Editor: David Reiss
Brooklyn Law School

September 26, 2016

Dipping Into Home Equity

By David Reiss

photo by Aitor Méndez quoted me in Americans Are Increasingly Dipping Into Home Equity. It opens,

Is there a flipside to rising home values across the nation?

Take California, where stronger home value figures “are giving many homeowners a reason to tap into their equity and spend money,” according to the California Credit Union League.

The CCUL states that approximately 5.2 million homes with mortgages across 11 different metropolitan statistical areas in the Golden State “had at least 20% equity as of June 2016,” citing data from RealtyTrac. Meanwhile, home equity loan originations rise by 15% over the same time period, to $2 billion. “Altogether, HELOCs and home equity loans (second-mortgages) outstanding increased 5% to more than $10 billion (up from a low of $9.2 billion in 2013 but down from $14.2 billion in 2008),” the CCUL reports.

The organization doesn’t see all that home equity lending and spending as a bad thing.

“The local surge in home-equity lending and cash-out refinancings reflects a strong national trend in homeowners increasingly remodeling their homes and enhancing their properties,” said Dwight Johnston, chief economist for the California Credit Union League.

Financial experts generally agree with that assessment, noting that American homeowners went years without making much-needed upgrades on their properties and are using home equity to spruce up their homes.

“Homeowners are cashing in on home equity again because they can,” says Crystal Stranger, founder and tax operations director at 1st Tax, in Wilmington, Del. Stranger says that for many years, home values have decreased or only increased very minor amounts, but now home values have finally increased to a significant enough level where there is equity enough to borrow. “This isn’t necessarily a bad thing though,” she says. “With the stagnant real estate market over the last decade, many homes built during the boom were poorly constructed and have deferred maintenance and upgrades that will need to be made before they could be re-sold. Using the equity in
a home to spruce up to get the maximum sale price is a smart investment.”

U.S. homeowners have apparently learned a harsh lesson from the Great Recession and the slow-growth years that followed, others say.

“Before the financial crisis, many used home equity as a piggy bank for such lifestyle expenditures,” says David Reiss, Professor of Law at Brooklyn Law School, in Brooklyn, N.Y. “Many who did came to regret it after house values plummeted.” Since the financial crisis, homeowners with home equity have been more cautious about spending it, Reiss adds, and lenders have been more conservative about lending on it. “Now, with the financial crisis and the foreclosure crisis receding into the past, both homeowners and lenders are letting up a little,” he says. “Credit is becoming more available and people are taking advantage of it.”

“Nonetheless, good financial advice is timeless, and that hard-earned home equity should be protected from casual expenditures,” Reiss notes. “Your future self will thank you for it, no doubt.”

Other financial industry insiders agree and warn homeowners who take out home equity loans that there is great risk attached to using the money in non-essential ways.

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September 26, 2016 | Permalink | No Comments

Monday’s Adjudication Roundup

By Jamila Moore

  • The 9th Circuit will rehear a case regarding a lien placed on a Sunnyslope Housing development. This comes after the reviewing court found that an Arizona federal judge made a mistake regarding the discount given on the amount of the lien.
  • Airbnb wants the county of San Francisco to stop impeding on their business. The city and county of San Francisco is enforcing an ordinance that will prohibit Airbnb from renting out homes in the area that are not registered.
  • Liberty Mutual is back in the court because policy holders believe a Virginia lower court erred by clearing them of liability in the collapse of a row house in the area.

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September 26, 2016 | Permalink | No Comments

September 23, 2016

Is The Mortgage Interest Deduction Inequitable?

By David Reiss

photo by Elana Centor

I have certainly thought so, as do many other housing policy types. Daniel Hemel and Kyle Rozema have a more nuanced view in their paper, Inequality and the Mortgage Interest Deduction, that was recently posted to SSRN. The abstract reads,

The mortgage interest deduction is often criticized for contributing to after-tax income inequality. Yet the effects of the mortgage interest deduction on income inequality are more nuanced than the conventional wisdom would suggest. We show that the mortgage interest deduction causes high-income households (i.e., those in the top 10% and top 1%) to bear a larger share of the total tax burden than they would if the deduction were repealed. We further show that the effect of the mortgage interest deduction on income inequality is highly sensitive to the alternative scenario against which the deduction is evaluated. These findings demonstrate that claims about the distributional effects of the mortgage interest deduction depend critically on the counterfactual to which the status quo is compared. We extend our analysis to the deduction for state and local taxes and the charitable contribution deduction. We conclude that the appropriate counterfactual for distributional claims is dependent upon political context — and, in particular, on the feasible set of politically acceptable reforms up for consideration.

To make this a bit more concrete, the authors offer a simple hypothetical:

to show how a provision of the tax code can provide a disproportionate share of dollar benefits to the rich while also causing the rich to bear a larger share of total tax liabilities. Imagine a society with two households—a rich household with pre-tax income of $100, and a poor household with pre-tax income of $50. Further imagine that the rich household pays $12 in mortgage interest and the poor household pays $9 in mortgage interest. Say that the tax system is structured such that the tax rate on the first $50 of income is 20% and the tax rate on all income above the $50 threshold is 40%.

If the tax system does not allow a deduction for mortgage interest, the rich household would pay a tax of $30 ($10 on the first $50 and $20 on the next $50), and the poor household would pay a tax of $10. Thus the government would collect a total of $40 in revenue; the rich household would bear 75% of the total tax burden ($30 divided by $40); and the poor household would bear the remaining 25%. If the tax system allows each household to deduct mortgage interest, the rich household would receive a benefit from the deduction of $4.80 ($12 times 40%), and the poor household would receive a benefit from the deduction of $1.80 ($9 times 20%). The benefit of the MID in dollar terms is clearly greater for the rich household than for the poor household. In percentage terms, the rich household received 72.7% of total MID benefits, while the poor household received 27.3% of total MID benefits. And yet the rich household now bears 75.45% of the total tax burden ($25.20 divided by $33.40), as compared to 75.0% before, while the poor household now bears 24.55% of the total tax burden ($8.20 divided by $33.40), as compared to 25.0% before. (Government revenue decreases from $40 without the MID to $33.40 with the MID.) (8, footnote omitted)

The authors conclude that their analysis “simultaneously confirms and challenges widespread beliefs regarding the effect of tax expenditures on inequality. The mortgage interest deduction does indeed appear to be inequality-increasing relative to a counterfactual in which the deduction is repealed and revenues are reallocated to all households on a equal basis; when the mortgage interest deduction is evaluated against other counterfactuals, however, the distributional effects are more nuanced.” (40)

Where does this leave us? It reminds us that we should be careful about promoting simple policy proposals without taking into account the likely context in which they might be implemented.

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September 23, 2016 | Permalink | No Comments

Friday’s Government Report Roundup

By Robert Engelke

  • A paper by the Federal Reserve Bank of Cleveland titled, Monetary Policy, Residential Investment, and Search Frictions: An Empricial and Theoretical Synthesis, shows that residential investment contributes substantially to GDP following monetary policy shocks. Further, it shows that the number of new housing units built, not changes in the sizes of existing or new housing units, drives residential investment fluctuations. Motivated by these results, this paper develops a dynamic stochastic general equilibrium (DSGE) model where houses are built in discrete units and traded through searching and matching.
  • Sales of existing homes slipped 0.9 percent last month to a seasonally adjusted annual rate of 5.33 million, the second straight monthly decline, the National Association of Realtors said Thursday. The monthly setbacks happened after a period of steady gains that have lifted home sales up 3 percent so far this year.
  • Commercial and multifamily mortgage debt outstanding grew by $39.9 billion in the second quarter, according to data released by the Mortgage Bankers Association (MBA). Multifamily mortgage debt outstanding rose by 2.6 percent to reach $1.09 trillion, while the total commercial and multifamily debt outstanding increased 1.4 percent to $2.90 trillion.
  • In August, ground breakings dropped 5.8 percent to a seasonally adjusted annual rate of 1.14 million from 1.21 million in July, the Commerce Department said Tuesday. The pace of construction was the lowest since May. Starts plummeted 14.8 percent in the South, likely reflecting the monthly volatility of the government report. Building activity increased in the Northeast, Midwest and West.
  • The GSEs current forecast shows the interest rate for the 30-year fixed-rate mortgage to finish 2017 at an average of 3.7%, hitting 3.9% during the year. Freddie Mac also stated that it continues to expect mortgage originations to top $2 trillion this year, which would be the first time originations have been that high since 2012. “Mortgage originations are expected to surge in the third quarter, reflecting the impact of Brexit in recent mortgage activity,” Freddie Mac Chief Economist Sean Becketti said. “We continue to believe that originations will reach $2 trillion this year, the highest since 2012.”

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September 23, 2016 | Permalink | No Comments

September 22, 2016

Financially Capable Young’uns

By David Reiss


The Consumer Financial Protection Bureau has issued a new model and recommendations, Building Blocks To Help Youth Achieve Financial Capability (link to report at bottom of page). It opens,

To navigate the financial marketplace effectively, adults need financial knowledge and skills, access to resources, and the capacity to apply their money skills and habits to financial decisions. Where and when during childhood and adolescence do people acquire the foundations of financial capability? The Consumer Financial Protection Bureau (CFPB) researched the childhood origins of financial capability and well-being to identify those roots and to find promising practices and strategies to support their development.

This report, “Building blocks to help youth achieve financial capability: A new model and recommendations,” examines “how,” “when,” and “where” youth typically acquire critical attributes, abilities, and opportunities that support the development of adult financial capability and financial well-being. CFPB’s research led to the creation of a developmentally informed, skills-based model. The many organizations and policy leaders working to help the next generation become capable of achieving financial capability can use this new model to shape priorities and strategies. (3, footnotes omitted)

I have been somewhat skeptical of CFPB’s financial literacy initiatives because there is not a lot of evidence about what approaches actually improve financial literacy outcomes. Unfortunately, this report does not reduce my skepticism. While it claims that it is evidence-based, the evidence cited seems scant, as far as I can tell from reviewing the footnotes and appendices.

The report concludes,

Understanding how consumers navigate their financial lives is essential to helping people grow their financial capability over the life cycle. The financial capability developmental model described in this report provides new evidence-based insights and promising strategies for those who are seeking to create and deliver financial education policies and programs.

This research reaffirms that financial capability is not defined solely by one’s command of financial facts but by a broader set of developmental building blocks acquired and honed over time as youth gain experience and encounter new environments. This developmental model points to the importance of policy initiatives and programs that support executive functioning, healthy financial habits and norms, familiarity and comfort with financial facts and concepts, and strong financial research and decision-making skills.

The recommendations provided are intended to suggest actions for a range of entities, including financial education program developers, schools, parents, and policy and community leaders, toward a set of common strategies so that no one practitioner needs to tackle them all.

The CFPB is deeply committed to a vision of an America where everyone has the opportunity to build financial capability. This starts by recognizing that our programs and policies must provide opportunities that help youth acquire all of the building blocks of financial capability: executive function, financial habits and norms, and financial knowledge and decision-making skills. (52)

What the conclusion does not do is identify interventions that actually help people make better financial decisions. I am afraid that this report puts the cart before the horse — we should have a sense of what works before devoting resources to particular courses of action. To be crystal clear, I think teaching financial literacy is great — so long as we know that it works. Until we do, we should not be devoting a lot of resources to the field.

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September 22, 2016 | Permalink | No Comments

Thursday’s Advocacy & Think Tank Roundup

By Robert Engelke

  • In New York City and elsewhere, homes purchased by white Americans have historically appreciated in value over the long-term, launching these families on a path of upward mobility and allowing them to build assets and transfer them to the next generation. In this week’s Building Justice blog, Colvin Grannum, president at Bedford Stuyvesant Restoration Corporation, writes that these benefits historically have not accrued to the vast majority of black homeowners, who tend to own homes in racially segregated communities which frequently suffer from disinvestment.

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September 22, 2016 | Permalink | No Comments

September 21, 2016

Multifamilies for Retirement Income

By David Reiss

photo by Laurent Montaron

Financial Advisor quoted me in More Retirees Turning To Multifamily Homes For Income. It opens,

Many clients are investing in multifamily residences as a way to generate retirement income.

“A common way for people nearing retirement is to buy a triplex or fourplex, live in one unit and rent out the others,” said Keith Baker, a financial advisor and professor of mortgage banking at North Lake College in Irving, Texas. “They sell their home and use the equity they have built up to do this, and if they still owe some debt, it will be paid down more quickly.” Among the best multifamily properties to acquire for supplemental income is one that has separate entrances with no shared common areas so that each family has their own space, according to Michael Foguth, a financial advisor in Brighton, Michigan.

“Townhomes are very popular,” Foguth told Financial Advisor. “Also popular are duplexes where you have one unit on the ground level and one unit on the second level.”

But clients should not spend so much money to acquire a property that their retirement income ends up undiversified. “If the bulk of your retirement income is tied up in one property, you are exposed to natural disasters like floods as well as economic downturns in that market,” said David Reiss, a professor at Brooklyn Law School who teaches real estate finance.

An alternative to buying a property is modifying an existing residence with the intent of renting out rooms on websites like AirBnB or HomeAway. “You would need to make sure that deed restrictions, zoning and city ordinances allow this,” Baker said. “It also will require property insurance and additional liability coverage.”

When a multifamily rental property is also a primary residence, a portion of the mortgage is tax deductible, according to Carla Dearing, CEO of SUM180, an online financial planning service. There may also be the opportunity to leverage tax benefits like depreciation.

“Selling your home and taking out a loan on a rental four-unit apartment complex allows you to deduct from your income the pro-rated interest expense along with the depreciation expense of the portion of the units you don’t live in so that much of the income is sheltered,” Baker said.

Over time, the income support received from a rental property can be greater than the interest income from investing in the stock market. “You’re likely to receive a nice stream of income when you are renting to people with guaranteed incomes,” said James Brewer, CFP, in Chicago. Nationally, the average price-to-rent ratio is 11.5, meaning that the average property owner is buying a property for a price of 11.5 years worth of rent, which is an estimated 8.7 percent yield on her investment, according to data from Zillow.

A house that cost $200,000 should bring in $1,450 per month in rent using the national price-to-rent average, according to Matt Hylland, an investment advisor with Hylland Capital Management in Virginia Beach. That’s compared to 10-year government bonds, which yield 1.7 percent and the S&P 500 index, which yields about 2 percent.

“But this 8.7 percent is before any costs,” Hylland noted. In other words, clients who add rental property to their portfolios should also add cash to their emergency funds so that have money on hand to maintain and repair the house. “If the roof needs replacing, do you have $5,000 available to fix it?” asks Hylland.

Ideally, a multifamily acquisition will be move-in ready. “Homes that require construction or renovation can easily turn into a money pit, costing twice what you estimate up front,” Dearing said.

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September 21, 2016 | Permalink | No Comments