Borrowing from homes in good times will hurt retirement income
A significant portion of the Baby Boom generation is going to head into retirement with a large decline in their net worth due to excessive borrowing against home equity, a new study says.
As home prices soared from 2001-06 about 30 percent of homeowners extracted an estimated $1.2 trillion from their home equity by borrowing.
That money was spent, the debts remain, and future retirees are in trouble, says Alicia H. Munnell, a management professor at Boston College.
Some Baby Boomers have burned up equity in their homes through borrowing.
That grim prediction illustrates the human toll of the current worldwide financial crisis over mortgage debt.False wealth
Homeowners had a false sense of rising wealth when their homes gained in value, the study says.
That’s because their homes are both investments and use assets—they have to live somewhere. If a home’s value increases, then the implied cost of future rent to live elsewhere also increases, and that offsets the real value of the home’s increase.
For an older homeowner, a rising home price does lead to some real wealth creation, because they do not have as many future years of potential rent to pay. But younger homeowners really don’t reap much of the gain in housing price, the study says.
Spent on consumption
The study looked at federal government statistics that indicate what homeowners did with the money they borrowed.
Munnell estimates that a third of the money was used to buy things, and the rest used for home improvements.
She estimates that the consumptions and home improvement sprees mean that Baby Boomers will enter retirement with $380 billion of additional debt.
The impact on the average household’s net worth may be dramatic. The study estimated that a Boomer family that did not borrow has an average net worth of $56,800 going into retirement. Those that borrowed reduced their net worth to an estimated $35,000.
Those who borrowed on average had children under 18 and problems with credit. Those who did not generally had college educations or were averse to risk.