Keep Those Hard Times Away From My Door

On the whole I think that lenders who grievously mispriced their mortgages for short-term gain get what they deserve when the homeowners walk away from a house. If the homeowners owe more on the house than it is worth, that seems a reasonable course, and they will pay a serious price in the form of lost downpayments and wrecked credit. And I don't feel inclined to join a moralizing chorus about how the homebuyers are greedy/irresponsible/whatever. No more so than the dumbasses at the bank who loaned them money with no collateral, right? Still, this strikes me as poor planning...

The struggles of Rebekah and Otto Ao in dealing with a crushing mortgage debt show how deep the problems go.

They bought their first home in 2005, for $269,000. They paid for it using an Option ARM, which allowed them to make a monthly payment of $850, which was less than what they paid for rent in Los Angeles. Only later did they realize that meant that their loan amount would grow over time, not shrink, as would their payments.

"When we saw the payments were so low we decided to buy another house," Rebekah Ao said. "With the market going crazy, we figured we could sell the other house in a couple of years."

They now owe $287,000 on the first one and $320,000 on the new home, which they are renting. Their credit card balances, which they once kept at zero, have ballooned to more than $14,000 as they struggle to make ends meet.

"It hurts to know that you are on a road that leads to a dead end," Rebekah Ao said. The Aos are weighing their limited options. Foreclosure? A sale that takes in less than they owe? "But right now," she said, "we're just throwing our money away every month."

Who just randomly decides to buy a second house? And this, "Only later did they realize that meant that their loan amount would grow over time, not shrink, as would their payments," can that possibly be true? I understand that people were inclined not to look at anything other than the monthly payment when considering what they could afford, but damn, y'all probably should have read the fine print on that one.

UPDATE: According to this Business Week "Map of Misery" like 30% of new and refinanced loans in Southern California were some kind of crazy interest only or negative amortization ARM (in 2006, I think). Who can possibly have thought that was a good idea?

Comments

[Rich Puchalsky]

I think that all of finance basically runs on people who have different risk preferences than what middle-class people usually consider to be "normal", although there's a whole lot of finance that relies on concealing this from the middle class that tolerates the system.

For instance, "margin" in the context of stocks. When someone buys stocks on margin, that's just another way of saying that they are borrowing money in order to make a bet. And predictably, whenever the stock market has a severe downturn, that's what really causes the crash. If someone bought a stock with actual money, and the stock lost 1/3 of its value, they still have 2/3 left. If they bought on margin, they could have nothing left and be bankrupt.

So these people bought a house on margin, so to speak. It's only poor planning if it doesn't work. But every financial transaction, everywhere, has options like that for the people with high risk/high reward preferences.

If they all go bad, society-wide, that's when the camouflage effect comes in. Instead of people saying that they lost their money at the racetrack or in the lottery, they can say that there's a "stock market crash" or that they're losing their home, which vastly increases the chance that the rest of society will bail out everyone involved.

The real bad people involved are the people who set up the market this way, knowing that this would predictably happen sooner or later.

[Brock Landers]

Who can possibly have thought that was a good idea?

Brokers and agents collecting fees.

[bitchphd]

It actually really probably is true that they didn't realize. IME, lenders talk to borrowers exclusively in terms of monthly payments, and they completely wave away questions about what this means in terms of the overall cost of the loan. Really.

And yes, people should read the fine print, but I'ma get on folks about that as soon as we all start reading every license user agreement we click "agree" to whenever we install new software.

[JB]

In those heady days when house prices kept going up and up and up, I doubt many people were giving any thought at all as to the principal of their loan. The plan was to sell for a huge profit in a few years, not to actually pay off the loan. Had they done it in 2001 instead of 2005 they'd have made a quick buck.

In hindsight, it's a terrible plan. But I can understand how someone would fall into it without being a total idiot.

[t-train]

Rich Puchalsky is right on the money, not to pun.

Of course it's hard to have much sympathy for the people who bought houses they couldn't afford. But the reason the subprime crisis is such a crisis is because of all the lending institutions (and their colluding auditors) who were willing to sacrifice sound accounting principles (like maintaining adequate loan-loss reserves in case of defaults) in order to maximize profits on their interest-rate gambles.

Like the S&Ls before them, these guys were making money hand-over-fist for a long time, gambling that each day would not be the day when the Reaper would arrive. But in the short term some people made a lot of dough playing the yield curve.

[John Horowitz]

FWIW: When I refinanced in 2003, I asked my mortgage broker about an interest-only loan and he said that would not be a good idea for someone in my position.

I thank my stars now.

[Heather]

Although I feel bad for their situation I have to agree that was terrible planning on their part! Too many people jump into crazy mortgages without looking at the future. Plus I think people buy more than they can really afford. I heard once you should aim to keep the purchase price of your home at no more than 3 times your income, until you have a lot saved. And after watching HGTV, I think there are a lot of people going WAY beyond that. I'm glad my husband and I went way low on our first home. Just keep on saving for the next one!

[JPool]

My grandparents did the slow-motion version of this (not flipping, but renting and rehabing a second house for resale) in the 1950s and 1960s in order to claw their way up into the middle-class, and looking back they were very lucky to do this when they did rather than in the 1970s when the price of urban housing was collapsing.

I too enjoy feeling better about myself after watching the morons on HGTV who refuse to acknowledge or change how dumb they're being in chasing their dreams of house flipping riches. The problem with these stories is that they make it look like this is what the majority of the sub-prime loan crisis is about. The most visible aspects of this locally, the swathes of forclosed housing forming little ghost towns across north Minneapolis, were not the result of avaristic flippers, but of people who were convinced that this was a real chance to own their own home. Based on the local reporting, some of these folks were told the risks going in and decided to hope for the best anyway, others weren't told the dangers and didn't know to ask, and still others were assured that an ARM wouldn't be a problem because they could always refinance, only to suddenly find themselves upside down with no real options.

[belle waring]

I know it's the old NYT joke, "world ends; women, minorities hardest hit", but it does seem that lots of lower-income people made the jump into home-ownership in good faith and as part of trying to move into the middle class (lots of single moms, too). many of these people were sold inappropriate loan vehicles by misleading/unscrupulous mortgage lenders (getting worse deals, more arms etc that their credit score would warrant) and are now underwater on their homes. this sucks, and I wonder how it affects neighborhoods that are in the process of "gentrifying" or whatever. seems like there could be a slide backwards in some neighborhoods as foreclosures/abandonments and attendant street crimes increase. bummer.

[JPool]

I don't know about previously gentrifying neighborhoods, though, annecdotally, I have friends in some of these who are trying to get out of what they thought was going to be their starter home who are finding either that they would have to take a substantial loss or that there are no buyers right now. In north Minneapolis, areas that were poor but stable, now have the folks who managed to hold to their houses surrounded by empties. They (understandably in an area that had record murder rates last year) are increasing worried about their safety and hoping that the abandoned houses don't turn into crack dens too quickly. And of course they are stuck where there are for the forseeable future. We're lucky enough to still be renters, but I'm hoping that folks are right that urban housing will turn around and not become the 1970s all over again.

[dominic murphy]

We looked into an adjustable rate a few years ago when we refinanced our old house. The guy on the phone told us a pack of lies, as we discovered when we read the small print after we got the forms in the mail. When we raised this with him he said "Oh, I sent you the wrong forms. But don't worry, just sign them anyway, it won't matter."

[bemused]

Who can have possibly thought this was a good idea? Why, Alan Greenspan!