The Insanity of Americans
Last week I covered the first three parties at fault in the Mortgage Mess that has turned into a global financial catastrophe. No doubt that the Federal Reserve, the mortgage industry, and Wall Street played a huge part in this mess; but if borrowers were making their house payments there would not be a Mortgage Mess.
Yes, some borrowers were taken advantage of by predatory lenders; but, borrowers have let themselves be taken advantage of by their naiveté or what I call financial insanity. Here are 5 points that I want to make on this topic of consumers' financial insanity--
First, our savings rate was negative for several years this decade, meaning we were borrowing more and more and saving less and less. Why did consumers do this? I believe it is our desire to keep up with the Joneses' (our neighbors) who we don't even like. They buy a better car and we must do the same we feel. At some point in time the Piper must be paid.
Second, borrowers took on too big of mortgages that they could not afford. For the last 6 or 7 years we could approve people for more mortgage than they could afford. Why? Looser underwriting standards from Fannie and Freddie and Wall Street investors.
This is why I always ask my clients what their budget says they can afford for a mortgage payment. For example, a client may tell me they can afford a mortgage payment of $1500 and I can get them approved for a $2500 mortgage payment. I tell them don't spend the entire $2500 a month as they are the ones that will have to make the payment each month.
Next, related to this idea are the millions of Americans who took out Liars' Loans in which they lied or misstated their actual monthly income. I have heard of dozens of stories where a borrower who was a clerk at WalMart stated that he or she made $90k a year on their loan application, when in reality they made $30k a year.
Besides committing fraud, these people must have been financially insane. Here's why: you buy a $300k home with no money down and your monthly payment is $2300; but your monthly income is only $2500. "How the heck are you going to make that monthly payment? You know what your REAL income is and you believe you can make this big monthly payment? You're CRAZY!" If in your deception to your mortgage lender about your real income you then believe your own lie this makes you a lunatic or insane. I am sorry to be so harsh; but it is true.
Fourth, borrowers took out mortgages they did not understand. First, the sub-prime ARMs that many people have a fixed rate for only 2 or 3 years and then the rate can skyrocket and people did not understand this risk. Also, I am sure this risk was minimized by many mortgage brokers.
Also, millions of people have interest only loans and they are improperly using this tool and like any tool used improperly it can hurt you severely. Many people used this tool's lower payments to buy a more expensive home. Insane!
Finally, millions of people used the most toxic of all mortgages the Option ARM. All the borrowers saw was the super low interest rate of 1% or 2% and they thought WOW! But, they did not understand that these loans feature 2 different interest rates, a payment rate and the real rate which was always much higher. Plus, these loans feature Negative Amortization meaning that you will owe more in one year than you do today.
Borrowers should have asked more questions and done more research before signing their loan papers. It is amazing to me in the Golden Age of the internet with billions of pages of information that we as Americans have become even more financially insane than any previous generation. I will end with this thought about Option ARMs and borrowers: "if it sounds too good to be true, it probably is".
Fifth, is a belief that home prices will always increase. Now borrowers were not alone in this belief as Wall Street and the mortgage industry believed this too it appears by their actions. People with short term fixed rates on their subprime ARMs thought they would easily be able to refinance in 2 or 3 years into a fixed rate loan because their home would be worth 20% or 30% more by then. And of course mortgage brokers reaffirmed this belief in their clients.
Maybe my biggest gripe with our country's education system is that there is no training in personal finance. Teens get sex education slammed down their throat; but no training in money or finances. This is true even in college. My undergrad degree was in accounting; but even in college I learned very little about personal finance and money. I have learned what I know on my own through my desire to learn.
One of my deepest passions is teaching about money and personal finance and later this year I will be developing a Real World curriculum on money and personal finance for all Americans.