What happened to EQUITY?

Common sense kicked in shortly after Pam George considered tapping into her home’s equity to pay for the expansion of the master bedroom in her Wilmington, Del., home. At first, that seemed like the answer given how easy it has become to get a home-equity line of credit. Not long after she considered doing that she realized that she was about to lose her carefully nurtured nest egg.

“It’s a scary thing to do,” she says. “Houses are not banks. They’re not credit cards.”

George is not alone in worrying about the loss of her nest egg during what has become a very sour economy. Many American homeowners have stopped thinking of home-equity lines of credit as free money and are shying away from using them. Despite that, a lot of families are living close to the financial edge because they treated their homes as ATMs to pay for such thing as vacations, college educations, home renovations and other bills.

The situation is rapidly approaching critical mass. The Federal Reserve reported in June that Americans’ home equity had dropped to its lowest point since 1945, when the country was emerging from a devastating two-front world war.

Equity levels fell to 47.9 percent in the fourth quarter of 2007, compared with 50.5 percent from the comparable period in 2006. Simply put, the average American owed more on their home than they had in equity.

As a result, there is a serious question as to whether many current homeowners will ever have sufficient equity in their homes for use in a real emergency. If they do not, a family financial crisis could force them to sell their homes in a down market for less than they could normally expect to get for their property.

Keith Gumbinger, vice president of rate tracker and financial publisher HSH Associates in Pompton Plains N.J., says U.S. home equity fell because of several factors, including the rise in nontraditional loans that sometimes financed as much as 125 percent of the home’s value and home equity lines of credit. Once prices started to fall, homeowners realized they had no safety net.

The Mortgage Bankers Association reported that in 2005 and 2006, the peak of the mortgage boom, about 13 percent of homeowners financing first mortgages put down less than 10 percent of the purchase price. About 1 percent of buyers locked into mortages that surpassed the sale price of their new home.

These ultra-liberal lending conditions are unlikely to return, Gumbinger says. Homeowners can no longer finance a home without a reasonable down payment, and access to home-equity lines of credit are harder to obtain.

“In many ways, we’re going back to the way it used to be,” he says.

The trouble is that for the time being, more homeowners will face foreclosure if they can’t sell their home for at least what they owe.

The real-estate bust created huge losses in areas of the nation that experienced the most growth during the boom. Homeowners in states such as California, Florida and others along the Atlantic coast are now feeling the effects of the down market more than other areas. Those who may escape the worst of this market are the ones who purchased their homes at least five years ago, says Gumbinger.

“You should be in reasonably good shape if you purchased a home before 2003,” he says.

The economic downturn and its subsequent housing bust seems to have changed the mindset of consumers who are no longer falling prey as easily to hyper-marketing by banks and credit-card companies.“We lost perspective of how valuable it is to accumulate home equity for long-term living, particularly if you hope to have access to it in retirement,” Gumbinger notes.

George says the temptation had been strong to borrow against her home. She was able to resist the urge, however, because of the wise advice she got from older friends and family, including her recently deceased father.“The older generation would never think of tapping into their homes,” she says. “That’s one lesson worth honoring.”