Originally Posted by YelloJeep
I just think that the folks that fell into adjustable rate mortgages, use check cashing places, title loans.....even credit cards.... I just think that if people were prepared and really knew what they were getting into they would be much better off.
I guess I am just trying to find a way to solve the ignorance. I hope it is ignorance and not stupidity. If it is stupidity then I guess you can't really fix that.
Originally Posted by blucher
I went to college ill prepared for anything financial including how to balance a checkbook. Despite this I think I did understand how a mortgage worked. You saved your money and when you had a sizable down payment (which tied your ass to not walking away) you applied for a mortgage.
The bank reviewed your credit history and current earnings and then gave mortgages to people who qualified.
None of this was relevant when no money down mortgages appeared. Instead of financing homes banks got into selling derivatives which both hid and masked the bad loans.
The banks knew.......
The applicants knew too but for a few years they got a nice house for playing the game.
People should get a basic education in finance but we will always need oversight to protect us from the Bernie Madoff types of greed. Fortunately it's looking like Bernie is about to bust a few bubbles of those who knew full well he was running a Ponzi scheme.
I agree with both of you. ARMs are the standard "evil loan', but there are other truly insidious loan agreements out there. Interest Only loans, where you pay only the interest accrued and never pay down the principal. Negative Amortization, loans, where you don't pay off even the accrued interest and your principal grows. Fortunately, these two beasts aren't as common as ARMs.
Blucher, you alluded to it when you said that a down payment tied your ass to the mortgage. The mortgage crisis was a house of cards stacked on top of a faulty premise. It worked, so long as the vast majority of borrowers was able and willing to pay their loans.
What happens if you put 20% down and the market value of your home drops 30%? You're now upside-down in your mortgage - you owe more than your home is worth. The bank is willing to take this home off your hands - they'll even give you $2000 if you leave peacefully, cleaning up your mess and not destroying everything behind you.
The likelihood of a house losing 30% of its value is almost zero, and he's not going to outright abandon the home if he can recoup some of his losses. If he can get some of his equity out of the home, he's going to sell it instead. Better to lose half your down payment than all of it, right?
Banks realized this, and began to search for exactly what amount of negative equity it would take to compel people to abandon their homes. The closer they got to that number, the more business they could do. They started (effectively) offering 10% down payments, then 5%, then 3%, then 0% down. Then they got really creative and started PAYING people to take out a loan. When you bought your home, your lender might write you a check! Ludicrous? I've seen it happen! Traditional lenders began lending at 103% of already inflated sales prices, then 105%, and even higher. They'd lend to 125% of market value, and push appraisers to raise their estimates!
The banks knew that when they foreclosed on a property, they would end up selling it at a loss. What they failed to realize was that selling those properties at a loss, they affected the entire housing market. They dragged housing prices down, which put more people upside down in their mortgages, which created a vicious cycle.
What was the problem? Under-regulation created an environment where success or failure depended on writing loans, regardless of their quality. Every other problem with the housing market was spawned from this initial failure. Everyone knew it was coming, there was no surprise here. It had been predicted for years, but placing any sort of governmental restriction on the private banking industry was unthinkable at the time.
I'm generally not a big fan of regulation - government should usually mind its own business and stay out of mine. But this was clearly a case where unfettered competition perpetuated the problem.
What would a comprehensive personal finance course do to that situation? Probably not much. With the ridiculously low interest rates, the fiscally smart idea was to pull out as much money as you could and invest it at higher rates. Or, take out an equity loan to pay off higher-interest debt - credit cards, car loans, etc. A comprehensive financial management course would have likely suggested this very course of action. And what would that same course say about cutting losses? Without sufficient banking regulation, a more fiscally intelligent consumer base could very well have deepened that financial crisis.