Underwater and Overextended
How new homeowner mistakes are sending the housing market on a downward tear
Ric Edelman: It's Monday, January 29th. I want to talk with you about home ownership and particularly a potential market meltdown. Is it coming? Well, just look at the numbers. A lot of the people buying homes are people who also have student loan debt. Monthly student loan payments are capped at 10% of discretionary income for a lot of these folks, which means a lot of student borrowers are not reducing their balance even when they are making payments. And it's worse than that. The size of their student loans is not counted against them when they try to qualify for a mortgage.
In other words, your total debt should not be more than 36% of your income. Most financial advisors will tell you to keep it to 30% of income, even less, the lower the better. But 26% of the mortgages that are backed by Freddie Mac last year they had debt to income ratios not of 30%, not of 36%, but 45% of income. Oh my goodness.
And Fannie Mae is now guaranteeing mortgages for people with debt-to-income ratios of up to 50%. And remember, these figures do not include the student debt for borrowers and those income-based repayment plans. The translation of all this people who can't afford to pay off their student loans are getting mortgages that are $100,000 or $200,000 bigger than they ought to be getting, and that's not the worst of it.
Mortgage lenders are now letting people make down payments of just 2%, not the 20% that financial advisors recommend. This is letting people qualify for bigger mortgages, and it lets them buy more expensive homes. But that all translates into much bigger monthly mortgage payments, so big that these homeowners can barely afford to buy anything else. If half of your income is going to your mortgage payment, how can you afford food or insurance or car payments? Oh my goodness, it's all good. If your house rises in value, you'll be able to tap into the equity to keep yourself going. But housing prices are starting to fall. In San Francisco, the total value of homes there has fallen $60 billion just since June. 12% of the sellers over the past nine months have sold for less than what they paid for their house, according to Redfin.
This is not just a San Francisco thing. Nationally, the median price of homes is down 13% just since October. That means recent home buyers who made small down payments already owe more than what their house is worth. Property insurance rose 20% last year. What happens if taxes rise, too?
Maybe this is why so many student loan borrowers are not making any of their payments on those loans. If you don't pay your mortgage, you lose your house. But if you don't pay your student loan, what happens? Not much that I can think of.
There are 43 million borrowers who collectively owe $1.6 trillion in student loans. In October, for the first time since the pandemic, 22 million of these people had to start making payments again on their student loans. But 40% of them aren't. They're thumbing their nose at the student loan program, and if the government presses them to start repaying, are these people going to be able to make their mortgage payments on top of their student loan payments? What happens if they can't make payments on both? What happens if housing prices don't rise?
The future is unclear on all this, but it's worth paying attention to for you as a financial advisor. Make sure your clients are not getting a mortgage they can't afford. Make sure their children are not doing it.
And if you're a consumer, make sure you and your kids are managing your finances properly. Clearly, the future is going to be bleak for a lot of people, but all of this is avoidable. You simply need to be prudent. Otherwise you'll wish you were.
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