A lot of attention has been
given to wayward homeowners and how
they are suffering. No one really touches the question of how they got
into their situation.
Starting in the 1990s,
there was a
simple, ingenious game to play in the American housing market. Home
prices were increasing at such a startling rate that someone could
essentially live for free by continually refinancing their loan to
adjust to a higher land value. Consider the following example:
I buy a home for $500,000 in a market that is appreciating at a rate of 10% a year (think that’s not possible?). I lock in a “teaser rate” of 3% for 2 years before it adjusts to 2 points above prime. My monthly payment on this loan for the first 2 years will be about $2,000/month (assuming 10% down and a 25 yr amortization for the payments in the first 2 years). After 2 years when my adjustable rate mortgage adjusts, I will have paid a total of $48,000 in debt service. At this point my home’s value is $605,000 (10% compounded over 2 years). I will refinance, take the 105,000 difference, and pay myself back for 2 years worth of mortgage payments. Then have a new loan with a new teaser rate. Then the process repeats, roughly every two years until the US Economy collapses.
Now some would say these are the very people our bail out plan should not be helping. I beg to differ. First, you cannot blame people for responding to incentives; if this structure exists, people are going to take advantage of it -- they would be stupid not to. Second, most people involved in this process fundamentally trusted that real estate values could only go up. And they were right for about the last decade and a half. If they had been buying a house during the late '80s they would have known better, but no one is perfect.
When looking at the foreclosures that are occurring around the country, it is worth looking at how we got here. The take away is the mentality of the person in the above example. He or she will never actually OWN the home, s/he will continue to refinance forever. This short-sighted thinking is the real crisis in America. This person thought his or her home could never depreciate, and I can bet he or she never thought the home would be in foreclosure. To truly overcome the crisis, we need to shift to conservative thinking: budgeting, saving, financial planning, and pride in living within our means.
On a final note, this purposely does not address predatory lending. There is not much to address this scenario other than the failure of our educational system to give a person the tools to know how to make the right life decisions. The story is shorter but the conclusion is the same: we Americans need to make a fundamental shift in mentality, take control of our finances, learn about the risks we take, and live within our means.