A bit outside of my normal topics, but lately I have a number of people in my "circle" that are purchasing or considering the purchase of a home. I thought I would share some thoughts and relate it to a topic favorite of mine, risk analysis.
In the mind of a trader the first thing that is usually analyzed is risk. What happens if the trade moves against me? Where do I sit if the asset moves away 10%, 20%, 50%? The second piece dissected should be reward. I know a lot of us count on our income to make the mortgage payment. But what happens if that "underlying" decreases 10, 20, 50, or 100%.
Back in 1999 when I bought my home I was absolutely floored at the amount the lender qualified me for. Sure, I had good credit and a decent income, but if I would've purchased a home with the approval amount, I would have no cushion at all. This amount made me immediately start number crunching and after I realized how ridiculous it was, I came up with the number I felt I could handle in good times and bad (it was less than half of the lenders number). So as I look at the news and see that Ed McMahon stands to lose his multi-million dollar home, I start to wonder, who's the fool here? I don't mean this about Ed in particular, although it's certainly applicable, but the question posed casts a wide net covering borrowers and lenders. If I were a bank, I would not have extended the amount of money to me that they did. And as I stated above, as a borrower, I knew that borrowing that amount of money would put me in a very risky situation. A prolonged illness, a layoff, a salary cut, or any other situation that choked income for a month or two would've put me in a bad situation in a hurry. Investors and traders talk about risking their trading accounts or retirement funds, but what's riskier than gambling with your home? Also, I was glad to hear Ed say what do you expect when you "spend more money than you make". At least he's not trying to blame the economy, the president or the federal reserve.
So what were the lenders thinking in this situation? They should know by now that bad things happen to good, payment making people from time to time. Why would they accept this level of risk for a relatively low return? I understand it's a numbers game, but even if a sector of the economy tanks, that's a lot of people unable to make payments, and apparently such a small fraction is taking these big institutions out. Who does risk analysis here and are the shareholders of these institutions so fixated on reward that they completely ignored risk?
My point about not accepting the full amount wasn't to show you what a smart and responsible guy I am, it was to point out that even someone like me, a regular joe, understood the risk (and I was just a snot nosed kid in my 20's at the time). Why was it not obvious to these lenders? Or maybe it was and they could simply wrap them up as CDOs and sell them on the market. At that point, it became a game of musical chairs or more fittingly, Russian roulette.
So the bottom line here is that the lenders apparently don't care about each other and they certainly don't have your best interests at heart. If you're considering purchasing a home, even in this alleged depressed market, don't bite off more than you can chew. Take the good faith estimate and add a good 10 or 15% to the monthly amount for taxes and insurance and analyze the risk. Also remember that even if you're lucky enough to have a house payment roughly equal to what you were paying in rent, it's still more expensive to own a home. These little unexpected expenses are what we affectionately refer to as "the joys of home ownership" in our household.
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