Thursday, November 15, 2007

How Much Cash is Left in the Home ATM?

by Bill McBride on 11/15/2007 01:11:00 PM

This post is a followup to: Bloomberg's Berry: No Recession (Hat tip NJ_Bob for graph ideas)

One of the questions raised by the Bloomberg article is how much more equity can be borrowed on U.S. household real estate. Based on the Fed's flow of funds report, the percent of homeowner equity was at a record low of 51.7% at the end of Q2 2007.

However, according to the Census Bureau, 31.8% of all U.S. owner occupied homes have no mortgage. You can't do a direct subtraction because the value of these paid-off homes is, on average, lower than the mortgaged 68%. But we can construct a model based on data from the 2006 American Community Survey (see table here).

Household Distribution by Valuation Click on graph for larger image.

This graph shows the distribution of U.S. households by the value of their home, with and without a mortgage. This data is for 2006.

By using the mid-points of each range, and solving for the price of the highest range (to match the Fed's estimate of household real estate assets at the end of 2006: $20.6 Trillion), we can estimate the total dollar value of houses with and without mortgages.

Using this method, the total value of U.S. houses, at the end of 2006, with mortgages was $15.27 Trillion or 74.2% of the total. The value of houses without mortgages was $5.32 Trillion or 25.8% of the total U.S. household real estate.

Since all of the mortgage debt is from the houses with mortgages, these homes have an average of 36% equity. It's important to remember this includes some homes with 90% equity, and some homes with negative equity.

The following graph shows the impact of falling house prices on the percent aggregate equity.

Aggregate Percent Equity At the end of 2006, aggregate equity for mortgage holders was 36%.

If household assets fall 10%, and liabilities stay the same, the percent equity will fall to 28.9%. If household assets fall 20%, the percent equity will fall to 20%.

If assets fall 35%, there will be no equity in the aggregate - households with positive equity will be offset by households with negative equity. Although I don't expect prices to fall anywhere near 35%, even a decline of 10% will probably severely limit the ability of marginal homeowners to borrow from their home equity.

This is based on 2006 data. Mortgage equity borrowing was still strong through the first three quarters of 2007 (Q3 estimated), and the situation is even worse now.

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