You Would Have Been An IDIOT Not To Take A Teaser Rate, Adjustable Mortgage in 1999.

A lot of attention has been given to the wayward homeowner and how they would suffer. 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. Secondly 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 were 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. They will never actually OWN their home, they continue to refinance forever. This short sided thinking is the real crisis in America. This person thought their home could never depreciate and I can bet they never thought their 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 education 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, the US needs to make a fundamental shift in mentality, take control of their finances, learn about the risks they take, and live within our means.