The housing meltdown.

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Interesting Explanation of why the American mortgage market has caused a few financial problems around the world this last week.

 

I think the explanation is much simpler than that. While some of what you describe does happen, the majority of people defaulting on their mortgages are defalting on ARM loans. ARM stands for "adjustable rate mortgages". The way they work is for a set period of time (usually 3-7 years) you get a "teaser" interest rate for your loan that is far below what it is be after the teaser period expires.

The problem is that people can afford to pay the mortgage at the teaser rate, but cannot afford it once the interest rate soars upwards. In some cases the new interest rate doubles what the old one was.

The big problem with this is that banks don't qualify people for loans based on the eventual rate hike - only at the teaser rate. The thinking is that even though a few years down the road the rates will go up, chances are the person's salary will also increase in that time, in which case they can afford the higher rate. Given the current rate of foreclosures, that is evidently not the case.

My wife and I have an ARM loan. We signed it in the fall of 2003, and thus we still have a little over a year at the low "teaser" rate. I also fall into the category of someone who can see his interest rate double after the teaser rate expires. My current mortgage is at 4.75%, but could go as high as 9.75%. That having been said, I'm not in any danger of defaulting because 1.) I can, in fact, pay the higher mortgage rate if I had to and 2.) My wife and I don't plan on staying in our house that much longer anyway, as we need to upgrade to a bigger house to accomodate what has become 3 (and probably eventually more) people.

This obviously begs the question of why can I do it but not other people? The answer is that my salary has risen at a higher rate than inflation. So I'm actually earning more money than I was a few years ago, not just in absolute numbers, but in buying power. Many people on the low end of the scale get very modest raises, and thus, even though their paycheck may increase a bit from year to year, the buying power of the paycheck is the same as it ever was. Thus, their income for housing when all of their other bills are paid is still the same dollar amount as it was a few years ago, and when their mortgage rates go up, it hurts.

 

In the UK, people can switch their mortgages as and when they want to. Although some mortgages have tie-ins or penalties, with a bit of shopping about you can get a low-rate fixed mortgage for somewhere between 2 and 5 years and swap when the "teaser rate" runs out. (The lenders betting on the fact that people won't bother)

That said, I haven't heard of it doubling except maybe in recent cases due to the hike in interest rates we've had.

 

That's an excellent article. This problem really hammers home the idea that we live in a global economy, and that the winds of fortune - for good or for ill - blow for all. There's no isolation anymore.

AFI, you describe the surface cause but we have to scratch a little deeper. Why were consumers so willing to ignore the risks and take on unmangeable levels of debt? Why were lenders willing to shell out the money? In a similar but unrelated problem, why are credit card companies willing to grant so much leeway to students who have yet to prove either their trustworthiness or their earning capacity?

The answer is simple: GREED. People see something they like and decide that they have to have it right away - no consideration, no saving, no analysis, just instant gratification through consumption. New clothes, a hot car, bling, or a big house... it doesn't matter what someone wants to buy, there is someone else ready to provide the goods, take the money and run. Who cares what might happen later, or to anyone else, as long as I Get Mine?

We bought our house in 2003 and insisted on a 30-year fixed rate mortgage. Over the intervening 4 years, I've lost count of how many re-fi offers we've shredded! They never provided a rate close to what we already had. Funny how few we're getting these days...

Conversely, my sister is now living in a 4BR house and renting out her former, more modest home. We couldn't figure out why she was buying up when her kids were starting to head off to college, and now, neither can she. She's talking about selling the new house and moving back to the other, but the financial damage will already have been done.