We Never Learn
A: And this will ultimately lead to more problems later on. I read this in the NY Dear John section this morning, right before I head out for work.
Via NY Post:
DEAR JOHN: I purchased my first home, a condo, for $384,000 in September. I have a mortgage of $332,000 through Wells Fargo and Fannie Mae. At the time of the purchase, my monthly income was $4,000. Since then I have lost a job and a got a new one which pays me $2,600 monthly.
My mortgage is $2,116 a month and maintenance is $194.31.
So I figured I would call Wells to see if I qualify for this "so-called" government relief program. They told me that I did not qualify -- for the loan modification program. And they told me I couldn't even refinance because I don't have enough equity.
The current mortgage is a 7-year fixed at 5.75 percent interest only. I really need to change to a regular 30-year fixed at a lower rate.
If I don't qualify for any help, who does? Do they really want me to default? As of now I haven't missed or been late on a payment. Who gets the help? J.F.
Forget John's response, my reply would have been...'why the heck did you buy a place you could not afford with an annual income of $48,000'?
This woman puts 15% down, or $52,000, and takes out a $332,000 loan while taking home only $4,000 a month in gross income! Forget for a moment that you have to pay income taxes, sure slightly less with deductions, and you have to have money to eat and survive. And what about other debt obligations - credit cards? It doesn't mention anything but certainly I think its safe to assume this buyer has some credit card debt to service?
But, lets assume the best and say she has no other debts and is of great credit! Still, this woman bought a place way above her means, and now she is wondering whether the bank 'really wants her to default'; as if its the banks fault! Its the banks fault for lending, its the person's fault for buying.
DEBT/INCOME RATIO - to calculate d/i ratio, you simply divide your total monthly debt service obligations by your gross monthly take home pay. Generally speaking, banks like to see a d/i ratio of 28% or less. This went completely out the window during the parabolic credit years of 2003-2007, when the party stopped. I was under the impression that natural market forces whipped the banks into shape, where exotic loans went extinct and underwriting standards naturally tightened. In short, I thought the banks realized that they need to start lending to people who are worthy and stop giving people a loan that cant afford one! I was wrong and the same shit is happening now, probably because there is pressure on banks to lend to stop the natural market forces from purging the excess from the system that is ultimately painful to banks. We have become a society that bails out everyone, so why stop making money when you have good ole Uncle Same to bail you out?
Back to the story. This woman made 4,000 a month, or 48K a year, and decided to buy a $384,000 house. Lets do some math. Her monthly nut is $2,116 and a monthly maintenance of $194, totaling $2,310 to service her ownership costs, and this is an INTEREST ONLY loan (hey, at least its not negatively amortizing)!
2,310 / 4,000 = 58% debt/income ratio
ARE YOU F**KING KIDDING ME!! How in the world did Wells Fargo allow this loan to go through? Have we learned nothing? Of course, macro fundamentals kicked in and this woman lost her job. Luckily, she found a new one and now makes $2,600 a month. Her debt obligations on the house alone, forget other possible debts, now takes up roughly 89% of her take home pay! Uncle Sam can forget tax collections on this woman, because her decision to buy just put her smack dab into the money pit! Now her home has lost equity, and Wells decided against refinancing her or modifying her loan to make it easier to maintain! Why would they anyway?
This woman made a very bad decision, bought a house she could NOT afford even with her 4,000 a month original job, and Wells gave a loan that should NEVER have been approved! We fail to learn from the mistakes that got us into this mess, and its probably because politicians are putting pressure on banks to lend to stop housing from falling further and keep the system going! When will we learn! How many more thousands of people are in this same situation?
One element of deciding whether or not you can afford a home, is by calculating what your debt/income ratio will be. Only you can tell how secure your job is and in this economy, nothing is certain. Debt/income ratio should at the very least, come in under 33%, or 1/3 of your take home pay. I prefer to see it under 28%. But you have to calculate in your total living costs of the purchase and your minimum payments on other debts.
This woman clearly didnt care, and probably just wanted to buy anyway - maybe she liked the granite countertops or marble bathroom. I bet a comparable rental would have been $1K/mth - $1,200/mth max. Now she will pay the price. Wells should not have granted the loan, and the market should have STOPPED this person from buying a home naturally. Yet, that didnt occur. Now, we have one more person that will likely eat up all her savings to service her living costs and max out other avenues of available credit, before defaulting. Good job America! Keep on truckin!
Comments (20)
Noah, You somewhat referred that banks are still lending on such terms. Is that true? For those of you out there who claim there was little speculation in NYC and only a minor amount of no doc or toxic type loans here.....well you have your example.
Situations like this take a few years to wash out. Its sad. But a real-estate downturn cannot just last for a year or two. Likely this goes full circle over 5-7years. In Japan it was 10. In Hong Kong it was 7. In Singapore it was 7. In Texas and California years ago it was easy 5+. Thanks for your writings Noah.
Posted by iven | May 31, 2009 10:32 AM
Noah - I agree with your general remarks, however, I was assuming that the 4000 per month she was making and her current $2600 per month were net earning. If so, it makes the numbers a little better and pushes her problem down the road. Although even if those are net numbers, she still purchased over her head, just not as much. Lets not forget recasts. If anything happens where she cant make the full payment and there is any neg-am going taking place in the future, she could be forced to pay Int+Prin immediately.
Posted by Brian23 | May 31, 2009 11:11 AM
Just one more comment. I do agree with 99% of your pieces, as I read your blog on a regular basis, but the Debt to income ratio is calculated using Gross monthly Income. During the boom, banks would concentrate on the Front end ratio, which is only housing debt and forget about the back end ratio, which is total debt obligations. Now, banks are concentrating on the back end ratio and the front end ratio is not as relevant in lending decisions.
http://www.investopedia.com/articles/07/debt_to_income.asp
Posted by Brian23 | May 31, 2009 11:21 AM
Noah -- nice post again. I continue to be amazed by the kinds of things banks have done in recent years
ONe example I just looked at is 10 W 123rd -- price just reduced to $1.495 million from an initial ask in 2007 of 2.495 million. They have also been trying to rent the place and the rent has come down from an ask of $12000 pm to $4000 pm
The seller is apparently very very very motivated. So, I checked into this.
They purchased this property in 2005 for $700k, and got a loan for the full amount -- 0 down.
In the next 9 months they got a new loan for 910k, then they have a couple of lis pendens actions. While this is going on they amazingly manage to secure a loan of $1.165 million, which goes into a Lis pendens situation a few months later.
So, in effect the banks continued loaning money to a deadbeat! I have not seen the house and know nothing about the owner's financial situation. Still a loan officer would/should know that these people got the property for 0 down, have not quite been able to make their payments, then got a bigger loan, did not succeed in making payments and now want another 250k -- so in effect these people have already "earned" $1.165-0.7 = 465k from this property while likely paying nothing towards the loan in the meantime.
Too bad their luck ran out and they couldnt cash out another 250k.
V hard to be sympathetic to the foreclosure victim in this kind of a setting.
Posted by joedavis | May 31, 2009 12:02 PM
BofA/Countrywide didn't discontinue IO pay-option ARMs until this year i believe. the idiocy continued far longer than it ought to have, and they have ZERO excuse for such lending. Wells was clearly engaging in idiotic behavior as well.
Posted by brenda | May 31, 2009 12:02 PM
remove the IO. what was i thinking?
Posted by brenda | May 31, 2009 12:03 PM
I interpreted it to be her gross monthly take home pay.
Posted by mobile-noah | May 31, 2009 1:49 PM
If she made 7K pretax, and 4K after tax a month, her d/i ratio would be 33%, or right at top edge.
That means a good 43% of her income is taxed. Doubtful with that income. I think she meant that her annual salary is 48K a year, or 4K a month.
Posted by Noah | May 31, 2009 4:11 PM
Agree, if its gross income, then its very high DTI. I have only seen it going as high as about 55%. Never that high of 58%. I guess if anyone is wondering how we got into this mess, this would be a perfect example.
Posted by Brian23 | May 31, 2009 5:18 PM
I don't understand why you are amazed. Then again, is this mock amazement? We all sat there watching Congress quiz banks on why they weren't lending like they had been lending with puzzled looks on their faces. They didn't get it. Hope you find more amusing stories like this and share them with the rest of us.
Posted by MeekSheep | May 31, 2009 8:20 PM
Noah,
This is actually an IMPROVEMENT. Back in the bubble days, banks were giving $750,000 loans to $14,000 a year grape pickers (I believe one of the panelists in one of your prior Bull vs. Bear debates pointed this out). So all hope is not lost. LOL
Posted by Donald | May 31, 2009 8:21 PM
If she has a $332,000 interest-only loan at 5.75%, shouldn't that mean a $19,090 yearly payment which works out to $1591 per month?
Posted by Foolish Jordan | May 31, 2009 9:45 PM
foolish - TAXES! The bank likely collects her re taxes in her payments, collects it, and pays quarterly for her. Hence the higher number.
I rememeber when I bought, taxes went up and my bank had a shortage spread because they collected too little. They always want a cushion. So not only did my bank collect the amount the taxes went up, they had to up it more to get the cushion back up - a shortage spread. My payments for taxes went from 481/mth to 820/mth for like 14 months. THAT SUCKED!
Posted by Noah | June 1, 2009 7:02 AM
Kudos, Noah for an excellent post on a real world, and unfortuntely, all too common situation. Putting aside how ill advised this loan was, your readers should know that it's never a good idea to take the bank's word(especially over the telephone!) as to whether you qualify for any government program.
1st rule for distressed borrowers: Go see a non-profit, HUD approved loan counselor! Do NOT use any of the fee based loan modification services, 99% of them are scammers.
NYC's new financial counseling program (available by calling 311) can help you find a counselor. Educate yourself by going to one of the federal government websites such as "Making Home Affordable" and reading about these programs for yourself.
Posted by Catherine | June 1, 2009 2:07 PM
Great article. I did enjoy reading it. Please feel free to read our articles as well.
Best, Jim
Posted by Boston Real Estate Blog | June 2, 2009 10:18 AM
Great post Noah. Could you please confirm the debt/income ratio that you recommend? Is the income based on gross or net income? I had always thought that the conservative limit should be a 25% D/I, using gross income.
Posted by guest | June 2, 2009 11:42 AM
sounds about right. Yes I use gross and 25% is solid, and 28% is usually bank standard I believe
Posted by Noah | June 2, 2009 12:34 PM
I also heard the rule of thumb was that the property you buy should cost no more than 3x your gross income, assuming standard downpayment of 20%.
Posted by Thisson | June 2, 2009 4:31 PM
On the one hand i think that many people buying houses they cannot afford have been extremely irresponsible and have dug their own holes. On the other hand, I really feel bad for these people who just don't know better. They think that b/c they paid $x dollars for their house -- that's what it is worth. They don't even KNOW they are being irresponsible.
I don't think people understand that spending 99% and not 101% of their income is poor planning. And I'm not talking about the people right after college scraping by on $30k per year. I'm talking about the people who earn enough money that socking away an extra $20k-$30k would simply be a smart thing.
http://finance.yahoo.com/career-work/article/107145/From-Ordering-Steak-and-Lobster-to-Serving-It
Posted by RegularAnon | June 3, 2009 9:56 AM
Thanks for sharing this info post.
Posted by Loan Modification Company | July 6, 2009 3:43 AM