The Invisible Housing Mortgage Hand: Analysis of a Society That Forces You Into Debt
Housing-Market / US Debt Nov 03, 2007 - 02:19 AM
The Ministry of Truth, otherwise known at the Bureau of Labor and Statistics, tells us that inflation is low to moderate. In fact, inflation is so low all you need to do is purchase 10-year Treasury notes and you'll be fine. But we do have inflation and this is apparent in the credit markets. We live in a society were folks are forced to go into debt. Instead of addressing our negative savings rate, corporate America decides to create credit products that will put you even further in debt . They use the machines of marketing to subtly make you feel that having 10 credit cards, student loan debt, and steroid induced mortgages is okay.
In fact, if you don't have these products you are some loser flunky that simply doesn't understand success 2.0 in this country. I'm sure many of you have seen the current spin of advertising. Have you seen the commercials where anyone paying with cash at the mall, fast food store, or ball game is seen as some slow scumbag? The subconscious message is this, “hey, you are a lowlife if you carry infectious cash, pay with a credit card and GET IN LINE!” So what if you want to pay with cash. In fact, you should get kudos for doing this since it demonstrates that you are paying with real world money instead of mortgaging your future for a cup of espresso.
We are going to examine how our society by default forces people into debt. We are going to look at credit scores and why there is pressure to maintain a high 3 digit number. 80 percent of millionaires in this country have a college degree so we will look at the cost of going to college. Many people live out in the boondocks and commute to work so we'll examine our driving culture. Most people eat and don't live off air, so we'll dig into our eating cost. And most of us need to live somewhere so we'll take a look at housing cost.
The Good Character Factory, Credit Scores
Most people realize that they need to have good credit. In a society run by information gathering and data mining, most of what you do can be tracked. Many insurance companies will use your credit score in determining your insurance rates. Some employers will run your credit as a method of determining your character. They can easily call references and ask you to submit official documentation but 3 digits are a much better representation of who you are. In fact, folks are sometimes penalized for canceling credit cards because their debt ratios fall lower than they would like. You aren't carrying around enough credit insurance. And if you are looking for a rental property, your credit score may determine whether you get the place you want. Relying on one single measure for character judgment is as useful as examining GPA for financial success. They are both important but relying on one single measure for all the important financial things in life is dangerous. There are technically 3 items in measuring credit worthiness; character, capacity, and collateral. In today's market fogging a vanity mirror means you are credit worthy.
Then we have the opposite extreme with the subprime debacle . Even though folks have horrendous FICO scores that looked more like baseball batting averages, mortgage lenders decided it would be prudent to issue out $500,000 exotic mortgages. In this case, greed is more powerful than a credit rating. And now these companies are surprised that someone with a $40,000 annual income doesn't have the character to pay back a $4,000 monthly mortgage payment. Maybe people should of thought of that instead of churning higher commission cuts. Believe it or not, getting credit is still not that hard even with all the talk about a tightening market. If you doubt this just take a look at all the spam in your e-mail box. Or you can see that credit card companies are still offering low rates in your snail mail. Credit scores also impact the interest rate on your auto, home, and credit cards and over a lifetime, this can add up to hundreds of thousands of dollars. And don't think we haven't had any historical warning. Let us take a look at some famous credit quotes:
Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
William Shakespeare (Hamlet 1:3)
One of the greatest disservices you can do a man is to lend him money that he can't pay back. Jesse Holman Jones
Lending money to someone that can't pay is wrong on so many fronts. We can yell personal responsibility but never in our history have people been able to have access to so much credit with such little repercussions for lenders and borrowers. Lenders are now screaming for a handout. Why don't we audit their underwriting standards and see if the people that got these absurd loans had sufficient income and good credit since they are so married to these tools? In fact, the government can amend their bailout corporate welfare by stipulating that only loans that met historical underwriting standards of 28 to 33 percent income to housing ratios and solid credit histories will be eligible for a bailout. In this credit bubble, character, capacity, and collateral were all thrown out the window.
Education Just Got More Expensive
The LA Times did a great story about families wrestling with the college price tag. Amazingly, some private institutions annual fees cost more than the median income of the American family. So what to do? Go into debt or forego a college education (which we already mentioned that 80 percent of millionaires have a college degree). They have a fantastic chart breaking down the numbers for a 4 year degree. I'll summarize the annual cost here which include tuition, housing, books, and transportation:
Georgetown: $51,290 (Private 4 year)
UCLA: $23,301 (Public 4 year)
Cal State Long Beach: $17,228 (Public 4 year)
Pasadena City College: $13,776 (Community College)
A student graduating from Georgetown paying down $20,000 a year, will end up borrowing $140,996. If they want to pay off their student loan in 10 years they will need to fork over $1,711 a month assuming 8% student loan rates. Now assume this student goes to Georgetown and comes out making $50,000 per year. Chances are many of these people will want to go further and pursue graduate school. Many top law and business schools will cost $50,000 per year. So we add another $150,000 in debt unless they have someone to help with these payments.
As you can see, many future undergraduates will come out with amazingly high student debt. We're not talking about $10,000 or $15,000. We are talking about mortgage level debt. And what if they want to buy a home? More debt! Debt, debt, debt. Its as if we are programming the future of America with this mentality that to get ahead, you are forced to go into debt. And for many students that come from lower to middle class families they have no choice. Well they do have a choice, either forego college or sign away for loans. The LA Times article also breaks the misconception of many parents sending kids to public 4 year institutions. Even though it is cheaper, competition is stiff and class sizes may not be as accommodating as a private school. It is a hard challenge and I don't envy parents of today sending their kids off to school.
What is The Median National Income?
The median family income for US households is $46,326. How in the world will the median family (which means half fall below and half fall above) near the median be able to send their children to college without saddling up debt? As you can see our society is almost completely based on credit. For those that don't have wealth reserves, you must bite the bullet and take student loan debt, mortgage debt, and credit card debt. Of course, you shouldn't spend beyond your means. But even if you have a distaste for credit you still need a strong credit score for better mortgage rates, lower insurance premiums, and sometimes a nosy employer.
But something doesn't seem right with the median family income. How can it be that the annual price of college looms over the annual family median income? Many stories are hitting the newswires about students graduating and struggling to manage their debt. Many turn to using credit cards to stay afloat. And the vicious cycle of debt goes on and on. To breakdown the numbers further on income, I wrote an article on affluence in America . Here are some stats breaking down the numbers further:Household income (overall percent of US households over):
Percent of Households over:
$65,000 34.72%
$80,000 25.6%
$91,705 20.0%
$100,000 17.8%
$118,200 10%
$166,200 5%
$200,000 2.67%
$250,000 1.5%
$1,600,000 0.12%
Even families making $100,000 a year, only 17.8 percent of all US households, will still have a challenge sending their kids to a 4 year private college. And most people want the best for their kids so they are not likely to scrimp in this arena. This isn't a choice between a Camry and a Hummer, this is your child's future. And here is a nice caveat, student loan debt is not wiped out by bankruptcy. And now imagine this hypothetical family sending a child off to college and carrying a $400,000 mortgage on a home. Do you think folks in these Real Homes of Genius even have the income to support their home loan? Too much credit floating around.
4 Wheels of Credit
We are a car loving society. So many car makes and models exist that you can assign each letter of the alphabet and still have remaining vehicles unnamed. Driving around on the freeways, you would think that hardly any person drives a car older then 3 years. But what is the average cost for all this? According to Edmunds the average car loan in 2003 is $23,801. And according to this same survey the average monthly payment is $447. This isn't factoring insurance and fuel cost. Insurance cost can easily be $1,200+ year for a new car and fuel cost can be $150 to $250 per month. And unless you live in New York City or relatively close to your work, public transportation is not an option unless you want to spend extra hours.
Do we Really Need to Eat?
You rarely hear about the monthly cost of eating. But let us take a look at some data put out by Claritas regarding yearly eating habits for California families:
Cereal: $342
Bakery products: $667
Seafood: $170
Meat: $1,286
Fruits and Vegetables: $915
Juices: $229
Sugar and other sweets: $427
Fats and oils: $64
Nonalcholic beverages: $703
Prepared foods: 1,252
Fresh mild and cream: $179
Eggs: $103
Other Dairy products: $436
Annual cost: $6,773
Keep in mind this doesn't factor in dining out. According to Restaurant.org :
“Consumers with a household income of $75,000 or more eat an average of 4.9 commercially prepared meals per week, compared with 3.2 meals for those with an income of less than $15,000. Close to two-thirds of individuals with a household income of $75,000 or more report eating at least one commercially prepared lunch per week, compared with one out of five consumers with an income of less than $15,000.”
So clearly the more you make the more you eat out. If you eat at a restaurant once a week with your family, it can easily cost you $50 with gratuity. So that is an added $200 per month on the lower end.
Putting It All Together
And how can we forget the median cost for a single family residential home in Los Angeles County . Even though the bubble is bursting, the median price for a SFR in LA County still sits at $547,500. So let us run a hypothetical budget using all these expenses from college, car, eating, and a mortgage payment. Let us assume that we buy the median home, send our kid to college and offer them $20,000 per year, have 2 average cars in our household, and eat the average amount of food. How will our budget look?
Monthly Budget
PITI: $4,100 (Putting down $54,750 on $547,500 and using current jumbo rates on a $492,750.00 mortgage - 30 year fixed conventional financing)
Auto Loan Cost: $894 (2 cars with each carrying a $447 monthly loan).
Auto Insurance Cost: $160 (2 cars full coverage)
Fuel Cost: $300 (assuming that we only use $150 per vehicle)
Food Budget: $564
Dining Out: $200
College Support: $1,667 (Providing our kid $20,000 a year support to attend a 4 year private school)
Utilities: $120 (includes Gas, Electric, and basic phone service)
Credit Card Service Debt: $168 (According to Bankrate, average household credit card debt of $8,400)
Health care cost: $575 (Lower approximation for a family of four full coverage, according to The National Coalition on Health Care.)
Total Monthly Expenses: $8,748 or $104,976 annually.
Is it any wonder that we are in a massive credit bubble? Helps us understand why we have a negative national savings rate. And I am hard pressed to believe that the above looks like low to moderate inflation. The game is rigged and forces everyone to go into some sort of debt.
How do these numbers compare to your household budget?
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By Dr. Housing Bubble
Author of Real Homes of Genius and How I Learned to Love Southern California and Forget the Housing Bubble
www.doctorhousingbubble.com
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