FEBRUARY 2004

Increase in Home Equity Withdrawal Improves Household Spending Ability

The Federal Reserve Bank of New York’s December 2003 edition of Current Issues in Economics and Finance examines the impact of the recent historic volume of mortgage refinancings on household balance sheets. Specifically, Margaret M. McConnell, Richard W. Peach, and Alex Al-Haschimi look at the effect of the rise in home equity withdrawal on near-term consumer spending.

Approximately 25 percent of home mortgages in the U.S. were refinanced in 2003. In the second quarter of 2003, the annualized rate of home equity withdrawal stemming from these refinancings was $450 billion. The resulting increase in mortgage debt "...is not leading to a deterioration of household net worth" (see the related article in the Forecast and Statistics section of this issue). Rather, for the eight quarter period spanning Q3 2001 to Q2 2003, households accumulated assets faster than liabilities: real consumer spending increased 3.2 percent; real disposable income increased 3.4 percent; and the personal saving rate was positive. The authors find "...that households... have been using mortgage debt to restructure their balance sheets... [by] funding [consumer goods] purchases with relatively inexpensive [tax-advantaged] mortgage debt...." In fact, the Federal Reserve’s measure of household debt service as a percentage of disposable personal income "...has been declining over the period of unprecedented home equity withdrawal."

Contrary to the concerns that record home equity extractions have left consumers unable to spend once interest rates rise and curtail refinancing activity, McConnell, Peach, and Al-Haschimi find that "...households may be in a better position to spend in the years ahead."