What were people thinking? Mortgage related

[disneysteve]

There is an article on the front page of the Wall Street Journal today titled, "One Family's Journey Into a Subprime Trap." It tells the story of the Montes family in California and how they are in imminent danger of losing their home because (supposedly) of the problems with the subprime mortgage market. They bought their home almost 2 years ago for $567,000 with a 2/28 loan, interest only for the first 2 years at a low rate of 5.45%. The broker told them that they could just refinance before the 2 years was up and the rate reset higher.

Obviously, things haven't worked out that way. Property values are down. Credit is tighter. The Montes family now finds that they owe more than the house is worth (they put down a very small downpayment) and their payments are set to increase dramatically to an unaffordable level. Bottom line is they're screwed.

But before we go blaming this totally on predatory lending and dishonest brokers, you need to hear the best part of the story. "My wife and I make pretty good money," says Mr. Montes. Together, they earned nearly $90,000 last year..

Nearly $90,000!!! And they bought a house for $567,000 with virtually nothing down with a subprime loan because they had poor credit.
What the HELL were these people thinking?!? This house cost more than 6.3 times their income! I don't think they could afford this home at any interest rate with any type of loan. They currently spend about $38,400/year on the loan before taxes and insurance. In December, when the rate resets, they'll spend about $50,000 a year - WITHOUT taxes and insurance added in.

Sorry, but I just can't muster up much sympathy for folks like this. No broker in the world could talk me into buying a home for more than 6 times my income with nothing down. Brokers do some sleazy things, but the buyer has got to do some homework and run some numbers himself to figure out what he can and cannot afford.

Oh, by the way, the mortgage has a 3-year prepayment penalty. The family also has 2 car loans totaling $700/month.

[txex86]

A sad state of affairs depicted in the article. Unfortunately, that scenario is playing out with thousands of others throughout the country. The mortgage brokers/lenders bear some fault for this, but ultimately those homeowners who find themselves in this predicament are adults and are accoutnable for their actions. But, what a painful mistake to learn from.

[rooskers]

It is not just housing that is the problem with a lot of these people. I live in an area where the median family income is around $40,000. We moved into our house about 8 months ago and love to walk at night. I was extremely suprised that while walking around at almost every other house is a brand new RV, boat, 4 wheelers, and each house has I would say on average 4 - 5 vehicles (not joking). The thing is most of these houses were built within the past 4 years so I know that very few if any are paid off. If anything the average income in the town I live is below the median income stated because that figure actually represents the city we have been incorporated in which is a little more affluent than my neighborhood. Average house price is here is $250,000. Walking about two weeks after we moved I was asking my wife "How the hell do they afford all this" since we make apporximately $90,000 which is significanlty higher than average around us. Well this past couple months I am realizing they can't. I feel lucky that I am able to afford my payments, have 6 months emergency savings, almost max out our 401k, and have both cars paid off, with only house for debt. Of course we got in this position by saving religiously going without couple years and working hard. So do I feel sorry for most of these people? No they had their fun in there brand new house, boat on the lake then sleeping it off in their RV with included satellite, calling home on their I-Phone, then getting home to their brand new pool or maybe watching TV on their 65" plasma in high def with surround sound stereo system. Of course talking to them they are just getting by with the bare necessities. Maybe they will have to learn the hard way what the bare necessities actually are.

[pearlieq]

Unbelievable!

I can't seem to muster any sympathy either. What on earth was going on in those people's heads?!?

[disneysteve]

Originally Posted by rooskers

It is not just housing that is the problem with a lot of these people. I live in an area where the median family income is around $40,000.

Average house price is here is $250,000. Walking about two weeks after we moved I was asking my wife "How the hell do they afford all this" since we make apporximately $90,000 which is significanlty higher than average around us.

I often ask the same question, not in my neighborhood, but nearby. There are 2 homes being built with a base price of $1.3 million (plus customization and upgrades). Who exactly are they being built for? I see plenty of new developments "starting from the mid-600s." Who is buying all of these homes. Median income around here is up around $62,000 or so. Are there that many people earning that far above median to buy all of these new homes.

[SnoopyCool]

I can't say that I feel sorry for these people, either. There's something beautiful about sacrifice and telling yourself no every now and then that they may never experience (but boy they'll wish they did sooner or later).

[InDebtInDC]

How many percent of annual income should the sale price be in order to be comfortable?

[LivingAlmostLarge]

It depends on how large a DP you have. Bigger DP = more expensive house you can buy. Nothing is ever set in stone. It also depends on where you are in your earning potential.

I can't say I feel sorry because I don't. They knew what they were getting into.

[Hot dog]

Don't people usually say that the house should cost 2 to 2.5 times your yearly salary? I have to say mine is at least 3x

[Dave Rowtree]

Well unfortunately not every person is money savvy enough to know about these things; they trust the broker is selling them a product they can afford. I'm sure everyone here wouldn't dream of doing something as unaffordable as buying a house 6 times multiple their earnings: the very fact the couple are still saying they thought it was affordable shows the broker wasn't doing his job.

Before we pass judgment on these people lets remember that those reading money forums are probably more in the know about money than most of the population.

Now adays with house prices rocketing in the UK multiples of 5 and 6 are increasingly being offered, simply because no-one could afford a house other than buy-to-letters otherwise. We are fast approching a situation where all the houses are owned by a small group of people letting them out to the rest of the population.

[FrugalFish]

I think that's going to be the big problem here in CA. The average income is $39K (so a household would be $78K), how does the average family afford a half million dollar cottage? People got scared that they would never be able to afford if they didn't get in now- many took these type of loans as a way to get into the housing market. I don't understand how so many people thought they could "just refinance later" if they couldn't afford a house with a FRM the first time. Wishful thinking, I suppose.

I don't feel a lot of pain for these people. You have to be smart and work with what you've got- ignore what the Joneses are doing. Ignorance is no reason or excuse. A lot of people thought they would still make a ton of money when the market took a downturn- after all, all you have to do is sell the house, right? Doesn't take into account that the market is saturated and that drives prices way down. It should be interesting to watch this unfold.

[Joan.of.the.Arch]

Do people generally do anything to educate themselves before buying a house? If one doesn't place any importance on understanding and learning the ins & outs, how can one make a wise decision?

I read a couple of books on the matter before I bought. I read newspaper articles a local column geared not toward investors, but toward ordinary people who need a place to live. I learned about how to do my own inspection of a house, what the most common means of financing were, what sort of things one can negotiate, where there were local government efforts to maintain population that would get us a better interest rate in return for a promise to live in the home long term, how some people might try to pull the wool over our eyes, how to decide how much I really was comfortable financing despite the huge amounts lenders would qualify us for, etc.

However, it was putting all this together with my conservative outlook on money spending that guided me toward making a very safe decision on our home purchase. And I'll admit, fear is part of what built my conservatism. The fear was born of my childhood experience of family-wide unemployment that lead to --guess what?-- housing problems.

[Scanner]

At the risk of psychobabbling, I can venture a guess of what these people were thinking.

I am only drawing upon experience and my reasoning here is going to be sexist (but not chauvinistic). It's also full of gross generalizations so if generalizations bother you, skip this post..

However, you need generalizations to answer questions sometimes.

Usually I think it's a woman driving these types of decisions. Really, men are mostly happy with 4 walls and a nail on the wall to hang a picture. And most men are wired, when it comes to homes to respond with:

"Yes dear. . . whatever makes you happy, dear."

All real estate agents know this. They show the house to the woman.

However, when marriage starts, and kids are on the way. . .expectations are high.

I saw it with my own DW and she's not a spendthrift by any means.

She feels immense pressure to do better than her parents (whether some of that pressure is real or applied by her parents is debatable) and her parents did pretty well, both retired at 55 y.o. I just don't think we are going to be able to compete with that.

So. . .what do you do when you earn $65,000 as a couple and the houses that matched your parents are $650,000? Yup. . .you get trapped into the subprime debacle.

It's an insidious trap because I think the woman is thinking, "Well, my parents struggled and built up what they have. . .we'll struggle a little while and it will all work out."

What the couple doesn't realize is that conditions are way different nowadays. Male wages have stagnated against inflation and home prices have exceeded the reach of families.

The last economic expansion under Bush did not create a "rising tide to lift all boats."

Everyone trapped in this subprime debacle has probably said, "A little voice told me this was wrong" but people generally make decisions on emotion, and that goes for male and female.

That's my best guess on the psychology of these buyers.

Not trying to keep up with the Jonzez per se. . .but rather keep up with the Boomers.

[rob62521]

As a rhetorical question...they weren't thinking. They wanted a fancy house and didn't use common sense. As my dh says, "You pay for your thrills!"

Some of you have added that you can't understand how folks are buying houses that are huge and expensive. Well, I guess this is how they are doing it. Of course, so many people no longer think about ever paying off a house. I have friends who laugh that when they die there won't be enough money to pay all their debts. Sad state of affairs.

[MonkeyMama]

The average household in the Bay Area pouts 50%-75% of their income to housing (whether it be rent or mortgage). There really isn't much choice if you want to live out here.

This is not a JOneses thing - the $567k house is probably a bungalow by the railroad tracks - a steal as far as housing prices go around here. Just FYI.

All that said I couldn't really agree more. We felt comfortable taking a mortgage 4-5 times my income but we sure as hell did not have a car payment. It beat renting. It wasn't so bad. But we drew the line around there. Most people around here have put little thought into the long-term consequences of their actions. For us we decided we could not live in that situation ($500k+ houses) so we moved. With low interest rates though I don't think we ever really went above the 30% rule when it came to housing expenses versus gross income, even though our mortgage was 4-5 times my income for a time. Probably about our comfort level. But a locked in rate was key there too.

It's more about desparation in an insane housing market than anything. & lack of education - indeed. Little long-term thinking. The belief it is impossible to pay off the house so why bother trying, etc.

I don't know, I just remember dh and I talking about it and saying as a rule we never would buy a house that relied on 2 full-=time incomes. IT wasn't a financial rule we had to read, it was just like COMMON SENSE. Common sense seems to be sorely lacking out here. & is exactly why home prices have gotten so insane. Only those willing to face great financial risk (ARMs and such) can afford these houses. MEdian income in 2005 was $85k or so in the Bay Area and the median house price was $610k (includes condos/townhomes which MANY people live in as an alternate). This situation has arisen from a lot of people taking some very creative financing, as the area has always been rather expensive anyway.

As for me, would I borrow $567k on an ARM with $90k income? No way in hell. I can give a little insight but for the most part don't understand it...

[dcox20]

move to Sacramento - pay half of that, and get ready for a commute (or train/bart) problem solved. lol - if only it were that easy...

Selling my house BTW - 1527 sqft, 3/2, In ground pool, large lot, hardwood and 18"tile, etc., model condition... $359,900

Link provided as an example of what you can get up here - not as an advertisement.
Link to Home for sale

there are plenty of great deals up in this area.

[Saving in So Cal]

I've been seeing similar articles and asking myself this question for several years now. I just couldn't understand the panic to get into the housing market no matter the price, especially since, at least in California, the real estate market is known to be dramatically cyclical.

Also, the loan described in the original post is still being offered by lenders and I can't imagine who would want it under any circumstances. A 2-year fixed with a 3-year prepayment penalty is a guarantee you will be paying a hefty price to the lender one way or another.

On a separate, but related note, I have been marveling over the stock market lately. When Countrywide announced yesterday that it was going to stop making subprime loans (i.e., loans to people that can't afford them) and stop making jumbo loans (i.e., loans based on over-inflated property values), the stock market responded very negatively. I would have considered the announcement to be a very positive development. I know the correction in the housing market is going to be painful to many, but I think it was foreseeable and probably economically necessary in the long run.

[katwoman]

Originally Posted by Scanner

At the risk of psychobabbling, I can venture a guess of what these people were thinking.

I am only drawing upon experience and my reasoning here is going to be sexist (but not chauvinistic). It's also full of gross generalizations so if generalizations bother you, skip this post..

However, you need generalizations to answer questions sometimes.

Usually I think it's a woman driving these types of decisions. Really, men are mostly happy with 4 walls and a nail on the wall to hang a picture. And most men are wired, when it comes to homes to respond with:

"Yes dear. . . whatever makes you happy, dear."

All real estate agents know this. They show the house to the woman.

However, when marriage starts, and kids are on the way. . .expectations are high.

I saw it with my own DW and she's not a spendthrift by any means.

She feels immense pressure to do better than her parents (whether some of that pressure is real or applied by her parents is debatable) and her parents did pretty well, both retired at 55 y.o. I just don't think we are going to be able to compete with that.

So. . .what do you do when you earn $65,000 as a couple and the houses that matched your parents are $650,000? Yup. . .you get trapped into the subprime debacle.

It's an insidious trap because I think the woman is thinking, "Well, my parents struggled and built up what they have. . .we'll struggle a little while and it will all work out."

What the couple doesn't realize is that conditions are way different nowadays. Male wages have stagnated against inflation and home prices have exceeded the reach of families.

The last economic expansion under Bush did not create a "rising tide to lift all boats."

Everyone trapped in this subprime debacle has probably said, "A little voice told me this was wrong" but people generally make decisions on emotion, and that goes for male and female.

That's my best guess on the psychology of these buyers.

Not trying to keep up with the Jonzez per se. . .but rather keep up with the Boomers.

Used to be that was the case but no more. I can't believe the way men have changed in respect to their homes. The home is just another trophy to show off. If you think I'm joking talk to a RE agent selling higher end properties or architects or designers. The MEN are making all the decisions!

[katwoman]

Getting back on-topic.

I don't feel sorry for anyone who thinks they can buy anything that costs that much with little to no money down and no points (even if it is in California). Heck, back in the early 90"s when I got my condo, I remember the hoops we had to jump through. My God, what a process! 40% down and they still insisted on a cavity search! Geez.

Nope, not feeling too sorry at all.

[disneysteve]

Originally Posted by Joan.of.the.Arch

Do people generally do anything to educate themselves before buying a house?

I don't know about anyone else, but before we went house shopping, we sat down and figured out how much we could comfortably afford to pay per month. We took into account our income, student loans, auto loans, savings, etc. The mortgage company preapproved us for about 20K more than we had determined we could afford. We went with our number, not their's.

How anyone can buy a home and not make that basic calculation first, I have no idea. How can you make a purchase of $500,000 or even $100,000 without first making sure you can actually afford the payments?