Monday, July 28, 2008
Turning the American Dream Into a Nightmare for Prudent Taxpayers
By John W. Lillpop
President Bush is about to sign a major bill to bail out 400,000 reckless homeowners who find themselves in the cross hairs of greedy lenders seeking to foreclose on delinquent mortgages.
This bail out will also throw tens of billions of taxpayer money at Fannie Mae and Freddie Mac, two private corporations specifically created by Congress to bring stability to mortgage lending.
Heaven knows, no one wants to see any American kicked out of his or her home. But this action is yet another punch in the stomach to millions of Americans who have chosen to live their lives responsibly and within their financial means.
Given the government's penchant for serving as Uncle Nanny when it comes to home ownership, why in Hades should any responsible citizen scrimp and save and work hard when those who are reckless and irresponsible can count on being bailed out with taxpayer money?
What is the point in being frugal and prudent when it is the foolish and imprudent who are rewarded?
During the most recent period of extravagant exuberance in the mortgage industry, several old school traditions have been cast aside in favor of more liberalized underwriting standards.
This new paradigm of underwriting has lead to a new way of thinking, including the following:
Fret Not About Your Credit
It seems as though those who worry about their credit worthiness are guilty of "old school" hysteria.
In these enlightened times, cagey characters do not pay attention to paying bills on time. They refuse to worry about how much debt they are ringing up on credit cards that cost 20-30 % annual interest, they fret not about derogatory items like repossessions, collections, liens, and judgments that usually muck up one's FICO credit score.
To really cool consumers, having a single-digit FICO score is vastly overrated as a disaster, especially since Uncle Sam is chopping at the bit to disburse scores of billions of dollars of funny money just to extract foolhardy buyers from self-imposed debtor hell.
Saving for a Rainy Day Is a Waste of Time
For years, prospective buyers were told to save enough money to make a decent down payment on that Dream Home. The idea was to put at least twenty percent down to avoid mortgage insurance, and to keep monthly mortgage payments as low as possible.
In addition, having money in the bank was seen as a sign of economic stability. Some institutions even required several months of "reserves" for certain loans.
Alas, saving for a rainy day is another old school concept that should be expunged from the modern home buyers' vocabulary!
In recent times, it has been entirely possible to get into a million dollar home with little or no down payment.
Under the right circumstances, lenders would approve a "piggy back" loan consisting of a low-interest first for 80 percent of the home value, and a Home Equity Line of Credit (HELOC) for the remaining 20 percent.
This scheme might sound risky, but pompous lenders and naive buyers were counting on rising home prices to cover such HELOCs in short order. As an added bonus, the HELOC provided lenders with ready-made refinance opportunities from which to profit.
But then a funny thing happened on the way to refinance heaven: Rather than the promised non-stop increase in home values, the bubble burst, leaving some buyers in the unenviable position of owing more on their homes than the fair market value of said homes.
Again, "old school" may not be cool--but it is often safer!
Buy Most Home Possible Now; Deal With High Payments Later!
Common sense should dictate that home buyers should never take on mortgage payments that will overwhelm them with debt and make their lives life miserable.
Requiring at least a twenty percent down payment used to help keep monthly payments in line. In addition, most lenders used to adhere to debt-to-income ratios of approximately 28 and 36.
Twenty eight percent was the maximum amount of gross income that could be spent on principle, interest, taxes, and insurance (PITI); thirty six percent was the amount of income that could be dedicated to total debt (PITI plus other debt).
Debt to income ratios were designed to protect buyers from purchasing homes beyond their means.
Unfortunately, during the recent run of extravagant exuberance, some lenders have disregarded the traditional debt-to-income ratios and have sanctioned total debt ratios in excess of 50 percent, leaving ill-uninformed borrowers vulnerable to bankruptcy and foreclosure.
One of the cruelest hoaxes perpetrated on unsuspecting buyers is the outrage called negative amortization. Simply put, a negative amortization loan is one in which the principal amount increases, rather than going down, each month.
This loan is usually sold to a borrower who cannot otherwise qualify for a traditional loan. The borrower accepts the loan because of lower interest rates and easier qualifying requirements, often ignoring exorbitant closing costs, excessive origination fees, and other unattractive terms.
With negative amortization loans, the monthly payment is based on an artificial interest rate, whereas the actual monthly payment is based on a much higher interest rate. The difference between the artificial and actual monthly payment amount is added to the principal balance each month.
What a thrill it is to make that monthly payment knowing that the principal amount has gone up--rather than down!
With any luck, the bail out bill about to become law will not encourage even more Americans to travel down the path to financial irresponsibility and recklessness.
The simple truth is that not all Americans can afford luxury homes, some cannot afford even the most modest of dwellings.
Greater individual responsibility, not government bail outs, is the solution to the mortgage and housing crisis.
Posted by John W Lillpop at 1:09 PM