Since everyone will probably come across it this weekend, I want to point out My Personal Credit Crisis, in the New York Times Magazine Debt Issue. It’s an adaption from “Busted: Life Inside the Great Mortgage Meltdown,” a book by New York Times economics writer Edmund Andrews. He talks about how he gets trapped in a too-big mortgage, and how between that and credit cards he goes bust – mentally and monetary.
In light of some recent things I’ve been sketching here, I want to point this out:
…It was August 2004…Patty discovered a small but stately brick home in a leafy, kid-filled neighborhood in Silver Spring, Md. We sent in an offer of $460,000 and one day later got our answer: the sellers accepted…Despite the obvious red flag of applying for a Don’t Ask, Don’t Tell loan, I wasn’t paying that much for the money….[Real Estate Broker] Bob’s view was that if I’d been unemployed for seven years and didn’t have a dime to my name but I wanted a house, he wouldn’t question my prudence…“Don’t worry,” Bob reassured me, saying what almost everybody else in real estate was saying at that moment. “The value of your house will be higher in five years. You’ll be able to refinance”…
I felt like a crack addict calling up my dealer. It was April 2006, and I had just reached Bob Andrews, our once and future mortgage broker, on his cellphone…“What we’re going to do is a two-step plan,” he announced. “The bad news is that your credit scores are down, so we can’t just do a simple refinance. But the good news is that you’ve owned your house for a year and a half, and it’s gone up in value. So you can borrow against the equity. So in the first step of the plan, we’re going to get you a really ugly mortgage that is big enough to pay off all your credit cards.”…
Within a few weeks, an appraiser valued our house at $505,000, almost 10 percent above the original purchase price two years earlier. On June 12, Patty and I signed a new mortgage for $472,000 with Fremont Investment and Loan in Santa Monica, Calif.
Fremont gave us a classic subprime loan. Our monthly payment jumped to $3,700 from $2,500. If we kept the mortgage for two years, the interest rate would jump as high as 11.5 percent, and the monthly payments would ratchet up to as high as $4,500.
The paperwork was so confusing that I was never exactly sure who was paying what. I hazily understood that I was paying most of the fees, one way or another, but I couldn’t figure out how, and I couldn’t see any better alternatives. After it was all over, I figured we had paid about $5,800 in fees to Bob’s mortgage company and the settlement company, on top of the sales commission that came out in higher interest rates every month…. In October 2006, Bob refinanced us once again, and our payments dropped just as he had predicted.
I’m not going to quote it, but look at how eager the real estate agent is to get the author, who has alimony and child support eating up 60% of his salary, to get his loan. He’s exactly the kind of guy who is going to need to keep coming back to the bank to refinance his mortgage. Note he also refinances the mortgage at 20 months, exactly as banks expect them to get refinanced – a perfect time to extract some of that house equity through penalties and fees.
$460,000 appreciates 10% to $506,000, at which point the author needs to redo his mortgage. Bob gets $6,000 of it, probably more if the author really paid attention. $6K/$46K = 13% of the rise in house price extracted to the bank. That’s on top of a high interest rate. $6K for a mortgage dude to resell the same mortgage he’s already done, to someone who can’t even follow it and won’t, because it is all coming out of his rapidly rising house price anyway.
In economics, adverse selection tends to be a worry because a person knows his situation better than his counterparty, be it an insurance company or a bank. Situations like these make me wonder if the opposite is often true. The author has no clue how stable his income his and is terrible at predicting it, while I bet that the mortgage company knows just what is going to happen to this guy’s mortgage.
UPDATE: After thinking about this overnight, it is a really good article. But I’d like to see more about the house. Was it even nice? Was it primarily an investment? For the schools? It seems that the house was the primary albatross around his financial neck, though as a hero or villain, or even as an object, it is missing from the story. I wonder if the houses of this crisis are going to disappear from our collective memory.