Foreclosure Hitting Well-Off Families Too

The More Money blog reports that foreclosures are hitting well-off families too. Consider these statistics on a recent study of foreclosure filings:

20% of the filings went to households with more than $100,000 in annual income.

35% of homeowners who received a foreclosure filing had lived in their homes for more than 10 years. These were not people who'd bought too much house, but more likely people who lost their jobs and suddenly couldn't afford the payments.

The piece also notes that "it was very rare for just one financial setback to lead to the foreclosure. It wasn't just a high-interest-rate, high-payment subprime loan that might have caused a foreclosure; it was a bad loan and then a job loss. Alternatively, it wasn't a job loss that caused an affordable loan to go bad; it was a job loss and a health issue."

I have a few thoughts on this issue:

1. Without a job, almost any financial plan goes south rather quickly. That's why it's important to have a good-sized emergency fund -- to help you try and recover from a job loss as soon as possible. I'm working on a piece centered on "protecting yourself in case of a job loss" that will give additional ideas on how to prepare in advance for a potential firing/lay-off. I hope to have it done sometime soon.

2. I can see how a one-two punch like job loss/health problem can be very tough. And it's not too difficult to imagine them coming together. For instance, assume you have a working couple, one of them gets sick, loses his job, and now the family gets hit with both a loss of income as well as mounting medical expenses. Tough to recover from this unless your finances are rock solid.

3. The above scenarios are arguments for being debt free. Someone who's been in their home for 10 years should have it paid off (or close to it) IMO -- assuming they used the right formula to buy their house in the first place.  It's not that difficult to pay off your mortgage in a decade if you apply some basic principles.

4. Don't take a bad loan. I know this kind of goes without saying, but it's noted above as one of the two factors needed to derail a homeowner. Why start out with one strike against you, knowing that you only need one more (a job loss, health problem, etc.) to sink the ship?

5. Some of these people (probably a good percentage) had to be in trouble because they bought too much house. So let me reiterate how important it is to buy a house you can afford. Stretching to meet a mortgage is placing your finances at great risk as one major setback can cause the whole house of (financial) cards to come down.

Comments

[jim]

20% is about proportional to the % of households that earn over $100k. But home owners would have higher income since many low income people rent. Of course $100k is not that high compared to the cost of living many places. I'd be much more surprised if people making over $250k had many foreclosures.

I found a USA today article from 2007 that said "Nearly one in five workers who earn $100,000 or more report they often or always live paycheck to paycheck".

We probably wouldn't have seen the foreclosures and defaults if housing prices hadn't plummeted. If house prices had held up then people would still have equity and would just sell the house or even cash in some equity to help them through their financial problems.

[MattJ]

Interesting article. It's worth noting, however, that the research on which it's based is from Florida mortgages. That seems to confirm Jim's speculations about cost of living. I would also mention a couple other possibilities - first of all, in Florida there are a disproportionate number of homes that are 2nd homes. That is, high wage-earners from out-of-state buy vacation homes on/near the beach. My guess is that a home you don't live in is at higher risk of being foreclosed on when it comes time to tighten your belt, ESPECIALLY in housing markets that have really tanked (can't resell except to take a loss)

Secondly, the research doesn't seem to adress the possibility that some of the folks who have lived in the home for 10 years or so may have taken out 2nd mortgages and simply have no equity cushion, making payments higher and foreclosure a more attractive option.

A study from Florida is probably not a good place to draw broad lessons about what's been going on in the housing market in the whole country.

[Squirrelers]

The reality is that so many people are just one or two simulataneous events away from total financial disaster. Job loss, divorce, plummeting real estate market, health problem, etc - each can be a tough obstacle. Multiple within a short time frame of one another can be crushing.

Living within one's means - keeping that income minus expense gap alive and well - while preparing/accepting the possibility of "unexpected" problems is vital. As for buying a home, I have heard far too many people talking about "stretching" to buy a good home they could live in for a while. I agree with staying put after purchasing, but not with overextending. Buy what you need, don't confuse that with what you want. Sometimes we can do such things, but not on everything or most things - especially those with large scale financial ramifications.

[MattJ]

Squirrelers:

I think the problem for many people (especially those who live in expensive housing markets - that is, big cities) is that 'buying what you can afford' when it comes to houses will often result not so much in minor downsides like sharing bathrooms and cramped living space but in major downsides such as leaving their families vulnerable to crime or sending their children to schools where academic achievement will never happen for them.

I'm lucky I don't have to make a choice like that, but if I did, I'm pretty sure I wouldn't choose the crime-ridden neighborhood with the razorwire-fenced schools.

Note that I'm not suggesting that most who buy 'too much' home are in that category, but some surely are. Probably nearly none in my town, but surely many in Miami and Tampa, two of the cities that the original study looked at.

[Michael Goode]

I bet a bunch of those foreclosures of people who had lived there for a long time were people who did cash-out refinancing.

[Stephan]

i like your point about making sure you are debt. its a lot easier to deal with a job loss if you have no consumer debt. huge credit card bills are a guaruanteed way to ruin your finances, especially if you lose your job or cant work because of a medical issue.

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[jim]

Another note in general, living in a home for 10 years and paying the normal payment will only whittle about 15% off the principal of the home. So if you bought a home with 20% down and paid the mortgage for a decade then the home values dropped 30% you'd be underwater right now. Thats not unusual in some markets.

MattJ, I agree that many people are probably buying homes that are more expensive to live in nicer neighborhoods with good schools. If the only house you can afford is in a ghetto then you really can't afford to buy a house. Average crime and average quality schools should be good enough. The best schools and a super safe low crime neighborhood are not a 'need'. I understand people will (logically) prioritize those things high, but they shouldn't prioritize them above their family's financial security.

[RobF]

It's easier to be in under water than you think. After ten years in our home, the value dropped from $522k in 2004 to 220K 2 months ago. We were financing college with our equity. We lost flexibility once values dropped that much. We couldn't even lock in a rate. We'll just retire here. At least the taxes are reduced. And the 401(k) recovered. I was out of a job for a long time, now that I'm working again, we're maxing out the retirement and savings and not focusing on paying off the mortgage.

However, my husband has a co-worker whose wife does not work. He has a interest-only mortgage and a huge HELOC. His financial advisor is telling him to walk away. I don't think he can, but he is in huge trouble. And the kids haven't started college.

Michigan wasn't inflated to begin with. We could see maybe a 10 or 20% drop. Who would ever predict this?

[MasterPo]

Getting out from under debt, especially a mortgage, sounds great on paper but just isn't practically implimented unless you have a truly large income, come into a big pot of money, or sell something of great value to apply to the mortgage.

With a $200,000 mortgage at 5% for 30 years, even if you send an extra $5,000 every year it still would take in the range of 17-19 years to pay off. Better than 30 but not like you'll be paying it off by this Xmas.

[BD]

It seems like a devastating Depression, like the one we're in now, would have the potential to bankrupt anyone, even those with "solid" emergency funds. If you get laid off (especially if you are single), and cannot find a job for years, even a fast-food job, then it's very possible to drain your emergency fund, and lose your house. Unless of course, you're renting, then you just can't afford to pay rent, and either have to rent a room from someone, or if you can't afford that, go homeless.

This is such a horrible depression, that even prepared people are finding themselves in a bind. :(

[Budgeting in the Fun Stuff]

I could not agree more with your housing suggestions. We would not be able to save nearly as much if our mortgage wasn't so low. Even though we are paying it off in 10 years or less, the payment and overpayment come to about 20% of our take home pay...that makes it so easy to save!

It also helps to know that even if one of us lost our job right now, we could live off the other income. If both of us couldn't work, we'd still be okay for a year or more. The key really seems to be "keep expenses low".