Thursday, June 5, 2008

Just Poor Decision Making

I work in the banking industry. Consequently, I hear and see things that happen to people, financially speaking of course. There is a lot of money in finance. You want something that you either can't afford to buy outright, or don't want to sink a sizable portion of your assets into one investment. So you leverage. You make a minimal capital contribution (down payment) and finance the rest over a reasonable period of time. All the while paying your banker the opportunity cost of lending you the money (interest). This is how things are normally done. It is not a secret or mystery. It is also known that you cannot get something for nothing. A prudent banker will require that you establish an equity position (as evidenced by non-refundable earnest money or a down payment) before financing the acquisition of some asset. For houses this has historically been 20%.

This all changed when real estate began heating up over the past 10 years or so. Competition was steep among banks and finance companies. This caused bankers to reduce and eventually get rid of the equity requirement that had been there in the past to protect them. To further the problem, bankers decided that owning a home was not only the American Dream but also a right of which everyone should partake. So what happened? Well, it got easier to get a loan. Not only did you not have to put any money into buying the house but you didn't have to have a good history of repaying debts or verifiable income to make those payments. So we have a lot of people in houses that don't belong there. I hate to say it, but it is true.

Recent news tells me that even the big and powerful of Hollywood are caught up in the crisis. Ed McMahon has defaulted on $4.8 million in mortgage loans on his $5.6 million dollar Beverly Hills estate. He is over $600 thousand dollars behind. Now granted, he suffered a broken neck in 2007 and had two subsequent surgeries in early 2008. However...this is no excuse. Mr. McMahon turned 85 earlier this year. I am not saying that he should not or can not have a mortgage due to his proximity to expiration. I am simply saying that he should have planned better. In the 1990s, Ed McMahon was worth an excess of $200 million mostly in real estate holdings particularly in Malibu, California. Somehow, that is gone now. He may lose his home to foreclosure. Is it his fault, his accountants, or mortgage brokers? I am not sure. But one thing is for was just poor decision making.

1 comment:

Karen said...

I realize this is an older post, but the message is still true. I find it funny that most people are blaming the government for all the financial problems these days. While it may be true that they did have some control over it, most of the problems these days are caused by people buying stuff they can't afford.

A couple years ago I was one of those dumb people that bought a house I couldn't afford, just because I could. Didn't have the 20% down payment so I just got 2 mortgages. Didn't have any emergency money, didn't have anything saved up for repairs. Just wanted a house so I got one. Lucky for me I was able to sell it just before I got into trouble and just before the housing market crashed.

There's something to be said for putting off things we want until we can actually afford to buy them. I definitely learned my lesson. I still want a house. But this time I'm doing it right. I'm saving my money and going about it the right way. No more quick fixes. I want a house, not a constant source of worry and stress.