It's on the House
Now Everybody Is Paying for Everything With Home Equity

By Margaret Webb Pressler
Washington Post Staff Writer
Sunday, May 8, 2005

Gabe Klein, a 34-year-old regional vice president for Zipcar Inc. car-sharing service, is getting a lot out of his Columbia Heights row house, including cash. By refinancing the Northwest Washington property twice in the past three years, Klein has been able to take nearly $300,000 in cash out of his growing equity and plow it back into renovation projects. Those improvements have helped lift the house's appraised value to $800,000 last year -- three times what Klein paid for it three years ago with just a $10,000 down payment.

Klein still has money to burn, too, if he so desires. The last time he refinanced, he took $80,000 out of the transaction to pay for renovations and was given a $100,000 line of credit. Though Klein said he didn't really need the money, he might use it to buy an investment property. The value Klein's house has generated -- more than he has made from working in the past three years -- is changing his view of the future.

"I'm thinking I need to buy a house a year for the next 10 years and then retire," he said.

Klein is like millions of Americans whose attitudes about homeownership have been transformed by the unprecedented growth in property values and the ability to tap that value today. It used to be that a mortgage was more or less forever. Rising equity, in turn, was considered the untouchable foundation of a retirement nest egg.

But the old psychological barriers to tapping home equity have crumbled in the past 10 years, and now, especially for younger homeowners, home equity is viewed a bit like found money. A whole generation of homeowners is able to live in a way their parents never dreamed of back when homes appreciated a percent or two a year and cashing out equity meant robbing from your retirement.

"If you go in at the age of 25 and you've seen 100 percent appreciation in your property, that's going to affect the way you look at housing for the rest of your life -- even differently than your parents, who saw 1 percent appreciation per year for decades," said Doug Duncan, chief economist for the Mortgage Bankers Association.

"Certainly we're in a new world today," said David A. Lereah, senior vice president and chief economist of the National Association of Realtors and author of the book "Are You Missing the Real Estate Boom?"

But there are trade-offs in this equity free-for-all. Clearly, the economy has benefited from our more liquid approach to homeownership, as consumers have taken money from their homes and streamed into home centers, garden stores, furniture retailers, car dealers and even travel agents. And mortgage brokers say most people are spending their equity prudently: reinvesting in their own homes, buying second homes, paying off more expensive debts and the like.

But could consumers become addicted to this wealth, and forget about the inherent risks? How will people react when the real estate market changes and there just isn't as much money to play with?

Andrew Chassaing, senior financial specialist for Wachovia Bank, said he is especially concerned that some people "feel they have all this equity burning a hole in their pocket" and can't keep their hands off it. He has clients like that.

"They keep coming back for more and I know they're not renovating their house," Chassaing said. "They just spend a lot."

House Banking

Even among the most conservative homeowners, though, converting equity into cash is commonplace now.

Elizabeth Cruppa, an office manager with a small downtown law firm, takes a conservative approach to home equity. Ten years ago she used a line of credit to put a new kitchen in the Alexandria home she has had for 18 years. Then last month she closed on another loan she'll use for a new furnace.

"I don't want to touch my savings," she said. "This way I get the interest deduction."

Several factors have combined to make all this lending and borrowing possible, especially the $4 trillion in value the nation has added to its housing stock in just the past four years. Compared with that figure, the $147 billion and $139 billion Americans have pulled out of their homes in the past two years doesn't seem like that much.

But it's not rising values that have prompted this surge, mortgage experts say, it's our growing comfort with the experience.

Even the most traditional homeowners began thinking about their homes as piggy banks during the first big refinancing boom in 1992, when mortgage rates fell below 10 percent. Since then, there have been several more surges of refinancing because of falling rates, giving people who were once intimidated by the idea of a real estate loan more experience with such transactions.

"The mystique of what a mortgage is has kind of gone away along with the competitiveness of the market," said Steve Calem, a local mortgage broker. "It's a big change."

To Paula Heichel, the growing value of her Capitol Hill home was just another tool she could use to streamline her finances. The financial consultant with Smith Barney took out a home equity loan to pay off some credit card debts, she said, and more recently refinanced to roll that loan into a 30-year fixed-rate mortgage. That lowered her total monthly payments by $400.

"I was concerned interest rates were going to keep going up," she said.

For homeowners such as Heichel and Cruppa, these transactions aren't a big deal anymore. And as consumers have become more confident about the intricacies of refinancing, the mortgage industry has responded by improving the process of getting a loan. It is much quicker, less onerous and cheaper than it used to be. Twenty years ago, the axiom was that it could pay to refinance if rates had dropped by 2 percentage points. Today, it can pay to refinance if you can drop your rate by half a percentage point, said Duncan of the Mortgage Bankers Association.

There is also much more to choose from. Twenty years ago, there were about 10 to 15 kinds of mortgage loans, Duncan said, but today there are 250 to 300. Banks have used advances in technology and consumer databases to reach new segments of the home-owning population, such as those with weaker credit, and have tailored financial instruments to meet the needs of just about any kind of consumer at any point in time.

That flexibility and growth have had a reinforcing effect: Newly available loans have increased the rate of homeownership nationwide, and that is helping to push prices up. Those higher prices mean more equity -- and more owners tempted to cash in on that equity.

Tom Regnell, for example, has refinanced five times since he bought his house in the Belle Haven area of Alexandria five years ago. When he refinanced this last time, he finally took out some cash -- enough to buy a piece of property near the Homestead resort in Hot Springs, Va., and start building a second home. He thinks it's a smart move.

"I've got a lot of money in it, so what the heck," he said. "I've pulled the money out, but at the end of the day, I'm still reinvesting the money."

Young Spenders

Roughly half of all refinancings in the past few years have included some cash-out. And while mortgage experts say that is going to taper off because of higher interest rates, the faucets aren't turning off completely.

Increasingly, homeowners are turning to home equity lines of credit to get cash out of their homes. And if there's one rule of thumb, it's that younger and newer homeowners are much less inhibited about it.

"Your twentysomethings, your thirtysomethings, they've got no problems with it," said Chassaing of Wachovia. "Because a lot of these first-time home buyers -- they won the lottery."

"Jackpot" is how Ileann Jimenez-Sepulveda describes it. Like Klein, she bought a house in Columbia Heights when the neighborhood was still known more for its crime and lack of amenities than for its gentrification. But the $300,000 house she and her husband bought four years ago was recently appraised at $850,000, and that equity has changed their lives.

They used their growing equity to buy another house three blocks away and renovate it to sell it. Then they bought a house in South America, and soon they'll close on a large single-family home in the upscale Crestwood neighborhood off 16th Street NW. In the meantime, Jimenez-Sepulveda, who had worked in the high-tech industry, quit her job to join her husband in the real estate business; he's a loan broker, she became an agent. Now they encourage their clients to use the equity in their homes to buy investment properties.

"It's very easy, it's very tangible for people to understand because they see their neighbors doing it -- taking the money out, buying something else, or investing in starting a restaurant," she said. "It's exciting to see people recognizing it and running with it."

Jimenez-Sepulveda dismisses the analogy she sometimes hears likening this kind of leveraged real estate investing to the frenzied investing in technology stocks of the late 1990s. She argues that real estate assets are bound to increase in value over the years, even if it's at a far slower rate than in the past few years. But economists and lenders worry about what happens when home prices stop escalating the way they have been.

"Certainly as things retreat, you'll have some households that find themselves with two sets of loans -- one on their equity line and one on their primary residence, as well as their new property investment -- and that could be a lot," said Lereah of the Realtors Association.

Then there are homeowners who feel all this value is almost like Monopoly money; they're just kind of surprised at what they're now able to buy. They're not trying to reinvest their home equity or even understand it. They just feel lucky.

"For me, it's like wizardry. It's like, 'Oh, we can do this? Oh, wow,' " said Noa Baum, a professional storyteller and performer who grew up in Israel. Baum said she still finds it hard to believe that she and her husband were able to buy two new cars outright because their Takoma Park home -- their first house -- has gone up so much in value since they bought it less than three years ago. She calls it "a very weird situation."

"The good out of it is the fact that I can refinance and get this car, but if I wanted to sell this house, I wouldn't be able to buy anything in my neighborhood," Baum said. "I feel like these rats that run on those round carousels -- they spend lots and lots of energy, but they're still in the same place."

In a speech last fall, Federal Reserve Chairman Alan Greenspan painted a relatively sanguine picture of all these cash-out transactions, saying they've "likely improved rather than worsened the financial condition of the average homeowner."

That may be, but it's still unclear what the long-term impact has been on our behavior as consumers, and our ability to plan for retirement. Some economists say they see some younger homeowners seeking immediate gratification -- they want to live well now, so why shouldn't they tap into their home equity?

The reason they shouldn't, of course, is that home-equity wealth is still a huge piece of the puzzle when it comes to the golden years.

"For the average family in the U.S., home-equity wealth accounts for about half of their net worth," said Frank Nothaft, chief economist for mortgage finance giant Freddie Mac. "That's why I do think it's important that families do that reality check and try not to borrow to the hilt every chance they get, because they're taking away from their own future."

Then again, to some people, tapping home-equity cash is all about the future. In a way, the real estate boom is giving younger homeowners a new breed of retirement plan.

Nick Koufos, an attorney for the Securities and Exchange Commission, is 36 and has three children. He recently did a cash-out refinance on his Silver Spring home to build a house in Pennsylvania -- to which he plans to retire someday.

"I think it's better to get it done sooner rather than later," he said. "I don't see how I could lose money."