Americans are reducing mortgage payments at a record clip, directing cash that once went for debt into consumer spending and savings.
Low interest rates, defaults and refinancing have shaved more than $100 billion off the nation's annual mortgage bill — an amount comparable to all unemployment benefits for one year or this year's Social Security payroll tax cut.
"This is a form of economic stimulus that goes to Main Street rather than Wall Street," says Nicholas Carroll, a journalist on consumer finance and author of Walk Away From Debt for a Better Future. When freed from a mortgage payment, people's first purchases tend to be necessities, such as socks and underwear, he says.
Homeowners have trimmed interest payments alone by 11% — or $67 billion a year — from the peak in 2008, according to the Bureau of Economic Analysis (BEA). The savings come equally from grabbing lower interest rates and reducing what's owed by paying down principal or defaulting on loans.
The nation has slashed total mortgage debt from nearly $11 trillion at the mid-2008 peak to $10.3 trillion in the first three months of 2011, the BEA reports.
The trend shows no sign of slowing. About 9% of mortgage borrowers are behind on payments, and 4.6% of homes are in foreclosure, says the Mortgage Bankers Association.
Even so, homeowners are reducing mortgages far more slowly than they added to them during the housing bubble. Borrowers took on $1 trillion in new principal and $90 billion in extra interest in 2006 alone, BEA data show. Shrinking mortgage payments are a sign of the economy resetting in the housing bust's aftermath.
"No one remained untouched, not homeowners, Wall Street, investors or the government," says economist Sam Khater of CoreLogic, which tracks real estate trends. "One positive sign is that housing is becoming more affordable."
Economic effects of lower mortgage debt:
•Savings. For the first time since 1998, households are saving more than they're spending on mortgage interest.
•Interest. Mortgage interest consumes 5.27% of the nation's after-tax income, the lowest since 2004 and comparable to the 1980s and '90s.
•Rates. The average interest rate on all mortgages — not just new ones — has fallen for 16 consecutive quarters to 5.96%, the lowest since the government started keeping track in 1977. The tumbling rate reflects borrowers restructuring loans to become better credit risks and shortening 30-year mortgages to 15-year loans.
"Households are managing their debt down by bringing cash to the table to qualify for super-low rates," Mortgage Bankers Association economist Michael Fratantoni says. That's a change from the housing bubble when "cash-out" loans let borrowers leave mortgage signings with spending money, he says.
Consumers have started borrowing more for cars, appliances and other big-ticket items in the past two months but not for homes, Fratantoni says. "Consumers are cautious."
In certain respects, it was just a matter of when consumer spending benefited from the real estate nightmare. That may sound odd, but when you think of someone who over bought and over leveraged themselves in the bubble days and decided to let the home go back to the bank only to move down or rent for less per month, they in fact do have less housing or fixed living costs. If they have retained their employment they should have more money to spend on consumer items. It's just math.
Add in refinancing at historically lower rates and cash in buy downs, and you have another subsegment of home owners with lower payments and thus higher cash levels for spending.
America is a consumption nation and that trend or impulse is very hard to give up for most. Many have made adjustments to their housing costs, which in part is helping the consumer to spend.
I made an adjustment a year ago to take on roommates to lower my housing costs to allow for a boost to personal savings. I went with savings over spending, but lower housing costs allows for either or both.
Just look at the weekly chart below of the retail index. It's trading at an all time high because retailers are enjoying better gross revenues and profits.
Note: There are other factors helping the retail index as well. Consumer confidence is up. Consumer credit is up. Retailers went through major cost cutting. And we lost some retailers in the last recession, which means those who survived are getting the benefit of slightly less competition, which helps the retail index because it's made up of the stronger surviving companies.
That being said, the dynamics in real estate are providing some help to consumer spending currently, as odd as that may seem.
But for how long?
The questions have to be what happens if we get another year like 2008? Or, what happens when wage deflation accelerates in the municipal world of 19 million employees? Or, what happens when tax rates go higher and net incomes go lower? Or, what happens when the Baby Boomer has to pull in their spending more drastically? Or, what if the bond market rolls over and interest rates go higher? All of which seem to be likely events in the near few years.
Note: I'm personally skeptical about an increasing savings rate. As someone who has gone through a major savings campaign the past couple years, I know how painful it is, and I highly doubt most Americans are saving or at least significantly so. I doubt they are trading in spending for any real savings. But that's my personal take!
The retail index above is riding high on better gross and net income data, however, I expect this index to make some kind of significant top in the next 3-18 months. The questions above should provide major head winds to consumer spending in the coming months, and if we get another year like 2008 as I think we do in the next 1-4 years, the cycle of deflation will take down the retail index, and consumer spending once again will struggle.
Hope all is well.
J.D. Rosendahl, Rosey