Saturday, February 23, 2008

Living Beyond Our Means

Michelle Singletary, who writes more good-sense economic advice than almost anyone else in DC, recounts a meeting with Daniel H. Mudd, chief executive of Fannie Mae:

Still, during our discussion about jumbo loans, I pushed Mudd to provide some idea of when jumbo loan borrowers might approach lenders to refinance.

"I don't know," he said.

Then Mudd added a very helpful tip that I thought I would pass along.

He said if you are worried about a 50 basis-point difference in your interest rate (that's half a percentage point), you might be living in the wrong place.

Mudd wasn't talking about bargain shoppers who negotiate hard for a good loan deal or who are calculating whether a refinancing would make sense long-term.

Let's say a jumbo rate of 7 percent for 30 years comes down half a percentage point as a result of the new loan limit. On a $500,000 mortgage, that's a savings of about $166 a month.

In other words, you shouldn't be buying a home or refinancing into a mortgage that leaves you with little cash cushion. That's what led so many to be in trouble now.

If you have a jumbo mortgage and a half-percentage-point difference is going to mean a great deal to you financially -- that is, it will free up money you need to pay for essentials -- you're in too much house.

It means you are living above your means. Cornering mortgage professionals or other real estate experts at parties to press them for the best time to refinance your huge mortgage is nonsensical. You need to be asking when you should sell.

Again, Singletary's not saying that the savings might not make it worthwhile to shop for a lower mortgage rate. She's saying that if a half-percentage-point difference is the difference between staying in your house or going bankrupt, you're in too much house. Of course, these days, it's easier said than done to sell your house, but that means you should start now, not that you should put it off.

An article in yesterday's WaPo emphasizes how many people are now living beyond their means:

In one brief phone call, Nancy Corazzi's lender yanked away what was left of the $95,000 home equity line of credit that she and her husband took out five months ago.

The lender informed her that her Howard County home had plummeted in value and the company did not want the risk that she would owe more than the house was worth.

"I got off the phone and I was shaking," said Corazzi, who was using the money to pay preschool tuition for her twins ."I was near tears. We needed this credit line to get us through some tough times."

Getting through tough times is what a nest egg is for. Nest eggs, savings that are in a non-risky but fairly easy-to-access form such as savings accounts and short-term CDs, should be equal to at least six months' worth of take-home-pay and other (aka child support) income. If you're taking equity out of your house to pay for preschool for your twins, you're living beyond your means.

For years, now, middle-class Americans have been falling behind financially, while a very small group of ultra-rich people became obscenely ultra-rich. (That's what happens when you elect Republicans. Every time.) Borrowing money, whether through home equity lines or through credit cards, has allowed a lot of those middle-class Americans to pretend that they were not falling behind. It's now getting lots more difficult to delude yourself that way. (Of course, our entire way of life is based on living beyond our means. Americans use a wildly disproportionate share of the world's resources. It can't last. That's what "unsustainable" means.)

Part of a witch's job is to perceive reality as accurately as possible. And, a witch takes responsibility. For herself and the world in which she lives.


Postscript: To be clear, we need both to work to change the current system and to protect ourselves while living in it. If you are falling behind economically, in order to protect yourself, you need to acknowledge that and live rationally within that reality. Sure, do magic. But don't ignore reality. You have to first perceive reality correctly in order to change it, magically or otherwise. If you are falling behind economically (and most of us are these days), you can't keep living as if you were staying in place.

1 comment:

Labrys said...

Incredible. Thank you for this--the story about the couple taking out a line of equity to pay for preschool tuition as if that was the be all and end all of middle class life, wow, that dropped my jaw. I have been decrying the greed of bankers---but some amount of screaming about the stupidity of people taking loans is obviously in order, too.