the wake of unanticipated disruptions. Parkinson et al. (2009) interpret the patterns of equity withdrawal they find as tending to suggest that households use equity withdrawal
to pull spending forward in the lifecycle, to cover the costs of the early years of household and family building. The direct spending power created by equity with drawal is very significant. Greenspan and Kennedy (2008) have produced a careful review of data relating to the sources and uses of equity withdrawn from housing in the United States. They show that there has been a gradual growth in mortgage debt as a proportion of total house value. They further estimate that since 1990 equity with drawal accounted for around four-fifths of the rise in mortgage debt since 1990 (their definition includes all equity withdrawal, including that subsequently rein vested in home improvements, which they enumerate separately). They estimate that total equity extraction in the United States rose from around $50 billion per quarter in the early 1990s to a peak of over $350 billion per quarter in 2005/06. The scale of the change is witnessed in the growth in aggregate equity extraction: it was $1.8 trillion between 2001 and 2007 compared to $440 billion between 1994 and 2000. The financial crisis saw equity withdrawal fall dramatically and eventually become negative (i.e., on aggregate more mortgage debt was repaid than equity withdrawn) to around 3% of disposable income in 2009. There is a debate about the extent to which housing equity is used in different ways to other money; in parti cular, whether it is particularly likely to be spent (reinvested) in the home. Greenspan and Kennedy (2008) track the changing way in which extracted equity has been spent. They find that the biggest share of the total was spent on personal consumption and nonmort gage debt repayment, closely followed by expenditure on home improvements. The remainder was spent on acquir ing other assets, though its share of total spending declined through the equity withdrawal boom of the early 2000s. They estimate that an average of nearly $60 billion of nonmortgage debt was repaid from housing equity withdrawal from 1991 to 2006 and that through this period it financed around 40% of home improve ments. Overall then, they conclude that housing equity withdrawal was used to directly finance approximately 1% of total US personal consumption expenditure. It is notable too that they find a considerable propor tion of equity withdrawal is used to consolidate other debts, such as credit card debts which, as they note, does not add to immediate demand in the economy. For con sumers, it may be a rational financial choice, at least short term, as the rate of interest charged on consumer debts is very much higher than that on secured, mortgage finance. However, it can be argued too that this should be seen as a way in which equity withdrawal is used to smooth out consumption spending (as increased spending is initially financed on credit cards and then subsequently refinanced into mortgage debt out of housing equity).
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In the United Kingdom, the Bank of England produces a quarterly series of estimates as to the amount of equity withdrawal (they net off expenditure on housing improvements from the estimates) and show a similar dramatic rise in the amount of mortgage equity with drawn through the house price boom years from the mid-1990s (Davey, 2001). In the early years of the new millennium, it regularly accounted for over 5% of posttax household income (see http://www.bankofengland. co.uk/statistics/statistics.htm). Smith and Searle (2008) combine a range of survey sources to examine how households in Britain spent their extracted equity and find, as in the United States, that there is a strong propensity to spend it on the house in some way. They estimate that between two-thirds and three-quarters of those who extract equity use at least some of it for home repairs or improvement, although they note too how hard it is to be precise about exactly what respondents to large-scale surveys may include in ‘improvement’ expenditure (for instance, the cost of buy ing new furniture and soft furnishings may be included in the cost of completing an extension). Some scholars have explored the extent to which there has been a change in attitude to wealth tied up in the home, which was traditionally seen as being carefully ring-fenced and protected to be passed on as inheritance to children (unless used to invest in the house itself). Evidence collated by Smith and colleagues (Parkinson et al., 2009; Smith and Searle, 2008) suggests that it is becoming increasingly routine and common practice for households to extract significant amounts of housing equity, and that this was true, at least up until the housing market crash, in both Australia and the United Kingdom. In parallel to the lifecycle hypothesis explored by econ omists, this sociological literature is also interested in questions to do with the place of housing wealth in house hold’s longer-term planning for the future. In particular, investment in housing may be used as a way of securing a more comfortable old age, and a strategy for dealing with the retrenchment of welfare provision in relation to pen sions and long-term care – that is, there is an insurance motive present. Of course, such goals are undermined if households increasingly look to housing wealth for day-to day spending throughout their adult life.
The Role of Financial Institutions These longer-term questions about the way that people seek to plan their finances raise important questions about the financial capabilities and competencies that people bring to these decisions and, ultimately, about the extent to which people are vulnerable to exploitation by aggres sive, profit-seeking financial institutions. The argument here is that people may be persuaded to make decisions
which are risky, and perhaps riskier than they realise. This is of particular concern where it is in the interests of financial institutions to encourage people to take par ticular types of product, perhaps with little regard to the longer-term viability of those choices for borrowers. Traditionally, in the United Kingdom and United States and elsewhere, banks and specialist mortgage lenders would have been seen as risk-averse lenders – seeking to lend on sound property (that can be resold at a price that would cover the outstanding loan) and to households who had low risk of default. Although they were criticised for conservative behaviour, such an approach does make it less likely that people acquire unsustainable debts, and arguably fostered an expectation that such institutions would not lend to people more than they could afford. The development of the subprime sector (in which specialist lenders lent money to those with a higher default risk) and its subsequent crisis (as debts of dubious risks were parcelled up in opaque and complicated ways, and sold globally) is relevant to the examination of housing equity withdrawal in two ways. First, concerns were expressed about subprime lending practices, particularly in the United States, where predatory lenders systemati cally degraded underwriting standards and encouraged repeated remortgaging in poorer communities, effectively stripping out the housing equity that had been accumu lated by these relatively disadvantaged, often minority ethnic communities. The subsequent delinquency and defaults on mortgages led to foreclosures as well as volun tary sales by owners no longer able to keep up payments on their loans. This has created spatially concentrated pockets of abandonment as well as causing hardship to the indivi dual owners affected (Immergluck, 2008; Renuart, 2004). Second, of course, the global financial crisis that ensued has had significant effects on the availability of credit. As would be expected, this has had significant effects on recent trends in housing equity withdrawal.
The Global Financial Crisis The global financial crisis that was prompted by the crisis in the subprime lending market has had global repercussions. In particular, there has been a dramatic reduction in the availability of credit as lending institu tions retreated to focus on the safest business they could identify; low-risk borrowers with substantial cushions of housing equity. The United States has experienced very significant falls in house prices since their peak in 2006 and substantial levels of foreclosures. Households have, therefore, seen their store of housing equity dramatically reduced. In the United Kingdom, house prices have not fallen so significantly, partly it is suggested because lenders have been unwilling to pursue repossessions too vigorously because of the risk to their balance sheets.
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Economic confidence has been knocked and there is the prospect of tough government spending retrenchment to reduce the high levels of public debt. In this context, it seems inevitable that there will be a reduced appetite for housing equity withdrawal among consumers at least in the medium term. It remains to be seen whether the financial system will ever return to the relatively easy lending that allowed households such free access to their housing equity, although by 2011 there were already signs that lenders were beginning to retreat from the extremely risk-averse lending practices initially adopted.
See also: Asset-Based Well-Being: Use Versus Exchange Value; Financial Deregulation; Health, Well-Being and Housing; Home Ownership: Economic Benefits; Housing and Wealth Portfolios; Housing Equity Withdrawal in the United Kingdom; Housing Wealth and Consumption; Housing Wealth as Precautionary Savings; Housing Wealth Over the Life Course; Monetary Policy, Wealth Effects and Housing; Mortgage Contracts: Flexible; Mortgage Innovation; Mortgage Market Functioning.
References Benito A (2009) Who withdraws housing equity and why? Economica 76: 51–70. Benito A and Power J (2004) Housing equity and consumption: Insights from the survey of English housing. Bank of England Quarterly (Autumn): 302–309. Case KE, Quigley JM, and Shiller RJ (2005) Comparing wealth effects: The stock market vs the housing market. Advances in Macroeconomics 5(1). Davey M (2001) Mortgage equity withdrawal and consumption. Bank of England Quarterly (Spring) 41: 100–103. Greenspan A and Kennedy J (2008) Sources and uses of equity extracted from homes. Oxford Review of Economic Policy 24(1): 120–144. Immergluck D (2008) From the subprime to the exotic: Excessive mortgage market risk and foreclosures. Journal of the American Planning Association 74(1): 59–76. Klyuev V and Mills P (2007) Is housing wealth an ATM? The relationship between household wealth, home equity withdrawal, and saving rates. IMF Staff Papers 54(3): 539–561. Muellbauer J and Murphy A (2008) Housing markets and the economy: The assessment. Oxford Review of Economic Policy 24(1): 1–33. Parkinson S, Searle BA, and Smith SJ, et al. (2009) Mortgage equity withdrawal in Australia and Britain: Towards a wealth-fare state? International Journal of Housing Policy 9(4): 365–389. Renuart E (2004) An overview of the predatory lending process. Housing Policy Debate 15(3): 467–502. Smith SJ and Searle BA (2008) Dematerialising money? Observations on the flow of housing wealth to other things. Housing Studies 23(1): 21–43.
Glossary Housing equity The amount by which the market value of an owner-occupied home exceeds any outstanding loans secured against it. Housing equity withdrawal (HEW) A process by which an owner-occupier is able to convert housing equity into cash that can be spent, increasing the debt owed on the home. Negative equity The situation in which the value of an owner-occupied house has fallen below the amount borrowed.
Housing Equity Housing is typically too expensive for households to purchase outright and so across the developed world households take out mortgage loans, often substantial and to be repaid over many years, to allow them to buy an owner-occupied house. ‘Housing equity’ is defined as the difference between the total market value of an owner-occupier’s home and the amount that they owe on a mortgage or other loan secured against it (so, e.g., a household buying a house with a market value of £100 000 which owes £60 000 on its mortgage is said to have housing equity of £40 000). For owner-occupier households, housing equity may at first glance seem to be somewhat intangible – a notional amount of money that is locked up in their home. But housing equity is a real asset which is increasingly not locked up, but can be accessed and spent. Housing equity is often a very sig nificant part of individual household’s total wealth holding and adds up to a considerable portion of the aggregate wealth that households own nationally. The three main ways in which housing equity is acquired are as follows: 1. Households will often pay some money towards the purchase of their house – a deposit (down payment) – typically from savings, gifts or loans from family, or the proceeds of selling a previous house. (Many lenders require some minimum proportion of the initial pur chase price to be provided as a down payment by the buyer as a condition of lending to them.) 2. Many mortgage loans are arranged so that over the life of the mortgage, households gradually repay their loan
364
Remortgaging A process by which an owneroccupier repays their existing mortgage by taking out a new mortgage on the same property. This may be to access a better deal (e.g., a lower interest rate) but is often used to increase the amount borrowed to provide cash for general spending or to repay other debts. Subprime lending Loans made, often by specialist lenders, to higher risk or credit impaired borrowers, typically charged at a higher interest rate reflecting the higher risk of default on the loan.
principal (the original sum borrowed), so they gradu ally accumulate housing equity (these are sometimes called self-amortised loans). Whatever the mortgage arrangement (e.g., there are interest-only mortgages where buyers do not gradually repay capital, but put money aside in other ways to repay their loan), at the end of the loan period the principal will be repaid and the household will own the property outright, so their housing equity equals the whole value of their home. 3. Importantly too, households accumulate housing equity through the effects of house price inflation: if the resale market value of the home increases, say by £10 000, the household acquires an additional £10 000 in housing equity. This last source of housing equity is a windfall gain to owner-occupiers – they accumulate this value, an increase in their net worth, simply by benefiting from prevailing market conditions. An increase in housing equity is pro duced by any increase in house prices whether nominal (i.e., where house prices are simply rising along with gen eral prices and wages in the economy as a whole) or real (i.e., where house prices rise faster than other prices, so that over time houses become relatively more valuable than other assets). House price inflation (see Price Determination in Housing Markets) has been a persistent, if highly variable, feature of many developed housing systems. In many countries there have been quite long periods where house prices have risen quite rapidly year on year. Over time, therefore, many households acquire significant amounts of housing equity simply by virtue of occupying their home and, indeed, the prospect of acces sing an asset with the potential to increase in value over
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time is argued to be a significant element of the attractive ness of house purchase compared to renting (see Economics of Housing Choice).
Housing Equity and the Advantages of Owner-Occupation Housing equity underpins the conception of owneroccupied housing as both an investment good (something worth buying to ‘make money’) and a consumption good (something that the household buys to meet a need and to enjoy using). Over particular time periods and in parti cular places, the rate of return from investing in housing may be (considerably) greater than investing in other assets (such as savings accounts, stocks and shares, or other goods), and/or it may be seen as a relatively attrac tive investment if returns are believed to be relatively low risk compared to other assets. But even if returns on housing investment are not particularly attractive, by buying a house, the household still benefits from the ability to live there – the ongoing consumption of housing services – as well as accumulating wealth and ultimately owning an asset, which can be passed on as an inheritance. Because of this dual feature of owner-occupied hous ing, households may also engage in expenditure that is deliberately targeted at increasing their house value (which is likely simultaneously to enhance their enjoy ment of living in the property). For example, extending the dwelling or making significant improvements to the fabric and fixtures of the house may bring an immediate increase in an estimated resale value and is therefore a way by which households can choose to increase their investment in housing wealth directly. (The immediate gain to the position of the household depends on the difference between that increased value and the amount spent.) Because of the longevity of much housing stock, it is difficult in practice to distinguish what spending should be classified as repairs and maintenance (that would maintain the quality and saleability of a house) and improvement (that would enhance its relative value). Activities such as updating bathroom and kitchen fittings would be examples that sit in this somewhat grey area. Internationally, different approaches are adopted as to whether expenditure on the home is deducted from esti mates of total housing equity. It should be noted explicitly that inflation-driven gains in housing equity are not an inevitable or guaranteed part of owner-occupied housing markets. Whole housing sys tems can experience long periods in which house prices remain relatively static or are falling (as in Japan in the wake of the financial crisis of the 1990s). And, of course, particular houses or particular neighbourhoods can suffer long- (or short-) term decline in their fortunes so that owners’ housing equity diminishes. A particularly
problematic aspect of this has been called ‘negative equity’. This develops where house price decline means that the value of a household’s home falls below the amount they have borrowed to buy it – which can create very real difficulties for owners and their lenders. The global finan cial crisis of 2008 onwards has seen the widespread reemergence of negative equity in many housing systems.
Housing Equity Withdrawal Housing equity withdrawal refers to the processes by which households convert some or all of their positive housing equity into cash; a liquid asset that can be spent, saved, or invested elsewhere. There are several ways in which this can be done. Traditionally, the main mechanisms were: down – buying a cheaper property than the • Trading one sold, and retaining the balance. from owner-occupation into renting – again • Moving retaining any balance from the sale. ‘last-time sellers’ – particularly referring to • So-called households that die, leaving their housing assets as an
•
inheritance for their beneficiaries, although sometimes also to households that sell their house as they move into long-term care, or another household’s home to access similar support. ‘Over-mortgaging’; when a household sells one house and buys another more expensive one, it might be possible not to put all the proceeds from the first house towards the purchase price of the new house. Instead, the household may choose to keep some of the proceeds as cash, put a smaller deposit towards the new house, and borrow a larger balance – that is, more than they strictly needed to.
It is clear that all these mechanisms involve the costly and disruptive process of selling and buying different homes. Costs include both the indirect costs of disruption to family life and time spent looking for a new home as well as the direct transaction costs of buying and selling which can be considerable (frequently including tax, as well as estate agents/realtors fees, legal costs, etc.). Not surprisingly, households are only likely to do this when they have other reasons for moving house rather than simply wanting to cash in some housing equity (trading down as a strategy to help fund retirement may be an exception). When mortgage finance is relatively tightly controlled and tied to housing transactions though, these are the only ways of extracting housing equity – indeed even the last mechan ism, of over-mortgaging, may be strictly limited (as it was in the United Kingdom when specialist building societies, and in the United States, when savings and loans organisa tions, ‘thrifts’, dominated specialist circuits of mortgage finance up until the late 1970s).
366
Mortgage Equity Withdrawal
In more liberal mortgage markets, there are, however, a range of easier financial mechanisms by which house holds may access the equity that is accumulating in their homes, without having to trade in the housing market. These have become more widely available and greatly varied and include: in situ: a household may choose to • Remortgaging borrow more when they switch from one mortgage to
•
•
another than is necessary to redeem the original mort gage. In doing this, they reduce their housing equity, releasing money that is then available to be spent. This may be the primary reason for remortgaging (for instance, a household may choose to borrow more to finance improvement expenditure or to pay off other more expensive debts (such as credit cards)). For others, it may be a more incidental opportunity offered by a decision to switch to get a better mortgage deal, such as a lower interest rate. Other secured lending or second charge lending: instead of increasing debt in a single mortgage, households may also secure other lending against the value of their home (assuming the lender judges them to have sufficient equity). For borrowers, secured lending is cheaper than unsecured lending, as the lender faces less risk of default. Households might choose to use their housing equity in this way, for instance, to make a major purchase like a car, or to put some money into a business. However, because the security to the lender is less than with a first charge mortgage, the cost of borrowing is also typically higher than first mortgages. Because of this, additional secured lending may be more prevalent among house holds in some financial difficulty, or whose credit rating is impaired. There may, though, be a trade-off in the terms of the loan, for example, a shorter repayment period, that makes second charge lending an attractive option for some households. Flexible mortgages: there is a vast and increasing range of mortgage products that are designed explicitly to allow households access to their housing equity. In the United Kingdom, these are typically called flexible mortgages (although it is too the case that an increasing number of ‘standard’ mortgages have some flexible features). In the United States, a similar explosion of ‘exotic’ mortgages include payment option mortgages and mortgages that offer home equity lines of credit (HELOCs). There is an enormous variety in the detail of these mortgages in relation to the ways in which and the limits that are placed on the extent to which bor rowers may draw down their equity (see article Mortgage Contracts: Flexible) but they share features that allow borrowers to increase their mortgage bor rowing almost or exactly as easily as repaying their loan. They may allow borrowers to slow down the rate of repayment (e.g., through payment ‘holidays’ or
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reduced payments), another mechanism which allows households to increase current spending rather than increase housing equity. Other special mortgages have been developed to allow older, outright owners to access some of the equity in their homes (often the lender recoups the money when the house is finally sold) – called equity release or reverse mortgages.
These ways of extracting housing equity are all relatively recent developments. Until the financial market liberal isation of the early 1980s, the withdrawal of housing equity was nearly impossible except through trading down or out of owner-occupation. This created credit constraints on households that meant they had little choice but to hold more housing equity (and spend less on other things) than they would ideally desire. That is, there was previously a suppressed demand for access to housing equity. The credit market revolution created by changes in regulation, technological change, and the deepening global markets for securitized contracts and derivatives increased the availability of all kinds of loans. Highly competitive mortgage markets developed in many OECD countries that offered borrowers a range of attractive and varied mortgage deals. This rapid product innovation responded to household demand to be allowed to access housing equity. Further, lenders were keen to expand their loan portfolios and actively sought to make customers aware of the possibility of increasing their lending against the value of their home, effectively selling such loans to households who perhaps would not have thought of equity withdrawal otherwise. In these highly competitive (also described as more ‘complete’) mortgage markets, the cost of accessing equity was also reduced. With some mortgage products, households may access housing equity up to an agreed limit (which may be the whole amount of equity accumulated) at no cost at all. These quite radical changes have been argued to have created a culture change – whereby people are increasingly likely to see their housing wealth as a resource to be tapped into at will – in a routine, taken-for-granted way (housing as an ATM) – for pur chases that might be large, such as a car, or small, routine grocery shopping (Klyuev and Mills, 2007). Smith and Searle (2008) estimate that the use of such mechanisms for withdrawing equity was becoming increasingly wide spread through the early years of the new millennium. But this change in the access to and use of housing equity has raised important questions about the way in which house price rises and increasing housing equity can have significant impacts on macroeconomic relationships. Consumption fuelled by housing equity has the potential to shift long-established relationships, that link, for instance, income and interest rates to aggregate levels of saving, consumption, and investment. The significance of housing equity withdrawal is underlined by evidence
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that the propensity to spend housing equity is signifi cantly greater than that out of other types of wealth (Case et al., 2005).
Equity Withdrawal and the Macroeconomy In the United States and the United Kingdom, rising house prices have been observed to be associated with increased consumer spending and reduced savings. Economists dis pute whether this represents a ‘housing wealth’ effect (whereby households spend more as house prices rise because they feel richer (see Housing Wealth and Consumption). Muellbauer and Murphy (2008) argue per suasively that in fact this association is caused by a housing collateral effect – that is, this increase in spending asso ciated with higher house prices works via households being able to access increased credit directly on the basis of their increased housing equity. The strength of the effect is therefore different depending on national institutional arrangements – they note that where mortgage markets are less well developed, rising house prices reduce con sumption because households need to save more for a deposit to enter owner-occupation (e.g., in Italy). Economists have examined the accumulation and extraction of housing equity in terms of the standard eco nomic models for saving and find support for the predictions of these models. The life-cycle theory of saving proposes that households seek to smooth consumption over their lifetime, even though income fluctuates. They are therefore expected to borrow when they are younger and expect their incomes to rise. However, it would also predict that wealth be used up in old age – which has not been generally true of housing equity (explained by a desire of many owners to pass on their housing wealth to their children). An alternative theory of saving is the precaution ary motive. This suggests that households accumulate savings in order to be able to draw on them if they should face any financial adversity. Work by Benito and others (Benito, 2009; Benito and Power, 2004) argues that house holds use housing equity in a way that is consistent with both of these models. Based on large-scale analysis of a decade of data from the British Household Panel Survey (BHPS), they find that withdrawal of housing equity rose as households aged through their 20s and 30s, reaching a peak when households reached 40. Similarly, there is evidence that households were more likely to draw on housing equity when they experienced financial adversity, for instance, when they had experienced unemployment or a divorce during the year. In this way, housing equity appears to provide a cushion to smooth household expenditure in the wake of unanticipated disruptions. Parkinson et al. (2009) interpret the patterns of equity withdrawal they find as tending to suggest that households use equity withdrawal
to pull spending forward in the lifecycle, to cover the costs of the early years of household and family building. The direct spending power created by equity with drawal is very significant. Greenspan and Kennedy (2008) have produced a careful review of data relating to the sources and uses of equity withdrawn from housing in the United States. They show that there has been a gradual growth in mortgage debt as a proportion of total house value. They further estimate that since 1990 equity with drawal accounted for around four-fifths of the rise in mortgage debt since 1990 (their definition includes all equity withdrawal, including that subsequently rein vested in home improvements, which they enumerate separately). They estimate that total equity extraction in the United States rose from around $50 billion per quarter in the early 1990s to a peak of over $350 billion per quarter in 2005/06. The scale of the change is witnessed in the growth in aggregate equity extraction: it was $1.8 trillion between 2001 and 2007 compared to $440 billion between 1994 and 2000. The financial crisis saw equity withdrawal fall dramatically and eventually become negative (i.e., on aggregate more mortgage debt was repaid than equity withdrawn) to around 3% of disposable income in 2009. There is a debate about the extent to which housing equity is used in different ways to other money; in parti cular, whether it is particularly likely to be spent (reinvested) in the home. Greenspan and Kennedy (2008) track the changing way in which extracted equity has been spent. They find that the biggest share of the total was spent on personal consumption and nonmort gage debt repayment, closely followed by expenditure on home improvements. The remainder was spent on acquir ing other assets, though its share of total spending declined through the equity withdrawal boom of the early 2000s. They estimate that an average of nearly $60 billion of nonmortgage debt was repaid from housing equity withdrawal from 1991 to 2006 and that through this period it financed around 40% of home improve ments. Overall then, they conclude that housing equity withdrawal was used to directly finance approximately 1% of total US personal consumption expenditure. It is notable too that they find a considerable propor tion of equity withdrawal is used to consolidate other debts, such as credit card debts which, as they note, does not add to immediate demand in the economy. For con sumers, it may be a rational financial choice, at least short term, as the rate of interest charged on consumer debts is very much higher than that on secured, mortgage finance. However, it can be argued too that this should be seen as a way in which equity withdrawal is used to smooth out consumption spending (as increased spending is initially financed on credit cards and then subsequently refinanced into mortgage debt out of housing equity).
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In the United Kingdom, the Bank of England produces a quarterly series of estimates as to the amount of equity withdrawal (they net off expenditure on housing improvements from the estimates) and show a similar dramatic rise in the amount of mortgage equity with drawn through the house price boom years from the mid-1990s (Davey, 2001). In the early years of the new millennium, it regularly accounted for over 5% of posttax household income (see http://www.bankofengland. co.uk/statistics/statistics.htm). Smith and Searle (2008) combine a range of survey sources to examine how households in Britain spent their extracted equity and find, as in the United States, that there is a strong propensity to spend it on the house in some way. They estimate that between two-thirds and three-quarters of those who extract equity use at least some of it for home repairs or improvement, although they note too how hard it is to be precise about exactly what respondents to large-scale surveys may include in ‘improvement’ expenditure (for instance, the cost of buy ing new furniture and soft furnishings may be included in the cost of completing an extension). Some scholars have explored the extent to which there has been a change in attitude to wealth tied up in the home, which was traditionally seen as being carefully ring-fenced and protected to be passed on as inheritance to children (unless used to invest in the house itself). Evidence collated by Smith and colleagues (Parkinson et al., 2009; Smith and Searle, 2008) suggests that it is becoming increasingly routine and common practice for households to extract significant amounts of housing equity, and that this was true, at least up until the housing market crash, in both Australia and the United Kingdom. In parallel to the lifecycle hypothesis explored by econ omists, this sociological literature is also interested in questions to do with the place of housing wealth in house hold’s longer-term planning for the future. In particular, investment in housing may be used as a way of securing a more comfortable old age, and a strategy for dealing with the retrenchment of welfare provision in relation to pen sions and long-term care – that is, there is an insurance motive present. Of course, such goals are undermined if households increasingly look to housing wealth for day-to day spending throughout their adult life.
The Role of Financial Institutions These longer-term questions about the way that people seek to plan their finances raise important questions about the financial capabilities and competencies that people bring to these decisions and, ultimately, about the extent to which people are vulnerable to exploitation by aggres sive, profit-seeking financial institutions. The argument here is that people may be persuaded to make decisions
which are risky, and perhaps riskier than they realise. This is of particular concern where it is in the interests of financial institutions to encourage people to take par ticular types of product, perhaps with little regard to the longer-term viability of those choices for borrowers. Traditionally, in the United Kingdom and United States and elsewhere, banks and specialist mortgage lenders would have been seen as risk-averse lenders – seeking to lend on sound property (that can be resold at a price that would cover the outstanding loan) and to households who had low risk of default. Although they were criticised for conservative behaviour, such an approach does make it less likely that people acquire unsustainable debts, and arguably fostered an expectation that such institutions would not lend to people more than they could afford. The development of the subprime sector (in which specialist lenders lent money to those with a higher default risk) and its subsequent crisis (as debts of dubious risks were parcelled up in opaque and complicated ways, and sold globally) is relevant to the examination of housing equity withdrawal in two ways. First, concerns were expressed about subprime lending practices, particularly in the United States, where predatory lenders systemati cally degraded underwriting standards and encouraged repeated remortgaging in poorer communities, effectively stripping out the housing equity that had been accumu lated by these relatively disadvantaged, often minority ethnic communities. The subsequent delinquency and defaults on mortgages led to foreclosures as well as volun tary sales by owners no longer able to keep up payments on their loans. This has created spatially concentrated pockets of abandonment as well as causing hardship to the indivi dual owners affected (Immergluck, 2008; Renuart, 2004). Second, of course, the global financial crisis that ensued has had significant effects on the availability of credit. As would be expected, this has had significant effects on recent trends in housing equity withdrawal.
The Global Financial Crisis The global financial crisis that was prompted by the crisis in the subprime lending market has had global repercussions. In particular, there has been a dramatic reduction in the availability of credit as lending institu tions retreated to focus on the safest business they could identify; low-risk borrowers with substantial cushions of housing equity. The United States has experienced very significant falls in house prices since their peak in 2006 and substantial levels of foreclosures. Households have, therefore, seen their store of housing equity dramatically reduced. In the United Kingdom, house prices have not fallen so significantly, partly it is suggested because lenders have been unwilling to pursue repossessions too vigorously because of the risk to their balance sheets.
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Economic confidence has been knocked and there is the prospect of tough government spending retrenchment to reduce the high levels of public debt. In this context, it seems inevitable that there will be a reduced appetite for housing equity withdrawal among consumers at least in the medium term. It remains to be seen whether the financial system will ever return to the relatively easy lending that allowed households such free access to their housing equity, although by 2011 there were already signs that lenders were beginning to retreat from the extremely risk-averse lending practices initially adopted.
See also: Asset-Based Well-Being: Use Versus Exchange Value; Financial Deregulation; Health, Well-Being and Housing; Home Ownership: Economic Benefits; Housing and Wealth Portfolios; Housing Equity Withdrawal in the United Kingdom; Housing Wealth and Consumption; Housing Wealth as Precautionary Savings; Housing Wealth Over the Life Course; Monetary Policy, Wealth Effects and Housing; Mortgage Contracts: Flexible; Mortgage Innovation; Mortgage Market Functioning.
References Benito A (2009) Who withdraws housing equity and why? Economica 76: 51–70. Benito A and Power J (2004) Housing equity and consumption: Insights from the survey of English housing. Bank of England Quarterly (Autumn): 302–309. Case KE, Quigley JM, and Shiller RJ (2005) Comparing wealth effects: The stock market vs the housing market. Advances in Macroeconomics 5(1). Davey M (2001) Mortgage equity withdrawal and consumption. Bank of England Quarterly (Spring) 41: 100–103. Greenspan A and Kennedy J (2008) Sources and uses of equity extracted from homes. Oxford Review of Economic Policy 24(1): 120–144. Immergluck D (2008) From the subprime to the exotic: Excessive mortgage market risk and foreclosures. Journal of the American Planning Association 74(1): 59–76. Klyuev V and Mills P (2007) Is housing wealth an ATM? The relationship between household wealth, home equity withdrawal, and saving rates. IMF Staff Papers 54(3): 539–561. Muellbauer J and Murphy A (2008) Housing markets and the economy: The assessment. Oxford Review of Economic Policy 24(1): 1–33. Parkinson S, Searle BA, and Smith SJ, et al. (2009) Mortgage equity withdrawal in Australia and Britain: Towards a wealth-fare state? International Journal of Housing Policy 9(4): 365–389. Renuart E (2004) An overview of the predatory lending process. Housing Policy Debate 15(3): 467–502. Smith SJ and Searle BA (2008) Dematerialising money? Observations on the flow of housing wealth to other things. Housing Studies 23(1): 21–43.