The Invisible Mortgage Hand: Analysis of a Society That Forces You Into Debt.
The Ministry of Truth, otherwise known at the Bureau of Labor and Statistics, tells us that inflation is low to moderate. In fact, inflation is so low all you need to do is purchase 10-year Treasury notes and you’ll be fine. But we do have inflation and this is apparent in the credit markets. We live in a society were folks are forced to go into debt. Instead of addressing our negative savings rate, corporate America decides to create credit products that will put you even further in debt. They use the machines of marketing to subtly make you feel that having 10 credit cards, student loan debt, and steroid induced mortgages is okay. In fact, if you don’t have these products you are some loser flunky that simply doesn’t understand success 2.0 in this country. I’m sure many of you have seen the current spin of advertising. Have you seen the commercials where anyone paying with cash at the mall, fast food store, or ball game is seen as some slow scumbag? The subconscious message is this, “hey, you are a lowlife if you carry infectious cash, pay with a credit card and GET IN LINE!” So what if you want to pay with cash. In fact, you should get kudos for doing this since it demonstrates that you are paying with real world money instead of mortgaging your future for a cup of espresso.
We are going to examine how our society by default forces people into debt. We are going to look at credit scores and why there is pressure to maintain a high 3 digit number. 80 percent of millionaires in this country have a college degree so we will look at the cost of going to college. Many people live out in the boondocks and commute to work so we’ll examine our driving culture. Most people eat and don’t live off air, so we’ll dig into our eating cost. And most of us need to live somewhere so we’ll take a look at housing cost.
The Good Character Factory, Credit Scores
Most people realize that they need to have good credit. In a society run by information gathering and data mining, most of what you do can be tracked. Many insurance companies will use your credit score in determining your insurance rates. Some employers will run your credit as a method of determining your character. They can easily call references and ask you to submit official documentation but 3 digits are a much better representation of who you are. In fact, folks are sometimes penalized for canceling credit cards because their debt ratios fall lower than they would like. You aren’t carrying around enough credit insurance. And if you are looking for a rental property, your credit score may determine whether you get the place you want. Relying on one single measure for character judgment is as useful as examining GPA for financial success. They are both important but relying on one single measure for all the important financial things in life is dangerous. There are technically 3 items in measuring credit worthiness; character, capacity, and collateral. In today’s market fogging a vanity mirror means you are credit worthy.
Then we have the opposite extreme with the subprime debacle. Even though folks have horrendous FICO scores that looked more like baseball batting averages, mortgage lenders decided it would be prudent to issue out $500,000 exotic mortgages. In this case, greed is more powerful than a credit rating. And now these companies are surprised that someone with a $40,000 annual income doesn’t have the character to pay back a $4,000 monthly mortgage payment. Maybe people should of thought of that instead of churning higher commission cuts. Believe it or not, getting credit is still not that hard even with all the talk about a tightening market. If you doubt this just take a look at all the spam in your e-mail box. Or you can see that credit card companies are still offering low rates in your snail mail. Credit scores also impact the interest rate on your auto, home, and credit cards and over a lifetime, this can add up to hundreds of thousands of dollars. And don’t think we haven’t had any historical warning. Let us take a look at some famous credit quotes:
Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
William Shakespeare (Hamlet 1:3)
One of the greatest disservices you can do a man is to lend him money that he can’t pay back. Jesse Holman Jones
Lending money to someone that can’t pay is wrong on so many fronts. We can yell personal responsibility but never in our history have people been able to have access to so much credit with such little repercussions for lenders and borrowers. Lenders are now screaming for a handout. Why don’t we audit their underwriting standards and see if the people that got these absurd loans had sufficient income and good credit since they are so married to these tools? In fact, the government can amend their bailout corporate welfare by stipulating that only loans that met historical underwriting standards of 28 to 33 percent income to housing ratios and solid credit histories will be eligible for a bailout. In this credit bubble, character, capacity, and collateral were all thrown out the window.
Education Just Got More Expensive
The LA Times has a great story about families wrestling with the college price tag. Amazingly, some private institutions annual fees cost more than the median income of the American family. So what to do? Go into debt or forego a college education (which we already mentioned that 80 percent of millionaires have a college degree). They have a fantastic chart breaking down the numbers for a 4 year degree. I’ll summarize the annual cost here which include tuition, housing, books, and transportation:
Georgetown: $51,290 (Private 4 year)
UCLA: $23,301 (Public 4 year)
Cal State Long Beach: $17,228 (Public 4 year)
Pasadena City College: $13,776 (Community College)
A student graduating from Georgetown paying down $20,000 a year, will end up borrowing $140,996. If they want to pay off their student loan in 10 years they will need to fork over $1,711 a month assuming 8% student loan rates. Now assume this student goes to Georgetown and comes out making $50,000 per year. Chances are many of these people will want to go further and pursue graduate school. Many top law and business schools will cost $50,000 per year. So we add another $150,000 in debt unless they have someone to help with these payments.
As you can see, many future undergraduates will come out with amazingly high student debt. We’re not talking about $10,000 or $15,000. We are talking about mortgage level debt. And what if they want to buy a home? More debt! Debt, debt, debt. Its as if we are programming the future of America with this mentality that to get ahead, you are forced to go into debt. And for many students that come from lower to middle class families they have no choice. Well they do have a choice, either forego college or sign away for loans. The LA Times article also breaks the misconception of many parents sending kids to public 4 year institutions. Even though it is cheaper, competition is stiff and class sizes may not be as accommodating as a private school. It is a hard challenge and I don’t envy parents of today sending their kids off to school.
What is The Median National Income?
The median family income for US households is $46,326. How in the world will the median family (which means half fall below and half fall above) near the median be able to send their children to college without saddling up debt? As you can see our society is almost completely based on credit. For those that don’t have wealth reserves, you must bite the bullet and take student loan debt, mortgage debt, and credit card debt. Of course, you shouldn’t spend beyond your means. But even if you have a distaste for credit you still need a strong credit score for better mortgage rates, lower insurance premiums, and sometimes a nosy employer.
But something doesn’t seem right with the median family income. How can it be that the annual price of college looms over the annual family median income? Many stories are hitting the newswires about students graduating and struggling to manage their debt. Many turn to using credit cards to stay afloat. And the vicious cycle of debt goes on and on. To breakdown the numbers further on income, I wrote an article on affluence in America. Here are some stats breaking down the numbers further:
Household income (overall percent of US households over):
Percent of Households over:
$65,000 34.72%
$80,000 25.6%
$91,705 20.0%
$100,000 17.8%
$118,200 10%
$166,200 5%
$200,000 2.67%
$250,000 1.5%
$1,600,000 0.12%
Even families making $100,000 a year, only 17.8 percent of all US households, will still have a challenge sending their kids to a 4 year private college. And most people want the best for their kids so they are not likely to scrimp in this arena. This isn’t a choice between a Camry and a Hummer, this is your child’s future. And here is a nice caveat, student loan debt is not wiped out by bankruptcy. And now imagine this hypothetical family sending a child off to college and carrying a $400,000 mortgage on a home. Do you think folks in these Real Homes of Genius even have the income to support their home loan? Too much credit floating around.
4 Wheels of Credit
We are a car loving society. So many car makes and models exist that you can assign each letter of the alphabet and still have remaining vehicles unnamed. Driving around on the freeways, you would think that hardly any person drives a car older then 3 years. But what is the average cost for all this? According to Edmunds the average car loan in 2003 is $23,801. And according to this same survey the average monthly payment is $447. This isn’t factoring insurance and fuel cost. Insurance cost can easily be $1,200+ year for a new car and fuel cost can be $150 to $250 per month. And unless you live in New York City or relatively close to your work, public transportation is not an option unless you want to spend extra hours.
Do we Really Need to Eat?
You rarely hear about the monthly cost of eating. But let us take a look at some data put out by Claritas regarding yearly eating habits for California families:
Cereal: $342
Bakery products: $667
Seafood: $170
Meat: $1,286
Fruits and Vegetables: $915
Juices: $229
Sugar and other sweets: $427
Fats and oils: $64
Nonalcholic beverages: $703
Prepared foods: 1,252
Fresh mild and cream: $179
Eggs: $103
Other Dairy products: $436
Annual cost: $6,773
Keep in mind this doesn’t factor in dining out. According to Restaurant.org:
“Consumers with a household income of $75,000 or more eat an average of 4.9 commercially prepared meals per week, compared with 3.2 meals for those with an income of less than $15,000. Close to two-thirds of individuals with a household income of $75,000 or more report eating at least one commercially prepared lunch per week, compared with one out of five consumers with an income of less than $15,000.”
So clearly the more you make the more you eat out. If you eat at a restaurant once a week with your family, it can easily cost you $50 with gratuity. So that is an added $200 per month on the lower end.
Putting It All Together
And how can we forget the median cost for a single family residential home in Los Angeles County. Even though the bubble is bursting, the median price for a SFR in LA County still sits at $547,500. So let us run a hypothetical budget using all these expenses from college, car, eating, and a mortgage payment. Let us assume that we buy the median home, send our kid to college and offer them $20,000 per year, have 2 average cars in our household, and eat the average amount of food. How will our budget look?
Monthly Budget
PITI: $4,100 (Putting down $54,750 on $547,500 and using current jumbo rates on a $492,750.00 mortgage - 30 year fixed conventional financing)
Auto Loan Cost: $894 (2 cars with each carrying a $447 monthly loan).
Auto Insurance Cost: $160 (2 cars full coverage)
Fuel Cost: $300 (assuming that we only use $150 per vehicle)
Food Budget: $564
Dining Out: $200
College Support: $1,667 (Providing our kid $20,000 a year support to attend a 4 year private school)
Utilities: $120 (includes Gas, Electric, and basic phone service)
Credit Card Service Debt: $168 (According to Bankrate, average household credit card debt of $8,400)
Health care cost: $575 (Lower approximation for a family of four full coverage, according to The National Coalition on Health Care.)
Total Monthly Expenses: $8,748 or $104,976 annually.
Is it any wonder that we are in a massive credit bubble? Helps us understand why we have a negative national savings rate. And I am hard pressed to believe that the above looks like low to moderate inflation. The game is rigged and forces everyone to go into some sort of debt.
How do these numbers compare to your household budget?
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■Massive Inventory Decrease in Southern California. Is This the Fabled Bottom?
■Are you a Don Quixote or Hamlet of Housing?
■The Short End of the Stick: Examining Short Sales in Southern California
September 11th, 2007 at 9:40 am
I am in the $80K+ but I do the following:
Brown bag lunches
Purchased my car for cash, and it was used. 2004 Sentra for 12K with 11k miles
Planted a vegetable garden
Use a solar power clothes dryer: clothes line
Use the library for books and videos
Tell my kids to study for a scholarship or join the military to pay for their higher education.
My wife calls me a tightwad, but I only have a manageable mortgage with a small credit card debt.
Maybe I am just weird.
September 11th, 2007 at 9:46 am
Hmm. For a family of two in Southwest Michigan.
PITI: $540 (20% down on $56K, 30-yr fixed at 6.5%)
Auto Loan Cost: None (own one car bought with cash)
Auto Insurance Cost: $20 or something (I don’t remember the exact payment) One car, two drivers, minimum coverage
Fuel Cost: $30
Food Budget: $250-300 including non-food supplies and vices
Dining Out: $20-$50
Student loan: $150/mo (gotta love that fixed 3% rate)
Utilities: $120 (gas, electric, phone, internet, trash removal, no TV)
Credit Card Service Debt: none
Health care cost: $200
Monthly total: $1330-$1410
(Yearly: $15960-$16920)
Current household income: $2500/month ($30k/year)
We’ve been spending more recently because we bought a bank-owned house and are renovating it, but most of those expenses are past now. And no, we didn’t put any of it on credit.
Around here, economic decline has been the reality for years. Our housing market’s collapse is due more to increasing unemployment and poverty, and less to any bubble in housing prices. Because of this, real estate actually isn’t a bad investment if you’re planning to be there for a while. The market’s flooded with cheap properties.
September 11th, 2007 at 10:37 am
Hi Doc Bubble,
This article is exceptional!! It is the most informative article I have read on this subject. I have a question. If your budget represented the sample budget featured in the article, what would be your solution?
September 11th, 2007 at 11:14 am
Maybe I missed it, but the over $8k a month is AFTER TAX required income. To take this home here in sunny CA, you’d need to make around $180,000 in gross income. And the numbers you used for expenses are very conservative - very little eating out, very low estimate for auto insurance (I’m 36 and have a spotless driving record, and for our two paid-off 5 and 6 year old cars, my wife and I pay $200/mo for insurance…), etc.
I wonder how many people here in LA are really living like this though - wouldn’t everyone have $100k in credit card debt? Or, I guess, maybe they just rolled it all into their mortgages over the past 5 years…? Hmmmm…. If so, seems like we’re headed for a much bigger crash than anyone is giving credit for… either hyperinflation or serious deflation…
September 11th, 2007 at 11:25 am
Rent: $1400 (not crazy enough to buy anything in So Cal right now)
Auto Loan Cost: $468 (2 cars, will pay cash for next car)
Insurance Cost: $190 Two car, two drivers, high coverage (100k/300k/100k), renter’s insurance
Fuel Cost: $100
Food Budget: $250
Dining Out: $250
Student loan: $0, Lived with parents and paid me way through at Cal State Long Beach (which is a bargain thanks to the state)
Utilities: $200 (gas, electric, phone, DSL, 2 cell phones)
Credit Card Debt: $0
Health care cost: -$100, I work for LA County and we get a benefits allowance, I don’t spend it all and keep the difference as additional pay
Monthly total: ~$3000
Current household income: $3200/month ($50k/year before taxes)
Just got married and currently have a single income, once my wife starts working things won’t be as tight.
Been reading your blog for a while now and just want to thanks and keep up the great work. I live in Downey so I’m in the middle of the bubble, would love to see a Real Home of Genius in Downey to show my friends and family how crazy things are here.
September 11th, 2007 at 12:15 pm
Here’s where the arch conservatives jump in to say that no one and certainly not “society” is forcing anyone into debt, that it’s all the individual’s choice of how much to spend and what to spend it on, and if you can’t afford it, you shouldn’t be buying it no matter how much you think you need it. There is a great deal of merit in this argument. What it fails to take into account is that something like 90% of people are too status conscious to accept this, and that actually making cuts to actually live within one’s budgets means that a family will typically slip a couple levels in the class system we’re not supposed to have in this country.
In other words, you won’t be able to hang with your old friends anymore; you are cut off from privileged sources of advancement etc. etc. In other words, you slip either into or closer to the powerless subclass that every middle class citizen is vaguely conscious of but mostly successfully ignores each day. And that puts fear into a person. As well it should, because it’s one step closer to being part of the working poor, with no health insurance, no 401(k) to fall back on in retirement, payday loans, creditors calling, etc. etc.
So while from a personal responsibility perspective it is something that everyone has utter control over–spending, that is–from a sociological perspective there is a great motivator–fear–that makes people strive to live beyond their means, ’cause to slip means to fall outside your class where all the comfort and protection is.
So, people try to maintain their class status by working or borrowing more. While these incentives to go into debt do not reflect well on us, they are very real nonetheless and cannot be so glibly dismissed if we wish to understand the phenomenon or address the problem. Of course, a lot of people don’t wish to understand or fix; they just wish to blame people for being greedy and vain, and I’m not sure I can totally disagree with them on that point.
My family mostly lives within its means, but I’ve lost friends because they went on to hang in expensive circles that we just couldn’t keep up with, spending in a responsible fashion. In fact, we’re more or less isolated, but at least we stay out of debt.
We have two cars. One has 105,000 miles on it; the other has 182,000 miles on it, with some patch-up paint jobs where it was starting to rust. You can bet there are some stares when I pull into a parking lot full of Lexuses, as happens frequently with the groups I am associated with. But it’s paid off and then some, which I bet can’t be said about many of those Lexuses. But I’ve had to learn not to care what other people think.
September 11th, 2007 at 12:50 pm
Big fan of the Dr. Housing Bubble,
but I got to say that this scenario seems a little odd. Our hypothetical SoCal family appears to have woken up one morning and found themselves with a brand new house, 2 new cars, an 18-year old kid, and a modest amount of credit card debt. These people are what, 45, perhaps? Never dawned on them to save ANYTHING for their kid’s college? No savings or investments of any kind? No profiting from the real-estate run up? Have they nothing to show for themselves?
Ok, life’s expensive here in california. To try to do all of life’s major purchases/expenses at once is an absurd proposition now or ten, twenty, or thirty years ago. The only difference is that now our society encourages you, or at the very least, no longer discourages you, to live beyond your means. Savings? Why plan for a rainy day, it doesn’t rain here!
BTW, what ever happened to “lay-away”, anyway? Can you imagine someone going to the Best Buy each week to put another $50 dollars down on a plasma…just another 20 payments and you’re mine!!
You know what’s weird about saving for things? Once you actually get the money for it, sometimes it’s hard to spend. I’ve wanted a new car for so long. I’ve had 4 cars in my life, and never owned one less than 5 years old. I’m getting pretty close to my 25K goal, and I think I’d be heartbroken to see that balance drop to $0.
I know we’ll never get to the point where people are buying houses in cash, it’s just not practical. But man, wouldn’t it be that much harder to get into a bidding war if everyone put 20% down?
September 11th, 2007 at 1:09 pm
Dr. HB,
Eureka! This married mortgage broker couple has found a way out of this housing bubble mess. I believe that their method is worthy of a special posting on your site:
http://www.nypost.com/seven/09112007/news/regionalnews/burb_brothel.htm
Got to give them props for highly creative financing.
September 11th, 2007 at 1:11 pm
Let me re-post that link:
http://www.nypost.com/seven/09112007/news/
regionalnews/burb_brothel.htm
You will have to piece together the url.
September 11th, 2007 at 1:21 pm
all things good staff said
“You can bet there are some stares when I pull into a parking lot full of Lexuses”
I worked for several years at a consulting firm in San Clemente and my boss at the time, in front of several junior employees, said “your car is too old and doesn’t fit our image.” I responded that I didn’t have enough money for a new car and he responded neither do I. Maybe he didn’t, seeing that he had just gotten back from his forth overseas trip of that year, but I still can’t believe he did that.
He knew exactly how much I made, so he should know that with the cost of living in the area that I couldn’t drop 20-30K on a car. But everybody else was and the message was clear, conform, look “successful,” or you don’t have a chance.
September 11th, 2007 at 1:56 pm
all things good staff: Very true, and very insightful.
number: What about the negative savings rate in the US? Every week it seems there’s a new story about how people in their 40s and 50s still haven’t started saving yet. This hypothetical couple may not have very much put away at all, or what they do have might be in retirement accounts that they can’t access readily.
September 11th, 2007 at 2:14 pm
Re. the negative savings rate, there is a pretty serious disincentive to save. With rates dropping (again) you’ll be lucky to get 5% interest on your savings. After paying 30-45% in taxes (depending on your tax bracket and what state you live in) this is lower than the inflation rate. In short, you are losing purchasing power on every dollar you save. It’s true that you can avoid taxes in a retirement account but the annual limits are pretty low and you shouldn’t save for a house in a retirement account. It’s also true that you might be able to do better than 5% in riskier investments, but then again it’s only just this year that the DOW and S&P have finally gotten back to break-even versus 7 years ago, so the risk should not be underestimated, especially now.
It sure seems to me that government has been waging war on savers for years, what with high taxes, inflation, and absurdly low interest rates on longer-dated bonds. Think about that the next time some politician moans about the lack of savings while also talking about higher tax rates on “the rich”.
September 11th, 2007 at 3:08 pm
Another good blog…thanks.
A couple points. To me, going into debt for an education is worthwhile. Personally, the best money I ever spent.
The government says inflation is moderate. Looked at a popular mayonaise jar lately? It is now 30 ounces instead of a quart. A popular maker of sausage has just dropped the portion size to 14 oz from a pound. Prices are going up in the supermarket. The government is lying.
Low interest rates are a way of stealing money from those that saved to give to those that are spendthrifts.
September 11th, 2007 at 6:18 pm
@utahbob62,
It seems that you know how to manage your finances wisely. Unfortunately the predominant message we get from media sources is “spend spend spend.” Most of this stems from our economy being fueled by two-thirds consumption. So what you are doing, that is finding ways of not spending and price cutting, is counter to the mainstream culture. If we had a society that emphasized savings, your wife wouldn’t view what you are doing as being a “tightwad” but as following the status quo.
@the duchess of Calcutta,
You’ve rightfully earned the duchess title. That is absolutely impressive and thank you for sharing that. It always helps to get a look at different budgets since it highlights the true nature of our spending habits. I remember helping a friend out that simply couldn’t save a few hundred a month. When we did a quick budget, it turned out that they were spending almost $1,000 a month dining out and “miscellaneous.” When we broke down this miscellaneous category it turned out money was going to smokes, coffee, and gym membership. Talk about conflicting values! Either way, we plugged a few wholes and he was able to save more.
Your post also highlights the fact that many areas in this country are actually having real estate recessions and are far from being in a housing bubble. If your PITI is $540, almost the average car payment for many, you’ve must of done a great job on picking up a REO.
@don,
For one, I wouldn’t have that budget since most of the monthly budget is being eaten alive by the mortgage payment. And I think you have a sense about how I feel about prices in California housing. In terms of cars, even if you want a luxury car, you should always buy a 1 to 3 year old car that is well maintained and has been serviced with low mileage. These are very hard to find in SoCal. Pay most of it in cash. If you have good credit, you can cash advance $15,000 to $20,000 on a zero down offer, and pay it off in one year in equal payments. This is a very risky move since credit card terms shift quickly and by far, I would recommend you save for 1 or 2 years and pay it in full. Of course, I’m more of the mind that you should pay cash for a vehicle and will have more leverage when negotiating with potential sellers.
In terms of college savings, I do not have kids so fortunately I’m not worrying about this. But for those that have children, you want to start saving early. There are some great programs where you can buy into a local university and prepay for your child’s education. You can also go with 529s and save a consistent amount for 16 to 18 years. Even a modest amount will go a long way after compounding. Or you can always send them for 2 years to a local community college and have them transfer for their upper-division course work. Either way, the people that have challenges in this arena are those that didn’t save and underestimated the cost of higher education. This is the majority of families and the only option left is student loans.
@jimatlaw,
Totally agree. Auto insurance here in SoCal is not cheap even with a spotless record. But you are right, people are racking up massive amounts of debt. Visually, what we see is brand new cars and big McMansions but we don’t see the monthly car and mortgage payments. These are the not so glamorous sides of living large. I think we are realizing that this bubble spans beyond the housing market. Even from this hypothetical family budget using average statistics, most in SoCal realize that not everyone posing with a BMW or Mercedes is really living that large. The devil is in the details and many folks are simply mortgaging their future.
Other people in different parts of the country may think $100,000+ a year will go far anywhere. Well as you can see, after taxes and regular expenses you are barely keeping up with the Joneses. And when we see the median income for Los Angeles County is $50,000, we realize that people are fueling today’s spending via tomorrow’s income. This is a massive credit bubble.
@andrew,
Thanks for the detailed budget. Your budget demonstrates the median income of someone out here in Los Angeles. In fact, you are earning what most households in Downey are earning. It also paints a picture of the necessity for 2 incomes especially here in California. I’m not sure if you put any money into a 401(k) or IRAs but it is crucial you start young in investing.
I’ll look into Downey for a potential RHOG. According to recent median SFR figures:
Downey has 3 zipcodes at $572,000, $693,000, and $535,000. The median household income in the area? $58,264. Yup, no bubble here.
@all things good staff,
Your post strikes a very familiar cord. We’ve all heard that if you save $400 at 11 percent over 30 years you will have $1 million saved. Yet when we look at recent retirement statistics, why is that half of those 55+ only have $50,000 saved for retirement? As we are seeing with all these posts, money and savings is largely driven by psychology. If you need a brand new car you can get it. If you need a larger home with extra rooms, you can have it. The only issue here is that you have to buy into the debt society. At a certain point the piper needs to get paid and we are starting to see that. You can only prosper so much under the pretense of debt.
If you run with the Joneses expect to pay like the Joneses. The prices of certain high profile places here in SoCal are criminal. The only reason people would pay those prices is the significance of being at a certain place. It boils down to value and what you derive your sense of worth from.
@numbers,
This is only to show that spending $8,000 a month is very doable here in SoCal without buying yachts and taking monthly trips to the Caribbean. You discuss something fundamental into the psychology of the wealth:
“You know what’s weird about saving for things? Once you actually get the money for it, sometimes it’s hard to spend. I’ve wanted a new car for so long. I’ve had 4 cars in my life, and never owned one less than 5 years old. I’m getting pretty close to my 25K goal, and I think I’d be heartbroken to see that balance drop to $0.”
Absolutely. I remember as a child I wanted a really nice mountain bike. So my father told me he would give me $20 a month (which I had to earn, no American Express here) and when I had enough, I could purchase the bike. Well the time comes and all the work and time invested for the bike now has a real consequence in the world. All the car washes and mowing the lawn now translate to this one thing. So I bought a lower priced bike and saved the rest. Some of us are savers and some of us are spenders. All the work that you put into saving for that car makes you think twice about spending it.
See, that is why a down payment is so crucial. It’ll force people to examine a home, local neighborhood, structure, and things that every buyer should do before signing on the dotted line. Yet with the past 7 years, people saw the home as a commodity that they could flip. Since many went zero down what emotional value does the home have to them? And people seem shocked that folks are willing to walk away with no hesitation. Lenders actually thought many of these families would be emotionally attached to their homes to the extent that they would forego food for the mortgage payment. That is why we are seeing absurd foreclosure rates and they will only explode. Economist fail to make this psychological connection in their data.
@john,
The world’s oldest profession makes a come back. Necessity is the mother of all inventions I suppose. I wonder if they started their business via a HELOC?
Either way, we are going to see a lot of high paid housing professionals displaced in the next few years. I wonder if the government included these people in their bailout projection models?
@david,
“your car is too old and doesn’t fit our image.”
Talk about putting you on the spot. I highly recommend anyone that hasn’t done so to read the Millionaire Next Door. The book is rather old but does a great job at breaking the myth of looking rich and being wealthy. We can toss around adages such as “all hat and no cattle” but the reality is that our consumption based society keeps on ticking by massive spending even if this means going into debt. For example, people in the housing industry such as lenders and agents, grew on the assumption that housing would always go up.
Even a minor stagnation - keep in mind the median hasn’t even gone down in SoCal! - in prices is enough to push the market into a recession. No where in their models did they factor in 10, 15, or even 20 percent drops. As we are seeing, this is already a foregone conclusion and we may even see steeper drops. This has been a massive credit bubble and now with the dollar at an all time low we are at a crucial road to save our currency. There is proposed legislation trying to raise government secured mortgages up to $625,000 limits. How absurd is this if the mission of these agencies is affordable housing? They want to institutionalize higher prices. Even if this goes through, people wouldn’t be able to afford the homes without kamikaze mortgages. Many people in the last few years were able to afford homes for 2 years on teaser 2/28, interest only, and option mortgages. So even conventional financing at 6.75% on a $500,000 mortgage will break a family even with higher incomes in SoCal.
September 11th, 2007 at 7:23 pm
- All vehicles paid for
- 1 student loan at 2.9%
- 1 credit card with a balance locked in at 4.9% “for life”
(Paying it down quickly since the credit card industry could change my terms at any time)
- Bought a house in a region of the country without a housing bubble. Here you can a brand new 1800 sq. ft home for $150K.
Some bank was dumb enough to give me a 30 year 100% mortgage with no PMI at 6.25%, no pre-pay penalty and I only have to pay interest for the first 10 years.
Once interest rates crank up and I can get 8+% in CDs, I plan to make more money from investing in CDs than I pay in interest. If that doesn’t pan out, I’ll just pay off the house.
My goal? Spend 1/3rd of what I make, save 1/3rd of what I make and pay 1/3rd (or less) in taxes.
Each month I get a little closer to that goal.
People are generally clueless when it comes to budgeting. I watch for two things on a monthly basis, positive cash flow and increasing net wealth.
September 11th, 2007 at 7:48 pm
Really nice article. But your gas figure is low.
Many people have more than one kid, certainly not so far apart in age where two might be in college at the same time.
And if you want to know, we really buy cheap food. And almost never eat out. No debts, including cars, at the moment.
September 11th, 2007 at 8:03 pm
“He knew exactly how much I made, so he should know that with the cost of living in the area that I couldn’t drop 20-30K on a car. But everybody else was and the message was clear, conform, look “successful,” or you don’t have a chance.”
What a jerk!
Our first home was built in the 1920’s and we paid $16,000.00 for it. It was all we could afford at the time and it was dated but comfortable. Being in a new town, we joined a church and became friends with many of the members. One Sunday, we invited a doctor and his wife over for lunch. He stepped in the front room and proceeded to say “what a dump!” This guy had money up the whaaazooo! He was a MediCal-type billing doctor and he owned lots of commercial real estate in town. He had no cooth (sp) or class as I found out. To this day, I never forgot what he said about our house. We since moved away from that town, but I later found out he lost his medical license through malpractice, was sued for malpractice, lost some of his real estate buildings through a pozi scheme, and he had to pay back thousands and thousands of dollars to the State of California for MediCal fraud.
It’s true, what they say about KARMA!
September 11th, 2007 at 9:45 pm
Would have loved the post, but really the contextual ads are very annoying. Surely there has to be a better way to try to monetize your blog.
September 11th, 2007 at 10:12 pm
I learn a simple trick to save. Treat your saving account like it is one of your bill preferably your health insurance bill as it tends to increase greater than wages.
Every month, you have to pay your saving account and your other bills.
My budget:
Rent: $438
Phone: $45
Electricity: $70 (cold here in Montana)
Student Loan: $106
Car Insurance: $36
Gasoline: $250
Internet: $20 (reluctant but I’m sharing, prefer poaching Wi-Fi)
Food: $350
discretional spending: $250 (clothing, drinking etc.)
Health Insurance: $590 (i’m single and really fit runner and young, and this is hell to pay, yes I know, government say I have to).
Saving account (bill): at least $500
Still have ~$400 to spare which goes mostly in to saving account.
Rent is cheap, because I have a roommate (by choice).
I consider myself lower class. Okay, no class.
I’m relatively young, and I think it is tough without a dual income for most people.
I pay bills in the middle of the month where I get pay (once a month). I feel comfortable really to have a fix amount in my bank account to take me to the next billing cycle.
I own an old Toyota Tacoma, and never had a credit card. My next worry is getting a new vehicle should this one go bad (200K miles). I’m thinking about downgrading to a Honda Civic, but would love to own my Tacoma for at least 5 more years. I want to get 500K miles on it, which I think can be done without breaking the budget on upkeep.
September 11th, 2007 at 10:26 pm
I have to wonder how many purchases / investments have had their price skewed due to the credit bubble.
If everyone had a maximum total credit card limit of say 25% of their gross income and let’s say you were only allowed to borrow 3X your gross income for a home, would we end up with deflation on some goods or services?
You could also argue that deflation on items such as houses, fuel, food, etc. in conjunction with consumption limits (due to limits on debt) would free up cash to save and actually raise the price of things that can be planned for many years in advance, like a college education.
I think the net is that the housing / credit bubble is distorting the prices of many things. So I guess the trick these days is to figure out what items are “cheap” and stock up…
I.E. a 30-year home loan at 6% is dirt cheap, assuming that your not paying too much for the house.
September 11th, 2007 at 10:47 pm
sorry but your budget is off.
“Auto Loan Cost: $894 (2 cars with each carrying a $447 monthly loan).”
yes, but much of that $447 is actually saved. 5 years of payments and you have a car that’s paid off and can be sold for a hefty chunk of cash. You can lease new Honda Accord for $300 a month.
“Auto Insurance Cost: $160 (2 cars full coverage)”
You can insure 2 new Accords for half that much when you’re over 40, but I’ll allow it.
“Fuel Cost: $300 (assuming that we only use $150 per vehicle)”
At 30 mpg and $3/gallon, $150 per vehicle buys you enough gas to commute 75 miles a day. Most people in LA county don’t drive that much. I’ll allow $200.
“College Support: $1,667″
You don’t send your kids to colleges one after another all your life. If you start saving the day your child is born, assuming zero return on your investment, you need to save $303 a month.
“Health care cost: $575″
I don’t have data, but I’ll venture a guess that many companies provide cheap health insurance to their employees. I’m paying $200/month for the entire family.
Total is $2515 per month or $30180 per year, not including housing.
Median income for a 3-person family in California is $64,766. (You are confusing households and families. A single person living on his own is considered a household by U.S. Census.) Married couple with one child earning 64k and taking standard deduction will pay around $4500 in taxes. They will have $2500 per month left on housing. At 6% interest rate that puts their ceiling around 400k.
Finally, there’s no reason to expect that they should afford a median-priced house, or, in fact, any house. The reason is very simple. There aren’t enough houses in LA for everyone. There are twice as many families as houses in LA County. Your median family does not have to be able to afford anything, your 75th percentile family should be able to afford a median house, etc.
September 11th, 2007 at 10:56 pm
@ sd scientist
“yes, but much of that $447 is actually saved. 5 years of payments and you have a car that’s paid off and can be sold for a hefty chunk of cash. You can lease new Honda Accord for $300 a month.”
So you sell your car for a hefty sum, and downgrade or walk to work? After your two year lease on a Honda Accord is up, what’s next?
September 11th, 2007 at 11:03 pm
(numbers approximate, as an example of handling not precisely what I personally do)
Rent: $1500
Bus passes: $75 for one person, work subsidized for the other
Food Budget: $450 (including supplements)
Dining Out: $200
College Support: None, I looked at the rising fees and dropped out.
Utilities: $120 (includes Gas, Electric, and basic phone service)
Credit Card Service Debt: $168 (According to Bankrate, average household credit card debt of $8,400)
Health care cost: Deducted from paycheck or none, supplements counted into food cost.
Total: $2513, call it $2600 so yearly $31,200
And that, is why I don’t wince at the price of a good pair of boots. My advice to anyone in the city trying to save money: Ditch your place if you live far from work, rent near public transit lines, make your home as energy efficient as possible (those lightbulbs paid off in a single month!), eat at home but eat well and learn everything about nutrition/health you can - those medical bills are real killers.
September 11th, 2007 at 11:12 pm
@ed scientist
“They will have $2500 per month left on housing. At 6% interest rate that puts their ceiling around 400k.”
I take it you base housing purchase on interest in large part.
What do financially astute people say again? You based your house purchase on the price and not the interest rate, because you can always renegociate rates but never the purchase price.
It is getting late, and I’m getting tire and will only comment on two points of your gross ill advice post, and allow others to disect your argument further.
September 11th, 2007 at 11:35 pm
I came to this country with a nickel in my pocket. Now I don’t have a pocket.
September 11th, 2007 at 11:50 pm
“After your two year lease on a Honda Accord is up, what’s next?”
you get a new lease.
“I take it you base housing purchase on interest in large part.”
i’m doing the same thing Dr. is doing, only backwards. He’s saying that monthly payment on $547,500 using current jumbo rate is $4,100 a month. I’m saying that you can finance $400,000 using current conventional rate for $2,500 a month. What’s the difference?
“can always renegociate rates but never the purchase price”
that is true, but you also shouldn’t make an assumption that you will be able to refinance at a lower rate. 7% is historically a very low rate.
September 11th, 2007 at 11:53 pm
Mortgage Brokers say 57% of clients couldn’t refi in AUG.
http://thegreatloanblog.blogspot.com
Keep up the great work Dr Housing Bubble. One of my favorite reads. We need to get you on CNBC and Capitol Hill
September 12th, 2007 at 3:58 am
Great article. Unfortunately, I think your student loan information is a bit off. The public colleges you mentioned are all in CA, which have much higher costs than in other parts of the country. In fact,in-state tuition a public school in VA can cost as little as $13,000 a year including room and board. VA state schools are known to be excellent, so one wouldn’t have to forego an excellent education due to high costs. There are many choices to make when deciding which college or university to attend and how much one (or one’s family) can afford.
Also, while I know that student loan rates have gone up, I think the 8% you mention is a bit high. I was fortunate enough to only have to take out Stafford loans in college, and after consolidation in June 2005, my current interest rate is a fixed 3.375%. If I make my first 36 payments on time, my lender will lower my interest rate to 2.375%. That’s some cheap money, and my college education was worth much more than the interet that I will pay. In addition, college graduates typically earn more than their counterparts that only have high school diplomas. This has certainly been the case for me - I started at a higher salary than one of my co-workers is currently making. She has a high school diploma and has been with the company for 20 years.
There’s no doubt that college education costs are rising, but there are a lot of choices involved that can result in much lower costs than what you have estimated in your article.
September 12th, 2007 at 7:08 am
DR:
Excellent work here–this should be on the front page of the LA Times or NY Times. It blows the doors off the “prosperity” we are supposedly experiencing.
charles smith
www.oftwominds.com
September 12th, 2007 at 9:00 am
Visa and Mastercard = the devil! I like how you point out the Visa commercials who make cash payers look like fools. Have you seen this one that makes Visa look good in New Orleans?
Here’s something you might not know. After Katrina knocked out the electricity and phone lines for the card swipe machines that merchants use to process credit card transactions, many merchants turned to the old-fashioned manual machines. All well and good but Visa charges retailers about twice as much to process those paper-receipt transactions as they do with an electronic transactions.
Wouldn’t you think they would have given New Orleans businesses and consumers a break in the middle of one of the worst natural disasters our nation has ever seen? Nope, Visa saw a windfall of millions and millions of dollars when merchants had to use those machines and those prices were passed onto the good people of New Orleans, the last thing they needed.
September 12th, 2007 at 9:35 am
I’m in the $40k. My costs are way lower:
rent: $320
car loan: $120 (almost paid off)
utilities: $100
car insurance (1 car): $100
school loan: $80 ($15k total)
cell: $60
gas: $30
I’m lucky because I’m relatively high income with no dependents and low living costs, but I’m concerned for a lot of Americans out there with much worse problems.
I think your analysis of our debt structure is spot on.
September 12th, 2007 at 9:53 am
family income - 80k - just had baby and spouse is working a bit now, after tax about 5k monthly income
rental income - 750/month from renting nanny suite out to a friend
piti - 2300 (9 yrs left at 5.25% currently, built our own house and put 250k into it when building it), mortgage balance 165k.
credit balance - paid off monthly so far
line of credit - under 10k all used for ongoing house completion costs with more cost forecast to complete house
car - paid off 2006 honda
insurance - 100
gas - 100
utilities, internet, etc, - 500
food - 750 per month
education saving - 100/month
other - hard to say…
money is tight every month since we had the baby. essentially impossible to save right now but dont want to cut back on the principal repayment schedule.
September 12th, 2007 at 10:21 am
Doc,
Ever read Minyanville? Kevin Depew writes a daily column called “5 things you need to know” - here is the link to today’s column. Quite apropos of this blog you wrote.
http://www.minyanville.com/articles/Fed-TOL-housing-Bernanke-savings/index/a/14078
If I might make a point to those who have chosen to comment on DHB’s blog and to echo his good response - it’s not the exact figures that matter - so don’t miss the forest for the trees. It’s the general attitude towards debt accumulation that accompanies the lack of budgeting, that is the point. And couple that with the societal imperative to flaunt.
There’s a reason that in the loan industry, OC is called “the land of all flash, and no cash.”