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The Mortgage Backed Delusion

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Since 1776, The United States has boldly declared that it’s the one nation where anyone can achieve great prosperity with not much more than hard work and a little luck. Granted it had to figure out how that would constitutionally apply to Native Americans, Africans, and women, but by the 1930s the idea that every citizen should have an equal chance to live a “better, fuller, richer” life developed into what’s commonly referred to today as the American Dream. But over the last half century, we’ve added a corollary to the Dream: home ownership, asserting that owning your own home is a realization of that time-honored American promise. A house does have its perks: there’s no landlord, no pet deposits, and ironically, the biggest problem with owning a home is actually owning it.America circa 2008

The subprime mortgage crisis exposed the vast numbers of Americans who weren’t homeowners but, mortgage owners, as they’d borrowed the money to buy their $200,000 dream house. When they couldn’t make payments inflated by higher interest rates, the issuing firms foreclosed and repossessed the properties proving that the banks that owned the mortgages were the real homeowners. After seeing that, it’s only logical to ask why the cost of a home has increased nearly 76 percent since 2000 and if owning a home is even worth it if a bank can just scoop it up after raising your APR without warning. Despite what many believe, most Americans should forego homeownership because of the cumbersome financial burden of a mortgage and the high level of exposure borrowers have to market forces.

The central issue here is the fact that the price of a house in America is too damn high. Looking at 2010 Census Data, we see that the average and median sale prices for homes in 2010 were $272,900 and $221,800 respectively, considerably more than what most of the employed work force will make in a year before or after taxes. So, for Americans who don’t earn enough to simply buy their home outright but who still want to purchase a home, a mortgage loan is an attractive option. Mortgage loans have the advantage of spreading that $272,900 over a long period (normally 30 years) while the borrower pays the bank back what they borrowed plus a little interest for the bank being so nice. Definitely sounds manageable with a little extra work and discipline, right? Well, consider the following three examples.

*Note that the following figures were constructed via calculations based on data from the US Bureau of Labor Statistics database for Average Annual Household Income by Gender, Race, and Profession. Figures on income were listed as weekly and numbers were estimated in thousands. For clarity I will express them as full values*

First, keep in mind that the average home sale price was $272,900 and the median home sale price was $221,800 and using the data provided from the BLS database, we can compare the median weekly income of three professionals at the higher, median, and lower income levels.

Jon Hamm as Donald F. Draper

For a PR Manager like Don Draper (High): Median Weekly Income came to $15,302.63/week per individual.




Sam Waterston as D.A Jack McCoy






For Jack McCoy the lawyer (Mid): Median Weekly Income came to $2,630.24/week.

Denzel Washington as Melvin B Tolson






For Melvin Tolson the educator (Low), preK-12, exempting Special Needs Educators: Median Weekly Income came to $628,44/week 

Now to outright purchase a home at either the average or median rates you need to gross in excess of $5,585.42/weekk or $4,620.83/week, respectively. Of the above three only the PR manager class has a high enough income to do this. Neither the lawyer or educator can afford to do so, hence they would probably seek a mortgage. 

*Note here that the following calculations were conducted using the following mortgage payment formula. Assume 10 percent down payment and listed national average APR of 3.88 percent*

With a mortgage it breaks down thus: 

At the average sale price, a 10 percent down payment would be $27,290. With a loan principal of $243,610 the expected monthly payment would be $1,155.65/month which after 360 payments (one each month over 30 years) amounts to $416,034. Final cost of that home to the buyer: $443,334.00

At the median sale price, a 10 percent down payment would be $22,180. With a loan principal of $199,620, the payments would come to $939.26/month which over the term of the mortgage amounts to $338,133.60. Final cost of that house to the buyer: $360,313.60

Now let’s relate these figures to what we know about our three professionals:

Don Draper makes $15,302.63 a week, times four makes $61,210.52 a month. So with a mortgage he’d pay between 1.53 and 1.88 percent of his income every month. Following that same math,  D.A McCoy should make $10,520.96 a month, so he would pay between 8.93 and 10.98 percent of his income a month. Sadly, the Mr. Tolson earns only $2,513.76/mo, meaning he would pay between 37.36 and 45.97 percent of his income per month on solely his house payment. The less you earn, the more of your income would go to your mortgage and unfortunately the lion’s share of America’s employed labor aren’t Don Drapers. But is the sticker price the only reason to be concerned, after all you can always change jobs and make more right? True, but there’s one thing you can’t control: what the bank that holds your mortgage does with it. 

For homebuyers and mortgage payers, there’s no real solid protection on the books for guarding consumers from the actions of the financial firms from whom they borrow. Unless you purchase your property outright, the bank that holds your mortgage can securitize it to venture off into the wilds of dangerous and potentially lucrative financial instruments while you, the owner-occupier is left to deal with the negative feedback from a transaction gone bad. Look at the number of people who lost their homes during the height of the housing meltdown in 2008. 

Banks securitized mortgages en masse to underwrite equities, assuming that continued payment from borrowers would result in an appreciation of asset value (via the cost of the property being less than 30 years of mortgage payments plus interest). But when housing prices fell sharply and insurance firms couldn’t cover the policies banks took out against their losses, financial firms dramatically increased the APR on their mortgages to keep the asset prices stable. Suddenly raising rates hit borrowers directly as higher rates result in higher monthly payments, which rose to levels that forced borrowers to default on their loans. But banks and lenders alike were recapitalized thanks to the TARP (2008) and ARRA (2009) relief packages, while the American homeowner has only recently gotten similar assistance. 

So the question remains: if not a house do I just rent forever? Not forever, but a while sure. Renting isn’t the American Dream but for most it’s a comparatively better financial decision. Unless you actually purchase your home outright, financing it via a loan or mortgage is essentially aggreeing to pay rent plus interest to a lender who then gets to play Russian roulette with your home. Apartments and townhomes are generally cheaper over the long term especially when you factor in the near-zero maintenance cost to the renter since such costs are usually handled by the landlord or management company.

The dream is that every American should own their own home, raise a few genetic replications with a golden retriever, an apple pie and a picket fence. The truth is that for most Americans the costs associated with buying or borrowing are so high that this has to remain just that, a dream. 

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About Alexander J Smith III