Beware Lifestyle Inflation When Your Home’s Equity Increases

Here’s a weird way lifestyle inflation creeps in: through your home equity. According to research, the more your home’s value increases, the more your budget stretches, and you don’t even realise it.

House made of money image via Shutterstock

The Wall Street Journal calls it a blind spot, citing a 2013 study published in the Review of Economics and Statistics. They explain:

Many people spend more when the value of their assets — particularly their property — goes up, even though in reality those assets often won’t add to their spending power in the future. In fact, for each $1 increase in the market value of a home, certain households increased their consumption by six cents to 18 cents.

It kind of makes sense when you think about it. When you see your home’s value has increased by thousands of dollars, your net worth has, too, so you’re more inclined to let loose with your finances. You’re richer!

But it’s not that simple. You’d have to sell the home (or borrow against it) to see that money. And, as US Federal Reserve economist Daniel Cooper explains, you’d probably pay the same amount for a house in the same market. So, actually, you’re not richer unless you downsize. Your spending power is the same.

Of course, you’re entitled to spend your money however you want, but you want to spend it consciously, otherwise lifestyle inflation can take over and have you living well above your means. Cooper offers a final word of caution:

What’s more, people shouldn’t think about a home as a tool for borrowing more money. “If you max out your home-equity line of credit and then housing prices change, chances are you will find yourself financially constrained.”

It’s something to keep in mind if you’re a homeowner. Check out the full article at the link below.

House Price Fluctuations: The Role of Housing Wealth as Borrowing Collateral [MIT Press Journals via The Wall Street Journal]