Wednesday, June 14, 2006

People who habitually make poor financial decisions annoy the crap out of me. I’m not talking about teenagers who max out credit cards, or welfare queens with lotto scratcher habits; I’m annoyed most by the people who should know better, the ones who are familiar with the basic concepts of money management, but choose not to employ them. These people annoy me because I am invariably subjected to incessant bitching about their woeful financial situation when the inevitable consequences of their poor judgment spoil their fun.

Money magazine recently profiled several people, mostly typical white bred suburban professionals, who now find themselves facing the prospect of huge jumps in their mortgage payments. Why? Because in the past few years they all bought homes they wouldn’t otherwise be able to afford by using short-term adjustable rate interest-only mortgages. Now that the fixed rate period of the mortgages are due to expire, these homeowners will have to begin paying down the principal portion of the mortgage, along with more interest as rates steadily rise. Some of the profilees are about to see their mortgage payments nearly double overnight. What gets me is that they grasped the basic math, they understood the contractual obligations of the mortgage, they were aware of the risks of holding interest-only (I/O) loans in a rising interest rate environment, they knew full well that when the fixed term expired they would have to pay down principal plus bigger interest payments, they knew their income wasn’t going to significantly increase to offset the greater costs down the road, yet they signed on the dotted line anyway. Considering all of that, the bitching is really hard for me to swallow.

Out of curiosity, I logged on to the Maricopa County Recorder’s website and looked up the escrow documents of several of my neighbors to see who in my immediate vicinity is financially savvy and who is a complete moron, based strictly on the mortgage options they selected. To my dismay, I discovered I’m surrounded by idiots. Considering that almost every single one of them concurred at a recent neighborhood BBQ that it was their intent to stay in their homes for a good long time, not one of them has a mortgage with a fixed rate period that extends beyond 5 years. Most of my neighbors’ mortgages are of the I/O variety, including one couple who purchased their home with a 3 year I/O adjustable rate loan that carries a massive balloon payment, a huge pre-payment penalty, and an interest rate that was 2% higher than the prevailing rate at the time the home was purchased. I shudder to think of how low their credit score is.

Personally, I’m a big fan of I/O mortgages, and of any other non-standard mortgage that offers buyers more choices to creatively finance their real estate investments. That said, potential homebuyers need to investigate their options carefully and use basic common sense in choosing the right financial instrument for their situation. Short-term I/O loans are not for people who want to buy a massive dream house and live in it forever. I/O loans work best for people looking to flip a house within a couple of years in a hot housing market and save money in the interim by avoiding principal payments. If you could not afford your dream house if you had to get a 30-year fixed rate mortgage, then you should lower your expectations and look elsewhere. Forgo the temptation to sign off on a short term I/O loan because you will have to pay the piper for living beyond your means sooner or later.

The same common sense principle applies to car loans, too. The Detroit News recently ran a story titled, “Car Buyers Stymied by Negative Equity”. Duh! If you buy a rapidly depreciating vehicle with a 72-month loan you’re bound have significant negative equity until the car is about five years old. Don’t cry because you’re sick of the 2003 Mitsubishi Eclipse shitbox you thought was so cool a few years ago, and you can’t trade it in for a new Dodge Charger because you’d have to roll $10,000 from the old loan on top of a new one. Use a few brain cells for once and stick with what you’ve got until you can afford something else. Don’t go further into debt because you absolutely have to have the latest, hottest wheels on the road.

Case in point, I used to work with a guy who got it in his head that buying a truck with a Hemi engine was equally as important as eating food for sustenance. He traded in his perfectly functional Ford pick-up for a brand new supercharged Dodge Ram, complete with Hemi engine and a massive loan with $4000 negative equity rolled into it from the Ford. A year later, after months of bitching about gas prices to anyone within earshot (including me), he came to the conclusion that the 10 mpg fuel economy he was getting on the Ram was just too low, seeing as how he had a 20 mile one-way commute to work. He reluctantly traded in the Hemi for a sensible, fuel efficient, 2005 Subaru Forester. His net negative equity rolled into the Subaru car loan after the Hemi trade-in: $12000.

I could go on, but I’m getting peeved just typing about this craziness. Bottom line, it’s your money. You worked hard for it, sort of. Spend it as you wish, but don’t go complaining to your friends, your family, your co-workers, or your local newspaper when the consequences of your poor financial decisions come back to bite you in the ass. It’s annoying, it’s rude, and it’s a scathing indictment of your stupidity.


At 6/14/2006 1:12 PM, Blogger Canuckguy said...

It's all about trying to keep up with the Joneses. The other reason, risky greed when playing the housing market like the stock market. They (the I/O ones) will bleed when the housing market bubble is pricked.

At 6/14/2006 4:16 PM, Blogger Ace said...

The prick has already happened. I doubt there will be an implosion in home values, but rather a controlled deflation in the order of 10% - 20% depending on the local market. We're already seeing it occur in a number of overheated markets, like Boston, Fort Lauderdale, Las Vegas, San Diego, and Phoenix.

As Galbraith noted, financial euphoria is fuelled by excessive leverage. I/O loans are just the latest version of it in the real estate game.

At 6/15/2006 10:18 AM, Blogger Canuckguy said...

The real estate bubble did not get pricked yet in Canada. But dark clouds are gathering. The slowing USA economy(a soft landing is predicted by some) will have its guaranteed adverse effect on Canada.


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