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December 15, 2017

Arkansas Homeowners No Longer Playing With House Money


Once upon a time, homeowners thought it was perfectly fine — smart even — to carry greater debt on their houses and take out the equity as cash for investments.

Ten years ago, Arkansas Business assessed the trend, topping the article with a playful headline about betting the house. Arkansans were getting second mortgages, home equity lines of credit and 100-percent mortgages on new homes, all to provide a seemingly magical cash pool for playing the market. Some were paying off existing mortgages as slowly as possible.

After all, interest rates were low, homebuyers were eager, and everyone knew that housing could never decline in value.

Well, that last part turned out to be a fairy tale.

American housing prices peaked in 2006, the year that story was published, and waves of foreclosures spurred the housing bubble’s big burst in 2008. The resulting crash in the subprime mortgage, collateralized debt and banking markets spawned the greatest financial crisis since the Great Depression, and the country still hasn’t fully recovered.

Money managers and homeowners got the message, and leveraging home equity for wealth-building is far rarer now, though some practices are still common on a smaller scale.

“I am struck by what we were like 10 years ago, like lemmings about to go off a cliff,” said Rick Adkins, president and CEO of Arkansas Financial Group Inc., the Little Rock investment advisory firm. “We were blissfully ignorant and just thinking about return.”

Adkins had been interviewed for that 2006 article, as was Leonard Hasson of Mann Hasson & Co. certified public accountants in Little Rock. The view from Hasson’s rearview mirror is the same as Adkins’.

“It was a fool’s game.” Hasson said. “Everybody back then was buying everything they could get, and people even borrowed money to invest. Things have shifted 180 degrees. Now it’s much more conservative.”

Not only is home equity less likely to be leveraged for investing, but many Arkansans are eagerly paying down their debts, said Rod Beckham, president of First Financial Mortgage in Little Rock. He, too, was quoted in the original story.

“Average buyers today are much more comfortable in the notion of having a good equity position in their home,” Beckham says now.

Beckham, Adkins and Hasson all believe the housing market is stable now, and that owning a home is still a great investment.

But the thinking 10 years ago was that a home seller could use a fraction of the proceeds to put 20 percent down on a new house and plow the remainder — say $100,000 — into the stock market, hoping for an annual return rate of 10 or 12 percent while paying 5 percent or less on the mortgage. That $100,000 would become $340,000 over 15 years at an annual return rate of 10 percent.

Today’s consumers, however, realize they may not get such a high investment return.

“People are starting to wonder if we’ll ever have a good year again,” said Adkins, a former adjunct professor of finance at the University of Arkansas at Little Rock and a regular columnist for the Journal of Financial Planning. “Two years ago we had a negative return, and last year there wasn’t much growth. This year it may be 3 percent. Folks who still think they’re going to get 12 percent a year have to realize that markets overall are not delivering those kinds of returns.”

Beckham said that even with today’s very low mortgage rates (3.4 percent on average nationally in July, according to Freddie Mac), “we see that buyers selling a current home and buying another are more likely to put all the proceeds from the sale into the new purchase. In many cases even additional funds are put toward the purchase from savings.”

That caution can be good, especially as homeowners age, Adkins said. “I guess as I’ve gotten older, I’ve started thinking what might happen. It’s one thing to have a heart attack in your living room, and another to have one when you’re driving 70 miles an hour down the freeway, or standing 20 feet up on a ladder.”

He said now that people have seen the damage from the housing bubble, they know they don’t want to be up on that metaphorical ladder when disaster strikes. “Low interest rates offer an opportunity to pay down debt, and people who have less stress and are happiest in retirement will be those with no debt. But as human beings, we make decisions on a transactional basis. We don’t look at things holistically.”

Psychological Scars

Victor Ricciardi, a finance professor at Goucher College in Baltimore and co-editor of “Investor Behavior: The Psychology of Financial Planning & Investing,” said the crisis of 2008 indeed left psychological scars.

“People suffer from an anchoring bias in which the financial crisis serves as a negative event,” he said. “This detrimental event reduces individuals’ appetite to endure high levels of risk, or accept new debt obligations such as a large mortgage loan.”

Rick Adkins pointed out another major difference between the mortgage climate today and 10 years ago: Now, once again, borrowers must prove they have the means to repay loans, and second mortgages are even more closely scrutinized. “Refinance is a whole new world,” Adkins said. “Documentation is asked for and verified. There were just so many abuses.”

The sleight of hand used in mortgage dealings before the 2008 crisis is the stuff of legend, seen in movies like “The Big Short,” “Too Big to Fail” and “Wall Street: Money Never Sleeps.” But those were the bad old days. “Now they don’t take your word for anything,” Adkins said. “They want documentation on income and assets, everything. They want proof.”

Some national observers have hinted at another housing bubble as the Federal Reserve continues its stimulus strategy of pumping money into the economy. And there are some exceptions to the tighter rein on borrowing here in Arkansas.

“We do see equity-out refinancing for various reasons such as investment property purchases, second-home purchases, paying for college or debt consolidation,” Beckham said. “Home equity financing is readily available at local banks in the form of second mortgages, and offered by most large aggregators of mortgages.”

Adkins said even 100-percent mortgages are starting to come back, but mainly for doctors coming out of medical training. He said that home equity credit is still possible, and that some borrowers, sadly, are misguided in how they use it.

“I was just at Disney World, and I know that some of the people I saw there were putting the cost of that trip — you know, $5,000 to take the kids there — right onto the credit card. And a lot of home equity still pays for things without lasting value. They’re spending on trips and merchandise. Again, the behavior aspect can be more important than hard, cold math.”

For that very reason, Hasson and Adkins were warning about the psychological dangers of cashing out home equity back in 2006 — the main behavioral risk being the temptation to spend.

As Hasson observed, some people were leveraging not to build wealth, but rather to in-crease their disposable income. Adkins described the availability of home equity cash as “financial heroin for some people.”

Ricciardi said that emotion often influences risk perception, and that extended levels of worry and fear might alter consumers’ tolerance for risk “over the long term.”

Millennials Missing Out

Hasson sees a downside to that, suggesting that far too few young people are buying homes, and thus missing an excellent way to build wealth early in life. “That’s the real pitfall I see now, that the millennial generation is not taking advantage of good values on existing homes and low interest rates,” he said. “They will blink an eye and will wish they had bought a home. The first ones in will definitely be glad, because interest rates won’t always be this advantageous.”

Noting that young people are saving and taking advantage of 401(k) retirement plans, Hasson said they should “step up to the plate” in homebuying. “When you don’t own a business, you can boil down wealth-building basically to two places: retirement plans and owning a home. Millennials are missing out on that second one.”

On the other end of life, Arkansans should reduce debt and plan for longer retirements, Hasson and Adkins emphasized. “Pay down your mortgage and invest in retirement plans,” said Hasson, who often suggests 15-year mortgages for clients who can make higher payments. “You don’t need appreciation to build equity when you’re making principal payments.”

Adkins said the keys to a comfortable retirement are managing consumption, spending less, saving more “and for some folks working longer.” But having the mortgage paid off can ease a worried mind. “What if the housing market caves in or interest rates shoot up again?” he asks. “What if your portfolio is suddenly worth a lot less and your cash flow drops? When that happens, disaster is in the air. And you don’t want to be 20 feet up on that ladder.”

Once upon a time, homeowners thought it was perfectly fine — smart even — to carry greater debt on their houses and take out the equity as cash for investments.

Ten years ago, Arkansas Business assessed the trend, topping the article with a playful headline about betting the house. Arkansans were getting second mortgages, home equity lines of credit and 100-percent mortgages on new homes, all to provide a seemingly magical cash pool for playing the market. Some were paying off existing mortgages as slowly as possible.

After all, interest rates were low, homebuyers were eager, and everyone knew that housing could never decline in value.

Well, that last part turned out to be a fairy tale.

American housing prices peaked in 2006, the year that story was published, and waves of foreclosures spurred the housing bubble’s big burst in 2008. The resulting crash in the subprime mortgage, collateralized debt and banking markets spawned the greatest financial crisis since the Great Depression, and the country still hasn’t fully recovered.

Money managers and homeowners got the message, and leveraging home equity for wealth-building is far rarer now, though some practices are still common on a smaller scale.

“I am struck by what we were like 10 years ago, like lemmings about to go off a cliff,” said Rick Adkins, president and CEO of Arkansas Financial Group Inc., the Little Rock investment advisory firm. “We were blissfully ignorant and just thinking about return.”

Adkins had been interviewed for that 2006 article, as was Leonard Hasson of Mann Hasson & Co. certified public accountants in Little Rock. The view from Hasson’s rearview mirror is the same as Adkins’.

“It was a fool’s game.” Hasson said. “Everybody back then was buying everything they could get, and people even borrowed money to invest. Things have shifted 180 degrees. Now it’s much more conservative.”

Not only is home equity less likely to be leveraged for investing, but many Arkansans are eagerly paying down their debts, said Rod Beckham, president of First Financial Mortgage in Little Rock. He, too, was quoted in the original story.

“Average buyers today are much more comfortable in the notion of having a good equity position in their home,” Beckham says now.

Beckham, Adkins and Hasson all believe the housing market is stable now, and that owning a home is still a great investment.

But the thinking 10 years ago was that a home seller could use a fraction of the proceeds to put 20 percent down on a new house and plow the remainder — say $100,000 — into the stock market, hoping for an annual return rate of 10 or 12 percent while paying 5 percent or less on the mortgage. That $100,000 would become $340,000 over 15 years at an annual return rate of 10 percent.

Today’s consumers, however, realize they may not get such a high investment return.

“People are starting to wonder if we’ll ever have a good year again,” said Adkins, a former adjunct professor of finance at the University of Arkansas at Little Rock and a regular columnist for the Journal of Financial Planning. “Two years ago we had a negative return, and last year there wasn’t much growth. This year it may be 3 percent. Folks who still think they’re going to get 12 percent a year have to realize that markets overall are not delivering those kinds of returns.”

Beckham said that even with today’s very low mortgage rates (3.4 percent on average nationally in July, according to Freddie Mac), “we see that buyers selling a current home and buying another are more likely to put all the proceeds from the sale into the new purchase. In many cases even additional funds are put toward the purchase from savings.”

That caution can be good, especially as homeowners age, Adkins said. “I guess as I’ve gotten older, I’ve started thinking what might happen. It’s one thing to have a heart attack in your living room, and another to have one when you’re driving 70 miles an hour down the freeway, or standing 20 feet up on a ladder.”

He said now that people have seen the damage from the housing bubble, they know they don’t want to be up on that metaphorical ladder when disaster strikes. “Low interest rates offer an opportunity to pay down debt, and people who have less stress and are happiest in retirement will be those with no debt. But as human beings, we make decisions on a transactional basis. We don’t look at things holistically.”

Psychological Scars

Victor Ricciardi, a finance professor at Goucher College in Baltimore and co-editor of “Investor Behavior: The Psychology of Financial Planning & Investing,” said the crisis of 2008 indeed left psychological scars.

“People suffer from an anchoring bias in which the financial crisis serves as a negative event,” he said. “This detrimental event reduces individuals’ appetite to endure high levels of risk, or accept new debt obligations such as a large mortgage loan.”

Rick Adkins pointed out another major difference between the mortgage climate today and 10 years ago: Now, once again, borrowers must prove they have the means to repay loans, and second mortgages are even more closely scrutinized. “Refinance is a whole new world,” Adkins said. “Documentation is asked for and verified. There were just so many abuses.”

The sleight of hand used in mortgage dealings before the 2008 crisis is the stuff of legend, seen in movies like “The Big Short,” “Too Big to Fail” and “Wall Street: Money Never Sleeps.” But those were the bad old days. “Now they don’t take your word for anything,” Adkins said. “They want documentation on income and assets, everything. They want proof.”

Some national observers have hinted at another housing bubble as the Federal Reserve continues its stimulus strategy of pumping money into the economy. And there are some exceptions to the tighter rein on borrowing here in Arkansas.

“We do see equity-out refinancing for various reasons such as investment property purchases, second-home purchases, paying for college or debt consolidation,” Beckham said. “Home equity financing is readily available at local banks in the form of second mortgages, and offered by most large aggregators of mortgages.”

Adkins said even 100-percent mortgages are starting to come back, but mainly for doctors coming out of medical training. He said that home equity credit is still possible, and that some borrowers, sadly, are misguided in how they use it.

“I was just at Disney World, and I know that some of the people I saw there were putting the cost of that trip — you know, $5,000 to take the kids there — right onto the credit card. And a lot of home equity still pays for things without lasting value. They’re spending on trips and merchandise. Again, the behavior aspect can be more important than hard, cold math.”

For that very reason, Hasson and Adkins were warning about the psychological dangers of cashing out home equity back in 2006 — the main behavioral risk being the temptation to spend.

As Hasson observed, some people were leveraging not to build wealth, but rather to in-crease their disposable income. Adkins described the availability of home equity cash as “financial heroin for some people.”

Ricciardi said that emotion often influences risk perception, and that extended levels of worry and fear might alter consumers’ tolerance for risk “over the long term.”

Millennials Missing Out

Hasson sees a downside to that, suggesting that far too few young people are buying homes, and thus missing an excellent way to build wealth early in life. “That’s the real pitfall I see now, that the millennial generation is not taking advantage of good values on existing homes and low interest rates,” he said. “They will blink an eye and will wish they had bought a home. The first ones in will definitely be glad, because interest rates won’t always be this advantageous.”

Noting that young people are saving and taking advantage of 401(k) retirement plans, Hasson said they should “step up to the plate” in homebuying. “When you don’t own a business, you can boil down wealth-building basically to two places: retirement plans and owning a home. Millennials are missing out on that second one.”

On the other end of life, Arkansans should reduce debt and plan for longer retirements, Hasson and Adkins emphasized. “Pay down your mortgage and invest in retirement plans,” said Hasson, who often suggests 15-year mortgages for clients who can make higher payments. “You don’t need appreciation to build equity when you’re making principal payments.”

Adkins said the keys to a comfortable retirement are managing consumption, spending less, saving more “and for some folks working longer.” But having the mortgage paid off can ease a worried mind. “What if the housing market caves in or interest rates shoot up again?” he asks. “What if your portfolio is suddenly worth a lot less and your cash flow drops? When that happens, disaster is in the air. And you don’t want to be 20 feet up on that ladder.”

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