No Sympathy, No Idea

I'm about ready to eviscerate the next idiot I run across in the blogosphere who says, "I don't have any sympathy for the borrowers. It's not my fault if they're idiots. They should have known better than to think they could really afford a house." Actually, I already took a fair swipe at the last one. He was dense enough it probably didn't leave much of a mark, though. I'll do a more thorough job on the next one.

Leaving aside for now the classist implications that these people didn't deserve an arrangement that allowed them an opportunity to accumulate a sliver of wealth--only because if I don't, this post will consist solely of hateful gibberish--these statements tell me two things about the person making them. First, they tell me that they didn't start with much sympathy. Second, they tell me they can't do math.

The reason people can't make these mortgage payments is not that they couldn't afford their original payments. It's that their payment amounts changed in ways they hadn't been prepared for.

There are two types of risks to the lender in making loans. The first is the risk that the borrower will not make the payments. This risk may or may not be covered by the collateral, especially if the collateral is overvalued at the time of the loan.

The second is that you won't earn interest from the loan quickly enough to cover the decrease in the value of the money you put into it. With an average 3% rate of inflation, the principal of a $100,000 loan is worth about $40,000 at the end of a 30-year repayment term. Any interest rate has to be higher than the rate of inflation in order for a lender to make money off a loan.

In a housing bubble, with interest rates indices held below inflation rates by the Fed's determination to keep the War on Terror from having a visible impact on the economy, lending to borrowers who represented some unknown additional risk beyond that of regular borrowers, lenders didn't like their odds. In order to push some of that risk off their plates, they made the borrowers liable for changes in interest rates, which for at least the last 30 years have varied with inflation as a matter of policy.

Adjustable rate mortgages (ARMs) protect lenders by passing changing rates on to the borrower. Good Math, Bad Math did a great job of explaining why that didn't get rid of as much risk to the lender as claimed. What it did do, however, is greatly increase the risk to the borrower.

"Of course it did!" the sympathy-challenged holler. "How could they not have known that an adjustable rate mortgage could be adjusted upward?"

They did know. What they didn't know, because nobody told them, is how far they could go up and how quickly. Following this requires a little sympathy, but stick with me if you can.

Say you're a borrower, excited at the prospect of buying your first home (or being able to buy a home again after you filed bankruptcy years ago to deal with the lingering costs of the cancer). You're talking to a mortgage broker about what you can afford. The broker says, "Well, with this ARM, you'll have a starting rate of about 6%. Your take-home income is about $1,800 a month. Figuring that a third of your take-home goes into your mortgage, which is less than you're paying in rent, you can afford a $100,000 mortgage."

Now, a $100,000 mortgage buys you a one-bedroom bungalow in an interesting neighborhood, but you can give the kids the bedroom and sleep on the couch if it means you're going to get them into a house. And a decrease in your housing costs...oh, wait. With taxes and such, it's not really that big a decrease. Huh. "So what happens if interest rates go up?"

The broker says, "If they go up a full percent, your monthly payment will go from $600 to $665. That's 37% of your take-home instead of 33%."

Well, there goes the rest of the money you save by not renting. A few bucks more a month, too. But if you have to, one of you will get a second job to get the kids into that house. "Okay. We'll do it."

Sounds simple, right? Remember what I said about interest rates being held below inflation? What the broker didn't tell you was that interest rates were two to four percentage points lower than they had been through the late nineties. Flash forward two years, from 2004 to 2006, through the inflation caused by rising gas prices, and your interest rate is now 10%.

There are people whose credit cards don't charge them 10% interest. And those cards give them frequent flyer miles.

Your broker told you what would happen if rates went up 1%. What happened when they went up 4%? Your mortgage payment is now about $880 a month. Even with small raises over the last two years, that's nearly 50% of your take-home. If you're lucky, one of you can work that second job and just hold it together. If not, well, there aren't as many second jobs as there were before gas prices went up and the price of everything else is so much higher now too. You love your little bungalow, down to the drafty back door, but you're now in default on your mortgage.

It isn't because you didn't ask what could happen to your mortgage. It's because the person who should have given you better information either didn't know enough or didn't care enough to give you a full answer. If it helps, your broker is watching the value of his/her IRA plummet and thinking it might be a couple extra years before retirement.

Yeah, I know. It doesn't help.

For what it's worth, you have my sympathy.