Who or What is Responsible for the Sub-Prime Loan Debacle?

There has been much ink spent lately on the problems in the housing market. Talk of people losing their homes because of bad loans, dishonest mortgage lenders and poor planning are rampant in most any paper you pick up today.

In fact, much of the blame has been heaped on those exotic mortgage instruments and their misuse. People who are marginal borrowers (what we call the sub-prime market) have often been the subject of these stories and will be the ones most at risk from the changes that have already occurred and those yet to come. Not that these changes are all bad, but as usual those who least can afford it are the ones most affected.

I would like to shed a little light on these issues from my point of view as a Certified Financial Planner and someone who helps people use assets, like their home, to build wealth.

First, is there abuse of the system out there in the market place? Certainly, but no matter what the regulatory agencies do to solve the problem, there will always be abuse. The real culprit, from my point of view, is our own unwillingness to take responsibility for our actions. If the lenders were more responsible they would do a better job of screening applicants and fitting them with the right mortgage products or even be willing to turn them down if they can't be confident of repayment. If the borrowers were more responsible they would demand clear explanations of how these products work and what they can expect in subsequent years. They would also be willing to settle for a little less house than stretch themselves to dangerous limits.

Fortunately, we have been lucky here in the Triangle. We have not seen the big run up in values that have occurred in Florida, California or the Northeast. We also live in an area of the country that people are eager to move into and we still have plenty of open space to accommodate them. The issue here is one of degree. We don't see the abuse that took place in these overheated markets but we still have people selling the same mortgage products with some of the same results.

The product most discussed is called the Option Arm or Pay Option Arm. Don't get me wrong, this is a great product for the right borrower but it has been used by some to get people into homes that they clearly could not afford using a standard fixed rate loan or even a fixed rate interest-only loan. If you don't know how these products work, the borrower has the option every month of paying either a 15 or 30 year amortized rate, a current interest-only rate or a minimum payment that usually starts at 2%. Now even though you have all of those choices you can bet that most people are going to choose the one that has the lowest out of pocket cost, the 2% rate.

If the current interest rate is 6% you can see that you are going to be adding to your mortgage every month rather than paying it down. In addition, the payment goes up only 7.5% per year but the interest rate is recalculated every month. If you lack the cash flow and or home values are rising at less than 4% you will begin to get into trouble very quickly, and that is what has happened to some.

Like any complex financial instrument, a mortgage must be managed if it is to be used successfully. This means that you need to forge a relationship with your lender that is deeper than just the "guy who wrote my mortgage". You might also want to run this by your financial planner so that it is coordinated with your overall financial plan. The lenders that I refer my clients to know their business and are educated on the proper use of the products they sell. Since my advice includes using mortgages to access home equity I have to be confident that my clients will be well served and that their goals will be reached. This should be your goal too regardless if you are using your home as part of your wealth strategy or if you just want to pay it off as soon as possible.

Remember, it is your responsibility to create the discipline and take control of your own financial future. Mortgages are not your business so it is critical that you do your homework up front and ask the hard questions of those people who are advising you. If you have good advisors, get educated up front, and manage your assets in intelligent ways you will reach your goals with greater speed, comfort and safety, and that's all any of us want.