Even in a Stagnant Market, There Are Benefits to Homeownership

Karen Dynan
Karen Dynan
Karen Dynan Professor of the Practice of Economics - Harvard University, Nonresident Senior Fellow - Peterson Institute for International Economics

August 27, 2010

The New York Times ran a piece earlier this week entitled “Housing Fades As a Means to Build Wealth, Analysts Say.” The article documents the fallacy in the once widely-held belief that ever-rising house prices made housing a sure-bet for those looking for an easy way to increase their wealth. This point is very important. The experience of the last several years has painfully demonstrated that there is no guarantee that housing prices will climb from year to year, and, in fact, that a good deal of risk accompanies homeownership.

That said, I am doubtful that we should be giving up on homeownership as a way for households to build wealth. Home appreciation was only one factor behind the original enthusiasm for this potential benefit to homeownership. A second (and perhaps more important) factor was the view that owning a home induced people to do some saving, first for the downpayment and later through paying down principal as part of their monthly mortgage obligations.

One might wonder whether households that wish to save really need any additional inducement to do so. However, increasing evidence from the behavioral economics literature suggests that even motivated households may have trouble saving because of self-control problems and other limitations. As a result, arrangements that allow households to pre-commit to saving, like traditional mortgages, are a powerful inducement to carry through with their intentions. Homeownership might be a particularly important commitment mechanism for low-income households, that typically have less access to other “automatic” ways of saving such as employer-sponsored defined-contribution pension plans.

The “forced saving” aspect of homeownership has been deemphasized over the past decade, both because the (temporary) boost to wealth through housing was dominated by home price appreciation and because new types of mortgages—like “interest only” and “negative amortization” loans—allowed households to side-step it. But such products have disappeared for the most part and probably will not reappear any time soon. Going forward, households are likely to continue to be able to undo some of their housing-related savings commitment by borrowing against home equity. But the cost and hassle of doing so through channels like traditional home equity loans and cash-out refinancings should help ensure that households do so for important purposes, and not because of some fleeting temptation.

I do not mean to suggest that promoting homeownership is the best way to encourage saving in this country. Nor do I mean to suggest that these considerations justify our current housing policy. For one thing, our system of housing tax subsidies tends to most heavily incentivize higher-income households to purchase housing, not the low-income households that may have the largest need to pre-commit to saving in this way. More broadly, in gauging the total amount of subsidy that we want to provide to housing, we need to weigh this potential benefit and others against the very important budgetary costs as well as the efficiency lost by redirecting our capital stock toward housing as opposed to other productive uses. But, with housing policymakers beginning to shift some focus toward the question of longer-run housing policy. I hope we will keep the lessons from the behavioral economics literature in mind.