One economic impacts of the housing boom during the decade of the 2000s was the additional spending that homeowners could afford by tapping into their home equity. How did this work? And where did the money go? N.C. State University economist Mike Walden answers.
“Well … on the how did it work, it actually worked rather simply. A home is an investment. So as home values appreciated during the housing boom, we saw homeowner’s wealth go up. And there is what we call a wealth effect, meaning that if your wealth goes up you will spend some of that wealth. And a recent study found that for every $1 increase in home wealth or home equity during the housing boom, spending by home owner’s increased by 14 cents. And how people did that is they took out loans … against the equity in their home.
“So that is actually a tremendous relationship: 14 cents increase in spending for every $1 increase in home equity. Now where did that money go? Overwhelmingly the same study found that money went to spending on home additions, on home improvements and on savings.
“So now we’ve seen the reverse. Unfortunately in the last three years we’ve seen the average home’s equity decline by 30 percent. We are, therefore, seeing some of these impacts go in reverse — less spending on home improvements and additions.”