Owning a Home Is No Longer a Shortcut to Upward Mobility

The pathway of upward mobility in the postwar era has been straightforward: a college degree and homeownership. But after the housing bubble and bust, homeownership as a springboard to upward mobility is now in doubt.

In the period beginning with the close of World War II and right up to 2005, buying a house opened up a pathway to upward mobility even for those without college degrees. Regardless of one's education or job, if you could buy a house, then the big tax breaks of home ownership began cutting one's taxes, while monthly mortgage payments on conventional 30-year fixed-rate mortgages increased home equity by steadily reducing the principle amount owed to the bank.

Even without any major appreciation, homeownership via a 30-year fixed mortgage functioned as a type of forced savings: When the mortgage was paid off, then the income previously spent on housing became available for other things, and the accumulated equity could be passed on to one's children.

A Foundation for Future Wealth

Inheritable wealth is part of what defines "middle class." Indeed, low-income households have a difficult time accumulating any assets to pass on, and even generations later, the family can still be poor. Families that accumulate assets in the form of home equity became middle class by building the foundations of wealth for future generations.

One of those foundations is paying off the mortgage and owning a home "free and clear." According to the U.S. Census Bureau, in 2008, 51.5 million housing units in the U.S. had a mortgage and 23.9 million did not. Thus, about 32% of all U.S. residences are owned free and clear.

According the Fed Flow of Funds, total equity of all household real estate, which includes the one-third of homes owned outright, fell from 60% in 2005 to 38% at the end of 2009. At the very bottom of the housing market in early 2009, it had sunk as low as 33%.

How did this massive reduction in home equity happen? One cause, of course, is that housing fell in value. According to the Fed Flow of Funds, the value of household real estate fell from $23 trillion in 2006 to $16.5 trillion at the end of 2009. That $6.5 trillion loss is more than half the total $11 trillion that vanished in the financial meltdown.

Homes as Cash Machines

The other cause is that homeowners extracted trillions of dollars of equity during the boom. According to a study titled "Sources and Uses of Equity Extracted from Homes" by Alan Greenspan and James Kennedy, the amounts of free cash from equity extraction during the boom years went like this:

2002: $757.8 billion
2003: $1,003.3 billion
2004: $1,170.1 billion
2005: $1,428.9 billion

This free cash from equity extraction was a sizable percentage of disposable income:

2002: 9.68%
2003: 12.29%
2004: 13.48 %
2005:15.81%

To rely on home equity extraction for 10% to 15% of disposable income was unprecedented.

The net result of these trends is that home equity has fallen to historic lows. The Fed Funds Flow data reveals the awful truth: Wealth held in household real estate has plummeted from 60% of total value in 2005 to 38% in 2009 . In essence, only those households that own valuable homes free and clear have any significant equity.

A Mere $1 Trillion in Equity?

To ascertain how much equity remains in the 51 million residences with mortgages, we have to take into account the one-third of homes owned outright. There's no way to calculate the value of the mortgage-free homes from the available data, but if we reckon they're roughly equivalent to homes with mortgages, then we would have to conclude that since 32% of all homes are owned outright, then the equity in free-and-clear homes is roughly 32% of real estate owned.

Since total home equity is 38% of all real estate owned, that means there is at best 6% of total valuation ($16.5 trillion) in the other 51 million homes with mortgages. So 6% of $16.5 trillion is roughly $1 trillion.

That means the 51 million homes with mortgages have perhaps as little as $1 trillion -- a mere 1.85% of the nation's total net worth ($54 trillion) -- of equity.

Home mortgages have declined by only a negligible amount, from $10.48 trillion in 2007 to $10.26 trillion at the end of 2009. So as of the end of 2009, total equity in household real estate was only $6.24 trillion ($16.5 trillion minus $10.26 trillion in mortgages outstanding).

Two-Thirds of Homes May Have No Equity

Coming at the calculation of remaining equity from a slightly different angle, we know that 32% of all household real estate had no mortgage, and 32% of $16.5 trillion is $5.25 trillion. This reaches the same conclusion: Of the $6.24 trillion in total home equity, $5.25 trillion is held in properties owned free-and-clear, leaving about $1 trillion in the 51 million homes with mortgages.

That is staggering conclusion because it suggests that two-thirds of the nation's households that own a home have almost no equity left. And without that equity, what foundation of middle class wealth is left?

According to recently published estimates, an estimated 11 million to 15 million mortgages, or about a fourth of outstanding mortgages, exceed the value of the home.

So the $1 trillion in equity is obviously not spread evenly over the 51 million mortgaged homes. If we deduct those 13 million "underwater" mortgages from the total of 51 million mortgages, that still leaves a paltry $1 trillion in equity spread among 38 million mortgaged homes.

Not a Very Bright Outlook

That matters, because most U.S. households hold little appreciable wealth beyond their homes. A modest sliver of the nation's financial wealth (7%) is spread among 108 million households, while 83% of that wealth (stocks, bonds, securities, etc.) is concentrated in the top 10%, or 13 million households.

While the recent upticks in home sales and prices suggest some stability has returned to the real estate market, as I wrote on DailyFinance recently, there are three powerful headwinds to any sustained recovery in housing valuations. As a result, the possibility that housing values will remain moribund or decline even further remains.

Over the long haul, paying off a mortgage and owning a home free and clear is still a pathway to wealth and the upward mobility such wealth provides. But in the near term, building equity from appreciation alone is no longer a sure thing.