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For most of us, our home is the single biggest investment we will make. We scrimp and save, and then spend and spend just trying to maintain it. Throughout the nineties we saw the economy turn north, and we saw the "paper" equity in our homes begin to rise. Suddenly, everyone realized that their homes represented more than a roof over their heads. I represented money, and that money is available for just about any purpose. According to the Federal Reserve, which keeps track of such things, home equity has deteriorated to the lowest level is two decades. This is how Americans have outspent their incomes, using collateral to boost economic expansions.
This is how it works. You borrow on house to pay off credit card debts, take a vacation, even to free up money to invest. You use the money to make improvements that you optimistically feel will return double or triple what you spent. You treat the very investment that for many is a statement of community and your place in it, as nothing but a credit card too large to carry in your wallet. Two things can happen from this point. First is the length of the downturn in the economy. And it is going to go down. The distance is as yet unknown, but it will fall. If interest rates fall also, and the Fed is widely seen as aggressively cutting them for the next several months, the likelihood of refinancing will escalate. You borrow more without increasing your payment and spend this excess cash. This will make the so-called landing or economy bottom a little softer. But suppose housing prices go down with those interest rates. Suppose, because of this downturn, families who have borrowed heavily suddenly see the error of their ways and start to pay off debt and not spend their money. This happened to the Japanese over a decade ago. There are millions of Americans who purchased homes with relaxed obligations and the ability to purchase the home with almost no money down. These types of loans are part of a proverbial house of cards. Lenders packages these loans into bonds and then sold them to investors. This practice created an America that has turned 68% of all households into owner occupied dwellings. Unfortunately, the equity that these folks own in their homes will not withstand even the slightest ill wind from the economy. A lost job, a salary cutback and this sometimes means no more overtime (an income supplement that many have become dependent on) or home repairs that are absolutely necessary such as a roof, would all lend to a domino effect. You default on your loan because you have become completely credit tapped. The loan, which was sold to investors, becomes worthless. You curtail spending, and spending is what keeps the economy humming. What is left is a much longer recession than anyone wants. The smart thing to do is to lower your expectations of what you feel your house is worth. I have repeatedly fallen into this trap when I look at what houses on my street are selling for and wonder outloud to my wife about the current value of our home. Remodeling improves your life within your home but adds little to what you think you will recover. If you have one bathroom and this is comfortable for you, adding another will only add to the amount of rooms that will need to be cleaned. Especially if you are forced to borrow to accomplish the task. It is very easy to look at the refinance as a way of taping your equity for improvements all the while receiving money at less than 10% that is also tax deductible. The smart thing to do would be to carefully evaluate your motives for borrowing against your home, the length of time it would take to repay the debt, and the possibility that you might have to walk away from your home with a lot less in equity should you borrow. Use refinancing the way it was meant to be used, to lower your interest rate so that your overall mortgage payment will be less. Don't use it to increase your debt.
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