The 28-33% Mortgage Payment Rule: Confronting Reality

Back in the old days of Mortgage Lending (when loans were originated to solvent homebuyers with down payments, and at levels they could comfortable service) , the common rule was that homeowners would be limited to a mortgage that was within 25-28% of their monthly gross household income, with 31-33% being allowed for high income buyers/people with a lot of disposable income.

I think that the architects of "homeowner rescue programs" should keep this rule in mind, because you can't modify, rescue, legislate, etc, someone out of a situation that is simply unaffordable.

I.e. the question offered should be: "would the monthly payment for a fixed APR, market rate mortgage for this particular individual be in the 28-33% (dependant on income level) range?"

If the answer is yes then this is an individual that can possibly be helped, if not then you're just delaying the inevitable for that homeowner as they've just gone from a financially unmanageable situation to one that's slightly less so. Individuals who fit in the latter category would be better served if they were provided assistance that would help them to move on to a more sustainable housing situation, as opposed to trying to enable them to stay in their homes at all costs.

Trying to enable people to stay in financially unsustainable housing situations will not only magnify the eventual negative impact on the finances of these individuals, but it will also extend the housing downturn as you're just creating a glut of future foreclosures.

While I'm sure this all sounds rather harsh, the fact remains that until we accept the mathematical reality of the current crisis (at all levels) we're not going to be able to engineer the solutions that will enable the economy to recover. The thinking needs to move towards the mathematical reality of things, as opposed to the reality we'd like.

In other words:

You can't rescue people from a financially unsustainable housing situation.

AND

Nothing should be done to halt the decline in housing prices, as they were hyper-inflated in the first place and a price correction is a necessary part of having a stable housing market in the future.

Again while these are unpleasant harsh realities that people would rather not think about/believe, confronting these realities is a critical part of devising the solutions that will help us emerge successfully from this crisis. Furthermore thinking/solutions that are disconnected from reality will only prolong the crisis, and/or in many cases serve to make things worse.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Comments

[consultant101:]

So, where all those people who need to confront" harsh reality" would leave? Also, why would banks get 700 billion dollars in help and ordinary folks get nothing? Why don't we we decrease value of outstanding mortgages not only on balance sheets but also on home-owners's bank statement. We can do it dollar of bailout for dollar of balance outstanding?

Cheers,

2008 Nov 17 05:23 PM

[Markham Lee:]

It doesn't do anyone any good to use taxpayer funds to enable cash strapped borrowers to live in homes they couldn't afford in the first place, it would make more sense to help these people become financially stable renters.

2008 Nov 17 05:42 PM

[Robert Nabloid:]

The beauty of the rule above is that it also lowers the valuations placed on homes and makes it cheaper for many people to afford reasonable accommodations. Our easy access to capital has made home prices soar to unreachable levels with everyone bidding homes up.

We wouldn't be having this conversation today if the rule had been in place.

2008 Nov 17 06:40 PM

[patricia otis:]

What is so bad about all of this is for people who lost jobs for medical reasons and can't afford to stay in there houses but mortage companys that all they will do is try to get you in at a lower interest rate and you have to stay for five years . Point in fact I had to have back surgery and live in a two story house I can't walk the stairs that well anymore but does the mortage lender want to help you no all you can do to get out of your home is to file for bankrupcy. Countrywide can have the house free and clear but no they can't do that so to them if I file bankrupcy so be it. Who gains what?

2008 Nov 17 09:33 PM

[Steven Hansen:]

Patricia, I doubt whether anyone here will respond to you. You are where the rubber meets the asphalt.

2008 Nov 18 03:52 AM

[rm:]

It's my belief that the seeds of this foreclosure crisis were planted back in the late 90's when companies began to increase the acceptable DTI ratios.

31% of GROSS income on a house payment?


Do the math on that. Take taxes/ss out and see what the REAL DTI is.

The "Help for Homeowners" plan pegs the front-end ratio at 34%

That's CRAZY.

What's even more absurd is the percentage of income people spend just to own a car. Trucks, even worse.

The average American's budget is a mess, and until that clears up, no amount of "streamlined" modifications is going to help.

2008 Nov 18 09:16 AM

[Blues Gal:]

I agree with the article. Another idea to add to this would be to help those
in unaffordable mortgages find new housing that they can afford. There is
a growing amount of housing that is being abandoned, at all price levels.
Lets move the folks down a notch into a house that has payments that are
within their budget! The banks probably already have houses in their own
portfolios of delinquent loans that they could work these people into.

2008 Nov 18 09:33 AM

[Dave Witherow:]

Markham-
I agree wholeheartedly with your observations and concern about legitimate, long-term affordability. Clearly any plan that does not allow a "buyer" (a term used in the loosest possible way) to make affordable payments for the long-term is just postponing the problem, elongating the housing crisis, and hiding the necessary bottom in housing prices. And while we can debate whether the right number is 25%, 28%, 31% or 33% of gross income, my deep concern is whether lenders are restructuring mortgages with regard to affordability of the long-term payments versus just the initial payments. One of the major reasons we're in this mess is that lenders were basing their mortgage debt-to-income ratios on the initial mortgage payment (often the teaser rate or a negative amortization amount), instead of applying that ratio to the payments that would happen after the loan rate reset or recast. Obviously this is a time bomb, and I think that some of the major lenders are doing it again, qualifying their loan modifications based on a new below-market initial rate (e.g., 2.5% for Countrywide). If lenders are allowed to do this as an expedience for 'avoiding foreclosures', the "glut of future foreclosures" you refer to seems almost inevitable.

This is the thing that keeps me awake at night.

2008 Nov 18 10:47 AM

[Still Renting:]

My wife was a real estate agent at the time when they threw out this rule. She came home that day and told me about it. I said that would flood the market with newly manufactured buyers, totally tilting the supply and demand equation and inflating prices.

Funny thing is, that was only the very beginning of the irresponsible changes that put us where we are. It was clear back then. In september of 2006 I said on another site that this could lead to a depression as bad or worse than the GD. I was villified for saying it.

Time does always seem to tell though...

2008 Nov 18 04:08 PM

[Still Renting:]

Markham, you said, "Individuals who fit in the latter category would be better served if they were provided assistance that would help them to move on to a more sustainable housing situation, as opposed to trying to enable them to stay in their homes at all costs."

I firmly agree and actually have a phrase for enabling them to stay in their homes at all costs: Indentured slavery

2008 Nov 18 04:10 PM

[realgelmer:]

Isay let the banks and their high % rates take their houses back and let them become the real landlords,let them come cut my grass,fix my roof,fix my heating system when it breaks ,let them pay the home insurance is in their names anyway,let them pay my high taxes,my sewar bill,let them be wat they really are" house owners" I will pay them a "rent to own " or rent every month untill the honest price is paid and then I will be the" house owner" WAKE UP AMERICA!!!!!!!!!! we have been sold on the wrong ILLUSION of home ownership,what the banks with the backing of the gov,have created is a modern way of slavery,yes!!! slavery.do the math multiply your monthly mortgage payment X 12 than X 12years and the house is paid.but the banks keep collecting for another 18 years and if you fall behind 3 monyhs in your payment they send you the police to kick you aout of their house,(the police you pay with your taxes to protect you)now the bank sell the house again to another "slave" and have him work another 30 years to pay for the same house you just paid 12 years nice racket Ha?!!!I love comments,,,,,

2008 Nov 18 10:51 PM

[Seattle Renter:]

These people would simply convert from being homeowners back to being renters. As a lifelong renter (I am the child of renters), I can tell you that there are plenty of rental units out there.

The reality is that these are people who simply couldn't afford to be homeowners, but the lack lending standards allowed them to temporarily move into that lifestyle. Now they will simply be going back to where they were before.

The good news is that rents are stable and are currently so much more affordable than the true cost of ownership. Add a 30-year, fixed-rate mortgage to property taxes, insurance, and maintenence, and you can generally pay 2 to 3 times LESS to rent than to buy the exact same place.


On Nov 17 05:23 PM consultant101 wrote:

> So, where all those people who need to confront" harsh reality" would
> leave? Also, why would banks get 700 billion dollars in help and
> ordinary folks get nothing? Why don't we we decrease value of outstanding
> mortgages not only on balance sheets but also on home-owners's bank
> statement. We can do it dollar of bailout for dollar of balance outstanding?
>
>
> Cheers,
>

2008 Nov 19 01:38 AM

[Marxwuzrite:]

Only a complete revamp of the economy is going to fix this mess. Rebuild manufacturing, raise wages and tax away most of the ill gotten gain the wealthy have stolen from workers over the past three decades.

2008 Nov 19 09:55 AM

[john1:]

Just more unpatriotic negativity from liberals who question the party of the REAL Americans, and hate freedom.

2008 Nov 19 03:21 PM

[eternitus:]

I agree... it amazes me that the same politicians who pay lip service to affordable housing are actually trying to keep housing expensive.

Why should I have to pay 5-10% more of my income than somebody did in 2000 for shelter. This is why our economy is tanking... that 5-10% of income that would ordinarily go to consumption is going to service debt.

2008 Nov 19 03:34 PM

[Wolfdaddy:]

To "John 1":

With your "Real Americans" comment, you, like Ms. Palin, are complete butts!! So a "real" has to have certain, non-decenting (in your world) views of America.

Sir, you should know that different/diverging views are what this country was founded on. So why in the he** would your views be more relevant than mine? That is a silly comment. It also smacks of division. Yeah, we Republicans are going to win with that logic ... aren't we??

All of us, will need the "others" of us to win in the future. We can ignore the future or embrace it. Our peril depends on the direction future leaders of the party take.

Finally, your views are no more "real" or "pertinent" or omg, "patriotic" than another's. Don't fool yourself into believing that the only view is a conservative one.

Ciao!!

2008 Nov 30 11:35 AM