Does anyone remember when it wasn't so easy to borrow money?
I have for years watched in amazement as banks loaned money to individuals to buy homes with no money down, no documentation of income, and significant issues on their credit report. To make matters worse, many of these loans were made at below market interest rates with provisions to significantly increase the monthly payment in just a few years after origination. They called this type of loan a "Sub Prime Loan." I call it ridiculous! Is it any real surprise that these loans are now defaulting at unprecedented rates?
What I know is you can't loan money to someone that can't pay it back. It's bad business for the bank and it's financially devastating for the borrower when they lose their home to foreclosure.
I remember when I bought my first home in 1986. I had to have a 10% down payment to make certain I had some skin in the game. The bank verified my employment and my salary to make certain I had adequate income to repay the loan. They confirmed cash in the bank to make certain I had adequate reserves. They verified any other outstanding debt to make certain I wasn't already in over my head. They also checked my credit to make certain I had a good history of repaying previous loans. After all of that, I was approved for a fixed rate mortgage that wouldn't increase in a few years and price me out of my own home. These measures protected the bank and me.
My personal philosophy about debt is quite conservative by today's standards. I screen all personal debt by the following filter:
• You must have a significant enough down payment so that if you need to sell the asset quickly you could do so and be able to repay the loan in full from the proceeds of the sale.
• You must have a reasonable expectation that the asset purchased will appreciate in value or generate an income.
• The monthly payment needed to service the debt must not place an undue strain on the monthly budget.
If it meets all of these criteria then it may make sense to borrow money and buy the asset. However, about the only asset the average Joe will purchase based on these criteria is real estate. Consumer debt, including borrowing money to buy a car, will never make it through my filter so I discourage it. I recommend my clients purchase consumer items from current income or savings. Some people may think this is ultra conservative and has no place in our "new economy." I call it a return to common sense. |
In The Money 