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Trillions at Risk in Mortgage-Backed Fiasco by JB Peebles
Housing Issue Basics
The money supply under Bush has approximately doubled. Now the cash stays mostly in accounts where it isn't spent, usually. However, during the housing boom, much of the money worked its way into the housing market. As home values shot up, more people borrowed on their equity. Subprime lending also skyrocketed as realtors were eager to sell into a bull market, to keep prices going upward. People with weak credit got into homes they're not able to afford. Attracted to teaser rates, many home purchasers wound up with too much houses and Adjustable Rate Mortgages (ARMs). These are expected to reset to much higher interest rates, which means people with marginal credit and lower income will be forced to pay even more of their income to housing.
Traditionally mortgage lenders established a fixed percentage of income to payment of housing. If for instance someone with $50,000/year income wanted a house, a more scrupulous lender would deny a mortgage application if the hypothetical payments on the loan--interest, principal, escrowed property and Private Mortgage Insurance (PMI)--were to exceed 30-35% of total income.
The 50K earner would be able to devote about 17K/year to housing, about $1400/month. Income caps mean a homeowner would be less likely to have to file bankruptcy. The 30-35% is not an arbitrary number, it's been calculated as a historically tested average maximum amount of income that borrowers can devote to their housing budget. While some people may be able to handle devoting more of their income to housing, with so many fixed expenses like insurance, taxes, car and loan payments, food, travel, as well as unexpected emergencies, increasing this amount is statistically imprudent.
Pushing past 40% is dangerous, but this became routine in the housing market bubble. Essentially, once the income threshold was crossed, this means the house payments would be less likely to be made, defaults and foreclosures would rise.
A rational and prudent lender understood that it was in their best interest to screen the borrower's credit worthiness in order to determine the likelihood that the mortage would be paid. Banks lose big when they have to take possession of a home--I've heard it said that banks want to be in the loan business, not the housing business.
In the irrational exuberance of the housing bull market, loan originators lost their minds. In the rush to cash in on the rising home values, issues like credit worthiness and ability to pay became secondary to the rising values of the homes, which most lenders and borrowers saw as rising so quickly as to make the long-term consequences of over-borrowing irrelevant. Borrowers could simply flip their homes and make huge profits quickly, and move on to the next better grade of housing.
Like all bubbles, equity or housing, this type of buying is simply unsustainable. Looking back with the benefit of completely rational hindsight, such buying and lending behaviors appear idiotic. Caught up in the moment, housing speculators enjoyed mind-boggling rates of return. Second and even third homes became common.
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(contd.)
The money supply under Bush has approximately doubled. Now the cash stays mostly in accounts where it isn't spent, usually. However, during the housing boom, much of the money worked its way into the housing market. As home values shot up, more people borrowed on their equity. Subprime lending also skyrocketed as realtors were eager to sell into a bull market, to keep prices going upward. People with weak credit got into homes they're not able to afford. Attracted to teaser rates, many home purchasers wound up with too much houses and Adjustable Rate Mortgages (ARMs). These are expected to reset to much higher interest rates, which means people with marginal credit and lower income will be forced to pay even more of their income to housing.
Traditionally mortgage lenders established a fixed percentage of income to payment of housing. If for instance someone with $50,000/year income wanted a house, a more scrupulous lender would deny a mortgage application if the hypothetical payments on the loan--interest, principal, escrowed property and Private Mortgage Insurance (PMI)--were to exceed 30-35% of total income.
The 50K earner would be able to devote about 17K/year to housing, about $1400/month. Income caps mean a homeowner would be less likely to have to file bankruptcy. The 30-35% is not an arbitrary number, it's been calculated as a historically tested average maximum amount of income that borrowers can devote to their housing budget. While some people may be able to handle devoting more of their income to housing, with so many fixed expenses like insurance, taxes, car and loan payments, food, travel, as well as unexpected emergencies, increasing this amount is statistically imprudent.
Pushing past 40% is dangerous, but this became routine in the housing market bubble. Essentially, once the income threshold was crossed, this means the house payments would be less likely to be made, defaults and foreclosures would rise.
A rational and prudent lender understood that it was in their best interest to screen the borrower's credit worthiness in order to determine the likelihood that the mortage would be paid. Banks lose big when they have to take possession of a home--I've heard it said that banks want to be in the loan business, not the housing business.
In the irrational exuberance of the housing bull market, loan originators lost their minds. In the rush to cash in on the rising home values, issues like credit worthiness and ability to pay became secondary to the rising values of the homes, which most lenders and borrowers saw as rising so quickly as to make the long-term consequences of over-borrowing irrelevant. Borrowers could simply flip their homes and make huge profits quickly, and move on to the next better grade of housing.
Like all bubbles, equity or housing, this type of buying is simply unsustainable. Looking back with the benefit of completely rational hindsight, such buying and lending behaviors appear idiotic. Caught up in the moment, housing speculators enjoyed mind-boggling rates of return. Second and even third homes became common.
.
.
.
(contd.)