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.