ShoreBank Blog

Can’t Pay? Won’t Pay!

by David on November 12th, 2008

Let’s compare two recent stories from the Home Front.

First, here’s a story, courtesy of The Wall Street Journal.  In 2006, Nanci Puerto refinanced her house near San Francisco for $637,288.  She and her husband “take home a combined $70,000 a year.”  According to the Journal, “Each month, she makes the minimum payment on her loan, $2,416. At the same time, she watches the outstanding principal swell since that payment doesn’t fully cover the interest costs.  Now she owes IndyMac $707,000 on a house that the county tax assessor says is only worth $410,000.”

The other story is from The New York Times.  Todd Lawrence of Norwich Connecticut “has a traditional 30-year mortgage that he has no trouble paying every month.”  Home prices in his area have fallen so much that he now owes more on his home than its market value.  “’Why am I being punished for having bought a house I could afford?’ he asked. ‘I am beginning to think I would have rocks in my head if I keep paying my mortgage.’”

Now we’ll do a little math.  It takes a monthly payment of $3,820 to fully amortize a loan of $637,288 at 6% interest over 30 years.  Just the interest, again at 6%, on $637,288, comes to $3,185 month. And, of course, these amounts do not include real estate taxes and homeowners insurance. The fully amortizing payment is equivalent to about 65% of the Puertos’ take home pay, which is about double the rule of thumb that housing costs should be a third of net household income.  No responsible lender would have made Ms Puerto a conventional, fully amortizing mortgage for $637,288.  Only an irresponsible lender would have made it.

The efforts that the FDIC, which now owns IndyMac, is making to keep Mr and Mrs Puerto in their home are laudable.  Restructuring Ms Puerto’s loan does far more than benefit her family.  It helps the local community by saving yet another house from foreclosure, and that, in its small way, benefits the whole country.  But our little math exercise cuts both ways, and we shouldn’t automatically picture Ms Puerto purely as a victim of IndyMac.  She was also a gambler.  She bet that the value of her home would keep appreciating.  Then she could keep refinancing at “teaser” rates that would keep the payments low indefinitely.  She lost.

But Mr Lawrence lost too, and he didn’t even realize he was playing.  The nationwide run-up in home values caused by cheap and easy credit has led to a vicious double-digit devaluation in nearly every part of the United States.  Mr Lawrence’s problem underlines an even greater danger than that of the Puertos.  Ms Puerto wants to pay, but can’t.  Mr Lawrence can pay, but is wondering if he should.  Creditworthiness is defined not just as the ability to pay, but also the willingness to pay.  Sorting out the mortgage mess must be done fairly, but rigorously.  Ms Puerto must be helped without making Mr Lawrence feel like a sucker.

Note:  Ms Puerto’s story appears on page 1 of the November 1 Journal in “FDIC Plan Tests Limits of Leniency” by Michael M. Phillips and Ruth Simon.  Mr Lawrence’s story is in a page 1 Times story on October 31 called “Mortgage Plan May Aid Many and Irk Others” by David Streitfeld.

Tags: community development, economic predictors, FDIC, financial crisis, foreclosed home, green banking, ShoreBank, triple bottom line

This entry was posted on Wednesday, November 12th, 2008 and is filed under Banking Industry. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.