Home Equity as an indicator of stability?

Question

So I just came across an article about American debt and why some economists aren't concerned that consumer debt (excluding mortgages) is about to hit $4 trillion. The economists who isn't worried about the debt says, "Deposits have grown by $2.5 trillion more than consumer debt, and homeowners have nearly $10 trillion more in home equity than they did a decade ago."

While bank deposits outpacing debt is an easy indicator to follow, I don't fully grasp how having home equity is an indicator as to why one shouldn't worry about the rise of consumer debt?

I'm sure we all heard the elevator pitch on how great equity is. It's sitting there, on tap for you at your choosing, to deploy these resources into new investments or to pay off/consolidate outstanding debt. This always sounded too good to be true to me.

Now there are commercial buildings where equity can be forced...to an extent. And it can also be forced to shrink by a recession or consecutive years of stagnant wage growth while inflation continues to work its magic or other issues.

But to try and limit myself to a shorter post (it's already long but diving into commercial assets will make it even longer) I am thinking about equity in relation to residential RE.

So we know that residential RE is a slave to its comps. This is good when in a seller's market and demand for product is high. Hence the $10 trillion home equity quote above sounds good. But that equity isn't really just sitting there, waiting for you to tap into it. Not even close. You have to convince someone to give you the funds and accept a (most likely) 2nd position note as collateral. Also a fairly easy process in an expanding economy.

But an expanding/healthy economy is only half the story. What happens when the economy is contracting? Well, RE sales slow down significantly and in most places, it becomes a buyer's market. Home values drop and yup, so does your home's value. There is that "slave to comps" thing again. Now, where did all that equity go that was just waiting for you to tap into?

But lets say you see the writing on the wall about a contraction and you decide to actually tap that equity before it gets wiped out by the falling home prices. Well, the banks can see the writing on the wall as well and you have a fairly good chance of being denied a HELOC or cash out. So now you know the equity is there, you just can't access it.

But lets say you were like the guy in "The Big Short", who noticed something was off WAYYYY before anyone else did and you decide to tap the equity before anyone catches on to what's about to happen to the economy. Bank gives you that HELOC or the cash out, no problem. Great. But now you have a new note you have to pay monthly (either right away, with the cash out or as soon as you deploy the money, if you got a HELOC). In either case, sooner or later, you have a new note to pay. If you used the money to consolidate other debt, you might actually lower your monthly cash outflow and that's great. But if you pushed the money into an investment, it may or may not succeed. And if you lose your primary job, you can't make the payments any more. Or if you bought a new rental and a recession hits, you may have to lower your rent or people may just move out in the middle of the month and you realize you have a vacant apartment when a rent deposit doesn't hit your account 2 weeks later (it happened to me multiple times in 2008-2010).

So with so many unknowns and risks with home equity, should it be used as an indicator of a sound economy and/or responsible consumers? Is there something I'm missing with the benefit of a healthy home equity figure? Are there other ways to leverage home equity without ending up with a monthly note to pay?

I'd love to hear your thoughts.

Seth Nadreau · Answer

Short answer. Larger equity in the market means more collateral for the debt. Massive debt isn't a bad economic issue if there's something securing that debt (or something liquid capable of securing that debt). It's the macro-market concept of leverage at work. While there may be some market corrections coming, the lending market isn't where it was in 2006-2007. PMI has been restructured to capture losses faster and better and many more deals going to closing have 20% down or more... ESPECIALLY in income properties. If a recession hits, it won't hit like it did in 2008. You'll see a stall in new home building, an increased inventory, higher days on market and then declining values at a much slower pace.As an appraiser, I analyze market conditions with every report I do. In my area, MOST property types are seeing stability or slow growth (less than 0.15% monthly). Some pockets with fewer buyers (higher end homes) have already seen some declines and are back to stable. The market is in a much better place to self-correct than it was a decade ago. Stock market earnings are in-line as well... and the Fed seems really cautious about increasing interest rates, so most factors point towards a healthy economy. As for that debt, I took out a $40K HELOC to fund my down payment on my recent buy and hold property. The rent pays for the mortage, HELOC payment and reserves with a bit of cash to spare every month. Sure, my debt increased, but so did my potential earnings and my net worth. :-)