Mortgage 101

The debate continues about how the subprime mess occurred. Let me tell you how it would not have occurred:

• Maximum Loan to value: 80% any higher requires PMI (Private Mortgage Insurance)
• Debt ratio permitted: 28/36 – This means that one’s mortgage payment and property tax cannot exceed 28% of one’s gross monthly income and all one’s monthly debt burden cannot exceed 36%.
• Income must be verified, i.e. ‘no doc’ loans not allowed.
• ARMs must be qualified at the maximum adjusted payment 3 years hence. This would insure that a year or two of rising rates would not be an economic time bomb.
• All documentation must follow the loan, no matter how it’s sold or repackaged

Would these rules eliminate foreclosures? Hardly. People still lose their jobs, and if unable to find work soon may be unable to make payments. People get sick and are unable to return to work, their disability pay not adequate enough to pay the mortgage. The rules above were broken, and the subprime mess resulted. Follow the rules above and it would take a 20% decline in prices for the lender‘s capital to be at risk. With the permitted debt ratio above, a family earning $60,000 can pay $1400/mo toward mortgage and property tax. A $1200 payment can support a $200,000 loan at 6%, 30yr fixed. 20% down, and this results in a $250,000 home. Now, the median price of a home is $206,200 per the latest CNNMoney report, down from $219,300 in the prior quarter. Seems reasonable to me.

Joe