From our friends at the WSJ:
As we reported recently, people whose mortgage payments are reduced through loan modifications often are still drowning in other types of debt. The loan-mod treatment can be akin to using a small Band-Aid to try to cover up a mortar-sized wound.
We may be relying too heavily on that limited loan-mod cure partly because another more holistic therapy, bankruptcy, is no longer as attractive to the patients.
A recent working paper from Wenli Li of the Federal Reserve Bank of Philadelphia and others tries to measure the degree to which the 2005 reform of U.S. bankruptcy law led to more defaults on home mortgages.
Bankruptcy has always been a way for distressed borrowers to save their homes by allowing them to shed other debts and concentrate their resources on mortgage payments. But the 2005 legislation raised the costs of filing for bankruptcy and decreased the amount of debt that is wiped out. “We argue that an unintended consequence of reform was to cause mortgage defaults to rise,” the paper says.
The paper looks at mortgage loans originated in 2004 and 2005 and concludes that the bankruptcy changes led to an additional 200,000 mortgage defaults per year. The paper doesn’t provide estimates for mortgages originated after 2005.
Of course, sloppy lending standards and crashing home prices would have led to an epidemic of mortgage defaults in any case. Nearly 8 million American households–around 15% of those with mortgages–were behind on their mortgage payments at the end of 2009, according to the Mortgage Bankers Association. But bankruptcy-law changes may have made a terrible situation even worse.
The authors of the paper suggest “rolling back” the cost of filing for bankruptcy to pre-2005 levels.
Here’s another idea: Teach your kids not to gorge on credit when it’s easy to get.
“All Your Worth: The Ultimate Lifetime Money Plan” by Elizabeth Warren & Amelia Warren Tyagi, is an excellent resource guide.
How about the basic strategy that spending 60-80% of your pretax income on housing and other debt service isn’t viable? Isn’t this obvious?
Jim – do you happen to know what happened to your old nemesis Schahrzad Berkland who used to run the site http://www.californiahousingforecast.com/
It was interesting, as more and more people came out to question her “all houses in SD will hit 1999 levels” call, I watched in amusement as she stubbornly refused to admit she was wrong, no matter how much time went by and how much data there was to the contrary.
I just checked on her site to see if she capitulated yet, and *poof* its gone. It appears she would rather roll up shop than admit she was wrong. Simply amazing…
She changed her website address:
http://www.sandiegohousingforecast.com/
“Isn’t this obvious?”
Nope. All the proof you need is in the chart referenced above – those that have been helped (which is a small minority of the overall number of the seriously underwater) went from 77.5 to 61.3, which is still above your recommended basic strategy. And, I would venture to further guess, there are plenty of people out there who applied and were summarily rejected, because they were over (perhaps even way over) 77.5.
The better question is – why isn’t this obvious?
“The better question is – why isn’t this obvious?”
That was the question I was really asking. What happened to those old rules about a mortgage payment being ~28% of gross income and total debt (mortgage, CC, cars, etc) being ~36% of gross? Anyone remember those?
When I look at this whole mess I really agree with the folks that say EVERYONE was at fault. The banks clearly messed-up by approving these crazy loans. But hey, they were just going to package them up and ship them out. The rating agencies were less than worthless as they essentially allowed these crappy loans to be passed from one bank to the next. However the borrowers, who asked for these loans in the first place, share possibly the greatest responsibility.
There was a great SNL sketch on this about a year ago.
Regarding the second stat: Median total debt payment to pretax income. I note that the debt payments include many different types of debt, including credit card debt.
Also consider comment #2-
“How about the basic strategy that spending 60-80% of your pretax income on housing and other debt service isn’t viable? Isn’t this obvious?”
Without running a report, I probably charge 50% of what I spend, and then when the bill arrives I pay the full balance. I suppose my total debt payment to pretax income ratio is higher because of this, yet never is a dime of interest paid.
Jawarbla, I don’t believe we will retract to 1999 but I don’t think we have been in any stable trend yet to say she is right or wrong. We could easily take another sharp leg down and do another 3 month recovery.
“What happened to those old rules about a mortgage payment being ~28% of gross income and total debt (mortgage, CC, cars, etc) being ~36% of gross? Anyone remember those?”
I think those rules left the station when two things happened:
1. Baby boomers decided that investing in MBS was a good idea, and risk-free above-average returns would be realized.
2. Much of America was under a spell and believed that housing only goes up in value, so higher income is based on higher borrowing. (See also: Positive yield spread)
“I suppose my total debt payment to pretax income ratio is higher because of this, yet never is a dime of interest paid”
I’d assume they use how much it takes to service the debt. So basically minimum payments.
“What happened to those old rules”
Well let’s see… people started drinking this super cool new kool-aid. Some of the ingredients included stuff like – the old rules don’t apply, extract all the equity out of your house ‘cus real estate always goes up, complete suspension of accounting rules/reality, reward yourself, you can have it all right now, don’t pay down your mortgage invest that money instead (play the market, you too can be a day trader, complete suspension of the laws of physics (what goes up, must come down), lack of accountability, lack of consequences, suspension of standards and practices across the board in lending/appraisal/banking/market/accounting/insurance/business/government…
And don’t forget, these famous phrases-
“Get down to Disney World in Florida”
“Take your families and enjoy life, the way we want it to be enjoyed.”
“…and I encourage you all to go shopping more.”
“Without running a report, I probably charge 50% of what I spend, and then when the bill arrives I pay the full balance. I suppose my total debt payment to pretax income ratio is higher because of this, yet never is a dime of interest paid.
As far as I’m concerned (and I think a mortgage company would see it this way too) this debt wouldn’t count. Basically your using your credit card as a debit card. Everyone’s gotta buy groceries. Those are just monthly expenses. “Debt” means long term debt that you can’t/won’t pay off and you’re paying the interest on it. This kind of debt affects how much of a mortgage payment you can take on, or at least it should.
So car loans, student loans, other mortgages, credit card debt where you’re carrying a balance from month to month – that’s debt.
Commenting on #11:
I hope now we can all collectly ask, “How’s that working for you?”
What would happen if we reset everyone’s debt to zero?
In a couple of years would be back in the same place?
i remember selling my home in 2006 for only $500k. It was listed for $650k, that is what the other comps were. My wife and I just kepted telling ourselves “DON’T BE GREEDY”
We took the proceeds and paid off our other home. Now that home we sell has been foreclosed and is only worth $200k. It in IB.
Life often changes the rules on us even when we follow them. When we bought our home our PITI was 22% of our gross. Thanks to corporate collapses, salary cuts and an involuntary job change, we’re now up to 32%. Fortunately we have zero other debt besides the mortgage, but like JP2, we put most everything we can on our cards and zero the balances every month to get cash rebates, bonus points, etc., without paying any interest, and from the number of offers we throw away every month for new cards and mortgage refi’s, it doesn’t seem to have made us any less attractive as borrowers. In fact, our theory is that the lending industry has decided it isn’t going to rest until it manages to entice us into paying some kind of non-mortgage interest. 🙂
#12: “So car loans, student loans, other mortgages, credit card debt where you’re carrying a balance from month to month – that’s debt.”
I don’t believe mortgage companies have any way to tell what credit card debt is long term and what is short term. I charge more like 80-90% of my non-rent monthly expenses and pay the full balance each month. But every year when I get my free credit reports, all that the credit card companies appear to report is the outstanding balance on one particular day each month, and the high watermark balance that I had at some point in the past. As long as everything is “Paid or Paying as Agreed”, I don’t think there’s much else to see. Experian includes a balance history, but that’s just a collection of each of the single values for each of several past months. Equifax and Transunion
only include the most-recently reported balance.
I agree that such debt “shouldn’t” count, but I don’t see any way to keep it out of your credit score. You could certainly show your payment statements to your lender, but the “outstanding debt” will go into your score calculation regardless.
A great book to start your kids on financial education is “The Richest Man in Babylon”
http://en.wikipedia.org/wiki/The_Richest_Man_in_Babylon_(book)
Cash flow is such a funny thing.
“So car loans, student loans, other mortgages, credit card debt where you’re carrying a balance from month to month – that’s debt.”
Notice how we are mixing cash flow and interest expense up. I know a guy that has some 3.375% (if I remember right) student loan debt. He takes fitness classes at the community college just often enough to avoid entering repayment. Cash flow is clearly zero per month, but some of the debt is unsubsidized, so the interest accrues. I wonder how this is factored into this whole servicing concept. For what it’s worth, I know a doctor with outrageous student loan debt (more than $150k), and he plays the same game. Basically he can take $500 bucks worth of classes to avoid paying $$$$ out per month. Yes, the interest accrues, but he doesn’t pay cash out. I am sure that one day his income will go up and his desire to avoid paying will go down.
This also brings up the issue of negative amortization…
Roughly speaking, I wish a few more people knew the difference between “interest expense” and “credit card payment.”
On the flip side, when it comes to mortgage-based debt, I wish more people had an understanding that paying interest does not add value to the home. Yes, yes, I know that the assets were positively leveraged in the past [=positive yield spread], so all interest paid was recovered at the time of sale (undiscounted).
Finally, I wish people understood the relationship between the present value tables and an amortization schedule. I’d start with those who should know, such as loan originators, mortgage brokers, and so on.
Dear spam filter, this comment really is not spam. I have posted here for some time, and I know you know it, or should know it. But I guess you do not. Maybe you, Mr. Spam Filter, do not understand present value.
What does a person have to type to get a comment posted?
The top half of my post is missing.
Darn spam filter!
Was it #19 that was missing? I fished it out of the spam pit.
Loan, credit, mortgage, etc. are words that trigger the spam filters. It’ll also hold back a comment that has two or more links in it.
Thank you. I kept trying to figure out how to clean the message, make it longer, etc. False positives are so frustrating.
This CNBC post is very enlightening on this topic relating to debt to income ratios and loan mods:
http://www.cnbc.com/id/37195628
Good times…
I’m really kind of shocked to see such high debt to income ratios. I know my husband and I were stupid before we wised up and paid off the credit card and the cars. It’s kind of nice to not have a car payment 🙂 I also know overspending is what got the US (and it seems much of the rest of the world) into the current situation.
But 77.5 and 61.3 for debt to PRE-TAX income rations is crazy!!! After taxes and debt payments do they have anything left?
No debt here – err except the house which has fallen some 12% +/-. Amazingly, Chase sends me a credit card application. They cancelled my HELOC a few years back and now want to extend me credit? HOW ABOUT GIVING ME BACK MY HELOC? What schmucks.
So Chase is willing to give me an unsecured credit card based on my FICO, but not give me back my HELOC which is secured against my house. They should look at my credit history (of all people, they should know it already) to see that I have never been late on a payment and have excellent credit including the back end debt ratio. But no, it seems that would be the right thing too do. The more things change, the more things stay the same.
Is the value of your house more than what you owe on the mortgage plus the HELOC? If not, they are just being smart-you did say the value of your house dropped. Credit cards are a different type of debt than HELOCs-in theory, more risky, which is why they have higher interest rates to compensate. Plus I doubt the limit on the credit card they are offering you is anywhere near as high as your old HELOC.
“Loan, credit, mortgage, etc. are words that trigger the spam filters”
Wow, they must be going a mile a minute filtering those words out of a blog about real estate bubbles…
Our mortgage is with Chase, and they have a strange “left hand/right hand not talking” sort of operation. A couple of months ago I clicked on the “check refi rates” link in my online account and the best they could offer was a 5/8 pt reduction with $5000 in closing costs added to the balance, so I said no thanks. A week later, they Fedex’d me an offer to refi at the same rate reduction with zero closing. At first I wondered if my turning down the earlier refi triggered the second offer, but I eventually came to the conclusion that these were separate and totally uncoordinated.
For those of you that stated you charge 90% of your expenses and pay it off right away, that would have a relatively small impact on the calculations mentioned in this post.
The calc is debt payments / pretax income. The debt payment is less than the balance outstanding, obviously. The total debt to pretax income for the median borrower in these stats must be through the roof.
Example: make $100k pretax, charge $60k per year and always pay it off every month. Monthly balance: $5k. Minimum payment: $200. Debt payments / pretax income: 2.4%. The median person in this example had a 23% debt payment / pretax income before taking into account the house payments. Crazy!
I think it is a brilliant idea to take JP2’s tax dollars and reduce the principle of the mortgage so these borrowers are only paying 61% of their pretax income to service their debt.