Is Debt Immoral?

When I got to the chapter “The Myth of the Immoral Debtor” in The Two Income Trap,  I was reminded of an exchange between A.B-G. and Markus at BREN.  A.B-G.  wrote: 

“We may lose a little in the first year or two, but if we can make the payments and we're there for the long haul--then what's the problem?”

Markus responded:

“No problem--as long as you have a written warrantee [sic] signed by God Himself guaranteeing that you will not lose your job, be transferred, get sick or have any major unexpected household emergencies over the next five years.”

Elizabeth Warren and Amelia Warren Tyagi explain that most people who get deeply into debt are not profligate. Many get into trouble because of emergencies. They then gave examples of who survives financial setback. They wrote:

“Of course, not every job loss, divorce, or illness ends in the bankruptcy courts. Some families collapse under the weight of too many bills and not enough income, but many families do not…” 

They tell the story of a couple they call Jamal and Trish Dupree. Jamal, at forty, had a heart attack. He lost five months of work. Trish lost income, too, because she took time off to be helpful to Jamal’s recovery. Health insurance exclusions and deductions added up. Yet they were a couple who did not end up bankrupt.

How did they make it? Luck and planning:  Luck, in that nothing else happened while they were vulnerable. Luck, in that Jamal had a job to go back to. Luck, in that Trish was able to get overtime pay after the crisis was over. Planning, in that they had health insurance. (But, health insurance is not nearly enough; 240,000 families with continuous health insurance file for bankruptcy every year.) The big advantage was that the Duprees had long-term disability insurance. Even so, they drained their long-term savings and did without essential things for a time.

Nothing is sure in this life. If you bought a house, ever, what made you sure enough to take the leap?  Do you feel more financially secure when you own your house? Do you need a warranty signed by God Himself?

Reprinted from BREN, March, 2010

Financial literacy and financial health

Ms Warren and Ms Warren Tyagi in The Two Income Trap wisely advise families to prepare for emergencies ahead of time. I am thinking of copying the chapter “The Financial Fire Drill” and giving it to my clients before they start house hunting. They pose three questions:

1. Can your family survive for six months without one of the incomes you rely on?

2. Can you downshift the fixed expenses?

3. What is your emergency back-up plan?

Rent or mortgage is usually the family’s biggest fixed cost. Since mortgage is almost invariably higher than rent here, would-be home buyers need to think about their fixed costs and how to prepare to pay them. Therefore holding the mortgage payment to something you can handle is key.

I would like to get specific about how to think about your mortgage payment.

The “front” ratio for a loan is your real estate monthly payment in relation to your gross adjusted income. A prudent limit is no more than 28 percent of your income that can be used for your housing expense. I advise my clients not to fudge it beyond that level.

Let’s keep it simple:

If a couple earns $100,000 gross adjusted income, their mortgage payment is capped at $28,000 a year, or $2,333 a month. That’s the whole payment: principal, interest, tax and insurance.  Most of the time, my would-be clients are clueless about the weight of property taxes. They can borrow $350,000 for less than $2000 in principal and interest. Fine. Property insurance is likely to be under $200 a month. Great. But taxes in that price range can get as high as $600 a month. Especially in the suburbs where there is more land on the parcel.

OK, scale back. Since a cheaper house will have lower property tax, on average, at $100,000 gross adjusted income, the prudent loan amount comes in at about $280,000, assuming a $500 a month tax bill. Where taxes are lower, say $300 a month,  that figure goes up to about $315,000.

In this market, that doesn’t buy a family home in a toney suburb. If both members of the couple are working full time to earn that $100,000, can you have a back-up plan that would work? Unlikely.

Depending on two incomes at maximum mortgage level is a bad idea.

When mortgages were calculated on a single income -- in those Father Knows Best days -- couples could overcome a set-back by sending Mom to work. I think the mortgage rules should be scaled accordingly, with a lower ratio if two incomes are being counted (maybe 20-25 percent.) Even if the rules aren’t changed, I try to convince my clients to scale themselves back so they have fixed costs that they can handle.

I feel like a lone wolf crying in the wilderness about this. At least The Two Income Trap authors take it seriously.

Reprinted from BREN, March 2010.

Real estate is about the schools, right?

In The Two Income Trap, one of the ongoing tropes is that the pressure to send one’s children to “good” schools underlies the competition for houses in well-regarded schools systems. Ms Warren and Ms Warren Tyagi explain that women in the workforce increased the spending power of the family. The extra income did not go to runaway spending on clothes and other consumer goods. They say:

“…families where swept you up in a bidding war, competing furiously with one another for the most important possession a house in a decent school district. As confidence in the school system crumbled, the bidding  war for family housing intensified, and parent soon found themselves bidding up the price for other opportunities for their kids, such as s slot in a decent preschool or admission to a good college. Mom’s extra income fit in perfectly, coming at just the right time to give each family extra ammunition to compete in the bidding wars – and to drive up the prices even higher to for the things they all wanted.”

I have written about schools on this blog and I have heard how important schools are. In my entry Is living well about the schools? the short answer was “yes!” Even for people without children, "everyone knows" that the price of a house depends on the reputation of the school system.

In The Two Income Trap, the authors quote a study that confirms that

“school quality was <em>the single most important determinant of neighborhood prices – more important than racial composition of the neighborhoods, commute, distance, crime rate, or proximity to a hazardous waste site.” [Emphasis theirs]

The Two Income Trap authors say the solution to the housing crisis is fixing the school crisis. If the competition for schools was neutralized by more opportunity for education that isn't tied to house location, then the inflation of "good school" towns would cool down.

"Any policy that loosens the ironclad relationship between location-location-location and school-school-school would eliminate the need for parents to pay an inflated price for a home just because it happens to lie within the boundaries of a desirable school district," wrote Ms Warren and Ms Warren Tyagi.

Do you think that’s a feasible solution? Do you think Ms Warren should take on this one when she’s done with TARP?

Another problem facing young families is the simple lack of affordable family-sized housing anywhere, not just in the "schools, schools, schools" neighborhoods.  Where there are larger condo units or houses, they are sold to people who have more spending power than many young families.  

Reprinted from BREN, March, 2010. 

The Banking Committee has Elizabeth Warren

I am not much for talking about elections like they are sporting events with losers and winners. But, Elizabeth Warren on the Banking Committee is a win. BostonMagazine  blogger Janelle Nanos tells the story of what she sees as a great bout coming, now that Dr. Warren is on the Banking Committee.

I have long been a fan of Elizabeth Warren and Amelia Warren Tyagi. In 2010, I did a “virtual book club” on the Boston.com real estate site  on their book The Two Income Trap.

Since then, Dr. Warren took her knowledge of how economic trends are affecting regular people to Washington. Her brainchild, The Consumer Financial Protection Bureau, began the work of taking on the institutions of consumer debt. No wonder Wall Street hates her. They are going to hate her more if she is effective in her new position on the Banking Committee.

I believe that consumer debt, in the form of credit card debt and student loan debt, is hurting regular people. Both the institutions and the way children are taught about math and money needs to be improved.  As a landlord, I see the credit reports of people applying to live in my unit. The amount of debt that young, marginally employed young people are carrying is astounding. Since I know that they are carrying the credit card balances with 12-25% interest, I fear for their financial futures.

In honor of Dr. Warren's appointment, I will be rerunning my series on her book, The Two Income Trap. Part one starts tomorrow.