The American dream is owning your own home, and for more than half a century the government has encouraged home ownership through low-interest loans and tax breaks. Today, about two-thirds of American households own their homes. Or I should say, partly own them. Banks and other mortgage lenders own the other part. And here's the potential problem.
You see, homes are about the only assets whose value has increased during these bleak economic times. That's at least partly due to the fact that interest rates are at rock-bottom lows, meaning that a lot of people can now afford a mortgage to buy a home, thereby boosting the housing market.
Low interest rates also make it easy for many cash-strapped Americans who already own their home to borrow more money against its value, and banks are only too happy to oblige. Homeowners are using the cash to buy all sorts of things they otherwise couldn't afford. More likely, they're using the cash to pay down mounting credit-card debt. You see, interest rates on home-equity loans are only about half that on credit card debt, and home-equity interest payments loan can be deducted from income taxes.
Last year, homeowners raised $130 billion through home-equity loans. That's nearly double the amount they raised the year before. So far this year, the home-equity borrowing binge keeps growing. Now, what happens if you can't repay your home equity loan because you lose your job or your paycheck starts shrinking? Well, as long as the value of your home keeps rising, you can always take out another loan -- which is exactly what many people are doing. Or if worse comes to worse, you can sell your home for more than the amount you owe, pay off your debt and settle into a smaller house.
But here's the catch. When interest rates start heading upward again, a lot of home prices will start heading south. That's because mortgages will become more expensive, which means fewer people will be in the market to buy a home. With all the new homes being built right now, some housing markets are already facing a glut. Home prices are softening in Oklahoma, North Carolina, Indiana, Ohio and Washington state.
If you can't repay your home-equity loan and the price of your home is flat or declining, you're in trouble -- and so is your bank. "Equity delinquencies" are on the rise. In Oklahoma alone, there was a fourfold increase at the end of last year. Not only will a lot of people lose their homes, but a lot banks will be holding pieces of paper not nearly worth their face value.
I can't predict the future, but I can tell you three things for sure: First, interest rates will be heading up again. I mean, just look at projected federal budget deficits and you'll find reason enough. Second, many people have taken on way too much home-equity debt and are going to find themselves in hot water. Third, a lot of boomers who assume their homes will be their nest eggs in retirement are going to have an unpleasant surprise.
Robert Reich, former secretary of labor in the Clinton administration, is professor of social and economic policy at Brandeis and the author of "Reason: Why Liberals Will Win the Battle for America."