A Leauki's Writings

Since I just sold a flat in Berlin (my dad was using it until late last year) and since I am thinking of buying a place in a few years, I searched the Web for property and mortgage information, theoretical such.

I found this interesting article from 2007 which gives an example of how circumstances can change. Don't bother reading the article itself, I will quote the relevant sections and numbers.

http://drhousingbubble.blogspot.com/2007/07/foreclosure-story-how-does-process-look.html

From the article:

Joe and Mary

Ages: 29 and 28

Professions: Joe - Senior Account Executive (lender), Mary - Real Estate Agent

Location: Orange County

Yearly Income Combined: $130,000 Gross

Net Monthly Income (After Taxes): $8,200

Automobiles: Mercedes E350 Sedan ($599/33 month Lease), GL 450 Suv Purchase ($56,000)

Monthly Auto Fuel Cost (Filling up Once Per Week): $350

Home Purchase: Costa Mesa 4/2 Home, Bought Late 2004 for $675,000

Credit Card Debt: $25,000

Monthly Food Budget (Including Dining Out): $700

They are both a bit younger than I (I am 32) but seem to be in the same income range as I. I don't have a car. And I never had credit card debt of more than EUR 4000 or rolling credit card of more than EUR 2000. I assume cars can be bought using car loans that cost less interest than credit card loans.

2004 Budget

House Payment (PITI – at 2.75% interest only/2 years): $2,249

Auto Cost (monthly payment/lease/loan/fuel): $1,749

Dining: $700

Credit Card Payment:  $500

Total: $5,198

Monthly Net: $8,200

Disposable income: $3,002

I cannot quite grasp the wisdom of buying a house using an interest-only mortgage but I already find the numbers scary.

Buying a house without having any money to begin with is one thing. Not everyone has savings and nor should they be needed. But 25,000 credit card debt is quite a sum to deal with. But the 2.75% interest for the mortgage are just great. That was a good deal. I have never seen such deals.

The disposable income is approximately what I have after rent and food, taking into account that I am only one person. But for me this is after pension fund and health insurance payments (but before credit card payments which I always consider special rather than part of the pre-spending money budget).

After two years the interest rate rises to levels more familiar to me:

2006 Budget

House Payment (PITI – amortized fully over 28 years/full rate of 6.25%): $4,962

Auto Cost (monthly payment/lease/loan/fuel): $1,749

Dining: $700

Credit Card Payment: $500

Total: $7,911

Monthly Net: $8,200

Disposable income: $289

Ugh! 300 dollars for living, health insurance and pension fund payment. This is not good.

And finally, one of them loses his job and only finds a cheaper new job:

2007 Budget

House Payment (PITI – amortized fully over 28 years/full rate of 6.25%): $4,962

Auto Cost (monthly payment/lease/loan/fuel): $1,749

Dining: $700

Credit Card Payment: $500

Total: $7,911

Monthly Net: $5,804

Disposable income: $-2,107

So this is how a couple with a yearly income of US$ 130,000 can get into severe financial trouble.

However, while the numbers look sound, the whole thing strikes me as odd. How could this happen? Don't tell me it's just stupidity because one really doesn't need to be that smart to see this coming and the couple at 29 makes more money than I made in most of my 20s, so the market still thinks they are smarter than I.

As I said in another post, there are different ways to assign blame. I am a "moderate", perhaps, and tend to assign blame mostly to the individual but also at least partly to society.

Something is wrong in a society where nominally smart people buy a house when they owe 25,000 dollars on their credit cards. In fact something is wrong when people owe 25,000 dollars on their credit cards, full stop. (Perhaps those were costs for medical treatment. I don't know.)

Of course, in 2007, if all credit card payments were duly made, most of the credit card debt would be gone (they would owe about US$ 5000 which I accept as "manageable"). And we could argue about whether 350 dollars per month per person is too much spent on food, although saving 100 dollars per month is really not the issue here.

So what did go wrong?

I can see five major problems:

1. They ammassed 25,000 dollars of credit card debt. (Ignore as a mistake if this was for medical costs.)

2. They bought/leased two expensive cars. (One expensive car is enough. The wife is a real estate agent and I guess it's part of the job description. But the second car can be cheap.)

3. They decided to buy a house when still owing 25,000 dollars credit card debt. (This is a big one!)

4. They decided to buy a house with no savings and no mortgage security. (This is something one can risk if one had no special debt and at least  few thousand bucks lying around. It's still stupid but at least it gets you a home.)

5. They didn't take into account the risks of job losses. (This is especially serious since they were two people and already had limited this risk by being a couple. Instead of seeing the risk limited they chose to reintroduce it for no good reason by buying an expensive house.)

Can someone explain to me how these things happen?

I am not trying to make fun of anyone, just want to learn what awaits me since I am in a similar position as these two, financially and age-wise.

Differences are I don't have rolling credit card debt of 25,000 dollars and more disposable income after health insurance and pension fund payments. I seem to have done something right.

 


Comments (Page 1)
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on Jun 14, 2010

No, this is not spam.

on Jun 14, 2010

Our government encouraged us to ignore the traditionally considered risks and benchmarks by rigging the rules for lenders (which, not coincidentally, was good for lenders & their middlemen), and 'smart' people said get the biggest and/or most expensive house you can pull off, because values can only go up.  The rest, as they say...

There was also the fact that no similar contraction in the real estate values had occurred in living memory.  There was a real estate 'bubble' in the mid-to-late 1970's but it didn't 'burst' in the same way - values just leveled off & the gains were mostly maintained.  Home values didn't really take much of a hit with the savings & loan crisis, either, though commercial values did.  So we were conditioned a bit to believe the bottom couldn't fall out.

on Jun 14, 2010

we see this stuff all the time in the CPA business especially with the younger people.  They want what they want now; not thinking about the rainy day ahead or leaving WITHIN their means but ABOVE their means.  They want to keep up with the Jones' or have what their parents have now. 

We counsel young couples all the time to live on one income as much as possible just in case.  Use the other income to do the fun things or repairs or any extras that make your living more enjoyable but make sure your budget can withhold one income. 

We also tell them to use credit cards wisely paying it completely off at month's end.  Never never pay interest.  Instead take advantage of the perks you can get by using credit cards.  make them pay you for using them without paying interest. 

I'm constantly staying in free hotels when we go somewhere (this weekend as well) by using my CC that gives points for hotel stays.  I charge everything, including my groceries and gas but I pay the balance off in full at the end of the month.  Usually it doesn't get up much past $500 but in the meantime I accumulate points. 

The 2007 budget here is absurd.  They're in the red but yet their eating out hasn't changed?  That's the first thing that needs to go.  Eating out is a huge waste of money.  Enjoy a pizza or takeout once in a while (no tip involved) and save tons of money by going to the grocery store instead. 

We haven't had a mortgage since I was 39 years old and our income never went as high as you're saying here.  Not once.   Our last two houses have been completely paid off with the last house (brand new) being over 300K .   But we did this by living below our friends and family for the first 20 years of marriage.  Now we live comfortably with no house and car payments while everyone else is working hard paying for their mortgages in houses they've lived in forever.   Instead most of our money is going towards retirement.  When the kids were home we didn't have alot of money to throw into retirement (just an IRA) and got started late.  But now, playing it smart, most of our money is being stashed away so my husband can retire in five years and we can enjoy the rest of our lives without killing ourselves to the end. 

It can be done.  You just have to be smart about it and by the looks of things Leauki, you've got the smarts to do it right.   

 

 

 

 

 

on Jun 14, 2010

Note that their "dining" included both meals out and normal meals at home.

 

we see this stuff all the time in the CPA business especially with the younger people.  They want what they want now; not thinking about the rainy day ahead or leaving WITHIN their means but ABOVE their means.  They want to keep up with the Jones' or have what their parents have now.

Indeed. But you see, I am one of those who wants what he wants now. I buy whatever I want. The computer I use cost over 4000 euros.

But I find it hard to spend much more than I have. The less I work, the more time I have to do things I like, and the less I have to spend on things. And the more I work, the more money I need to buy instant fun, and the more money I get for working more. It evens out.

When I turned 31 I started a pension fund. It's late I know, but it looks like it will be sufficient if I retire when 65. I can also survive a few months without a job. Plus I live with room mates not only because it saves money but also because I get bored alone.

 

 
We counsel young couples all the time to live on one income as much as possible just in case.  Use the other income to do the fun things or repairs or any extras that make your living more enjoyable but make sure your budget can withhold one income. 
We also tell them to use credit cards wisely paying it completely off at month's end.  Never never pay interest.  Instead take advantage of the perks you can get by using credit cards.  make them pay you for using them without paying interest. 

Such counseling is a great idea. I sure could have used it in the past. Young people don't take life seriously. I still don't. But I was lucky enough so that my income always matched my increasing expenses.

As for credit cards, you are right. I still wonder how anyone could get a 25,000 dollar balance! And it wouldn't even occur to me to buy an expensive car unless I had the money.

I pay more than EUR 350 for food every month. I eat too much and I eat in restaurants too much. But that's a monthly expense I cut cut to a minimum (less than 50% of current) immediately if I had to. I eat in restaurants because I don't have the time to cook. If I had no job and had the time to cook, I wouldn't have to eat in restaurants.

Living with family wasn't really an option for me although the flat I owned in Berlin was originally bought by the family in my name and I wasn't the only use in the last ten years.

 

It can be done.  You just have to be smart about it and by the looks of things Leauki, you've got the smarts to do it right.   

I rate myself as just above average when it comes to planning life. I am doing a little bit better than random decisions would. But I have two advantages. I enjoy my work and I have a good "bullshit detector", meaning that I don't very often fall for stupid schemes that cost me lots of money.

It really helps when you attend services every week and talk to people in the same situation in an environment that doesn't reward bragging (If you brag in a synagogue, they will ask you for donations) and isn't about work.

 

 

 

on Jun 14, 2010

 

I eat in restaurants because I don't have the time to cook. If I had no job and had the time to cook, I wouldn't have to eat in restaurants.

my son is just like you.  He's single, works hard and long hours and goes to Wild Wings almost every night for dinner.  He doesn't have the energy nor the time to think about cooking.  I get that.   That's part of the single life I guess.  It's not so bad if it's just one but even still..you could save alot by eating home at least half time.  Or you can do what I do, get a good meal, take half home and have it for lunch the next day.  Quite often we go to places that have a salad bar with the meal.  I go heavy on the salad bar, and end up taking most of my meal home with me for a second meal later.  It's like getting two for one. 

what kills me also is I've seen young couples (maybe that's where the 25K credit card amount comes from) take out second mortgages on thier homes to take a lavish vacation or buy that expensive car that depreciates big time minutes after you drive it away. 

Add some unexpected roof/furnace/ or any house/car repairs later or a medical situation and before you know it it mushrooms. 

on Jun 15, 2010

The root cause of the economic problems that the USA is facing is the prime lending crisis and the collapse of the housing market.

on Jun 15, 2010

 

my son is just like you.  He's single, works hard and long hours and goes to Wild Wings almost every night for dinner.  He doesn't have the energy nor the time to think about cooking.  I get that.   That's part of the single life I guess.  It's not so bad if it's just one but even still..you could save alot by eating home at least half time.  Or you can do what I do, get a good meal, take half home and have it for lunch the next day.  Quite often we go to places that have a salad bar with the meal.  I go heavy on the salad bar, and end up taking most of my meal home with me for a second meal later.  It's like getting two for one. 

Funds for food are not a problem here.

I can't actually save anything by eating at home. If it takes me an hour to prepare food I lose more money by not working that hour than I save by cooking myself.

But the salad bar trick is good. I'll keep that in mind.



what kills me also is I've seen young couples (maybe that's where the 25K credit card amount comes from) take out second mortgages on their homes to take a lavish vacation or buy that expensive car that depreciates big time minutes after you drive it away. 

You see that's the sort of thing I don't understand. Who takes out a mortgage to go on vacation? It's like a category violation. It wouldn't even occur to me. And who needs a vacation before working hard to make the money the vacation will cost? What are they vacationing from?


Add some unexpected roof/furnace/ or any house/car repairs later or a medical situation and before you know it it mushrooms.

 

All these things can happen, but I just don't get why anybody would buy a house when they owe 25,000 on credit cards.

I can envision three different situations in which a house can be bought:

1. Buyer has the money. He should buy.

2. Buyer has some money, gets a mortgage for the rest. He should buy if he wants to live in a house.

3. Buyer has no money, gets mortgage for entire amount. He can buy, if he is aware of the possible repercussions.

The fourth situation is just not in my list:

4. Buyer owes money, gets a mortgage for house price.

This guy shouldn't buy a house. In fact, number 3 shouldn't buy a house either. But I wouldn't rate his decision to buy anyway as deeply stupid.

Numbers 1 and 2 are useful strategic decisions unlikely to be very wrong.

Number 3 is an even bet.

But number 4 is an uneven bet and a clear mistake.

The clear advantage of number 2 over number 3 (and 4) is that a loss can be taken up to the amount originally saved and a bit beyond.

If the buyer has 10% of the house price in cash, he can take a 10% loss without losing everything. It sounds simple, but it's something to keep in mind.

on Jun 15, 2010

he computer I use cost over 4000 euros.

You are going to have to blog on how ANYONE can spend $5k on a computer these days that does not say "Good Morning Dave"!

I still wonder how anyone could get a 25,000 dollar balance!

Ask my ex.

 

As for your questions, I think Daiwa and KFC both went over the whys and hows.  It started with bad laws, salted with no history, and then added bad judgment.  It is a different mindset from most of the conservatives you see here at JU.  We plan for bad times.  Many do not.  The Balloon mortgage you describe is just such bad planning.  And that is abetted by mortgage lenders to a degree.  The siren song is that "your income is not so great today, but it will go up, so get a low entry mortgage and then let your income take care of the balloon payments".  It was especially prevalent in the 70s (when inflation was making it a steal to finance at almost any rate).  People remember the 70s.  They do not remember the 30s (when a similar housing bust occurred).

But one slam against most Americans is they are economically stupid.  And that is indeed the case.  The 70s brought run away inflation (relatively speaking 10-20%), and people expected that to be normal.  It has not been since (although it will probably occur again unless the US declares bankruptcy).  They forgot that crucial element when they decided to buy like it was the 70s.  And of course their income did not go up by double digits each year to pay off the huge mortgages they needed to buy the houses they could not afford.

A long time ago, I saw one of those news shows.  They were crying poor mouth about the high rate of bankruptcies (some things never change).  And so they interviewed one SoCal couple like the one you described.  The couple was in the middle of bankruptcy proceedings, and had not cut back on their "luxury" spending.  Why?  "We deserve this stuff" was the response.  That is the mentality of those you describe.  They never grew up.  Like a child, they want their wants when they want them.  The world is full of them. It is a symptom of a society that has eliminated hardship.  When there is no downside to risk, the sky is the limit.

on Jun 15, 2010

You are going to have to blog on how ANYONE can spend $5k on a computer these days that does not say "Good Morning Dave"!

It was easy. I had enough of waiting for the machine to react, even if it was less then a second.

And so I bought an octocore (two CPU) Mac Pro with 8 GB memory and two 1 TB SATA drives attached to a 24" Apple Cinema Display. I finally have a machine I can run all my VMs on without noticing that I forgot to shut them down.

For an entire year I thought that maybe I spent too much and should sell it, but it worked out. And now I am only worried about the weight should I ever decide to move again. (I'd probably sell it then.)

 

And so they interviewed one SoCal couple like the one you described.  The couple was in the middle of bankruptcy proceedings, and had not cut back on their "luxury" spending.  Why?  "We deserve this stuff" was the response.

I have noticed this new concept of "automatic deserving". I wonder where it comes from.

Thanks for the other points. They explain a lot.

While I myself don't really plan ahead, I still find it difficult to throw quite as much money away as the couple described. I wouldn't even have the time to buy a luxury car let alone to drive it.

 

on Jun 15, 2010

I have noticed this new concept of "automatic deserving". I wonder where it comes from.

Our government.  They are trying to eliminate the down side of risk (pity parties nightly in the news and the politicians 30 second sound bytes about how bad it is that some go-zillionaire is being foreclosed on).  That is also why the US is not far behind Greece in its Bond ratings.  Bailing out everybody is a limitless expense.

on your computer, that is still pricey, but it is a Mac.  I would have gone for a lot more memory though.  Right now, 8gb is my starting point for a desktop, and I do not know the words "enough memory".

on Jun 15, 2010

While I myself don't really plan ahead,

Yes you do.  You have already started a retirement plan.  That is more planning than the average citizen does.

on Jun 15, 2010

on your computer, that is still pricey, but it is a Mac.  I would have gone for a lot more memory though.  Right now, 8gb is my starting point for a desktop, and I do not know the words "enough memory"

I could get a single CPU box with 4 slots for memory or a dual box with 8. I got the dual and put 4x2 GB in it, figuring the 4 GB pieces would become cheaper within the year. They didn't really. Now I am thinking of buying another set of 4x2 GB.

 

on Jun 15, 2010

Yes you do.  You have already started a retirement plan.  That is more planning than the average citizen does.

It's just something one has to do...

Where does the average citizen think pensions come from? Santa Claus?

 

on Jun 15, 2010

Where does the average citizen think pensions come from? Santa Claus?

I take it you have not seen the videos or listened to them.  They will all tell you that it comes from "Obama".  From his private stash.

on Jun 15, 2010

Just did a spot check on memory prices.  Yea, I guess the manufacturers have finally stopped the price hemorrhaging.  A bit pricier than a year ago, but considering they were dropping like stones before then, they are getting expensive.

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