Outer Limits

Reading a recent WSJ article on the FDIC's "Limits of Leniency," I was shocked to see the ratios between income and size of home mortgages. When I was doing financial planning, I recommended a maximum limit of 2.5 times income for the principal size of the mortgage.

The reasoning was if the loan was $250,000, then it would take 30 years to pay down $8500 per year with zero percent interest. Add interest, taxes and insurance of roughly $16,500 per year and the total is $25,000. If pretax income is $100,000, then after tax is $60,000 and 40% of $60,000 is $24,000. Different taxes and interest could vary the limit down to 2 times or up to 3 times.

The recent article describes a 30 year old bartender "who watched the balance on his adjustable mortgage balloon from $424,000 to $463,000 in three years, while the value of his house dropped from $530,000 to less than half that." The article says that he is married. I would guess the combined income is roughly $50,000 giving a multiple of 9 times.

The article further describes another woman who refinanced her house for $637,288 in 2006. She and her husband, who works in a machine shop, take home a combined $70,000 a year. Each month, she makes the minimum payment on her loan, $2,416. At the same time, she watches the outstanding principal swell since that payment doesn't fully cover the interest costs. Now she owes $707,000 for a multiple of 10 times.

The only bright spot is that the house values have dropped to such an extent that a mortgage would work on the new reduced values. If the mortgages are modified by such a principal reduction and if the individuals maintain their incomes, the succeeding structure would seem to have longevity and not simply be a crapshot on rising home values.