The Home Equity "Myth"

[John Carbone]

I hear a lot of talk about how it's different this time, and real estate prices won't be affected too much because everybody has so much "equity" in their homes. What people fail to understand is, why do they have so much equity in their homes in the first place? Sure, 3-4% gains are normal in real estate to account for wage growth and normal inflation, but the run up in real estate values to these astronomical levels is not healthy. All of the equity gained is highly driven by cheap money/2-3% mortgage rates. The interest rate is the main component to housing affordability (monthly payment.) So by having 2-3% interest rates, it artificially inflated housing values. This "equity", while it appears real, is really phantom. The fed has aggressively raised rates, we are now sitting at a 7% primary home mortgage rate. A 500k mortgage in 2021 at 3% has a payment of $2,108. a 500k mortgage now at 7% is $3,327. In order to have the payment be $2,108 now at 7% rates, you need a 320k mortgage ($2,129). That is a 36% drop in value now due to rates rising to where they are now. We can adjust for inflation and it's probably closer to 25-30%. The "equity" is being recaptured now to reflect the reality. The fed giveth, and the fed taketh away.