The housing crisis resulted in a great deal of finger pointing. Politicians blamed Wall Street, Wall Street blamed government, and each political party blamed the other political party. What gets lost in the drama of political theater is that real people signed mortgages that could not be afforded. Somewhere in the buck-passing, we are left to wonder what happened and how financial consumers can avoid future foreclosure catastrophes.
A paper published by the St. Louis Fed, titled “The Foreclosure Crisis in 2008: Predatory Lending or Household Overreaching?” gives us an idea of the financial state of the average household in foreclosure during the housing crisis. The paper compiled characteristics of debtors in foreclosure during the recession and classified these struggling households using PersonicX Life Stage Segmentation, a classification that divides households into 21 groups based on socio-economics, marital status, and household size. Researchers found a number of trends in the collected data worth taking note:
Generation X was Most to Blame. The largest percentage of households in foreclosure belonged to those in Generation X—in particular, Gen-Xers who had high average household income ($59,500) and years of education (14.8 years). It seems counter intuitive that a well-educated and affluent group of families would lead the foreclosure charge. Yet this group of households made up more than 1 in 10 foreclosures. How do affluent families end up in foreclosure?
Luckily, the researchers provided statistics about the types of mortgages that were in foreclosure.
Mortgages with High Loan-to-Value. The size of the down payment at closing can vary greatly. FHA loans can require as little as 2.5 percent of the purchase price. A review of mortgages in foreclosure found that the median mortgage had a loan-to-value of about 65 percent. Mortgages in foreclosure had a median of 96 percent.
Avoiding financial trouble can be as easy as thinking about how hard it is to afford a reasonable down payment. The down payment is meant to be a barrier to homeownership. The easier it is for you to cover the down payment, the more stable your finances are and the less likely you are to default on loan payments.
High Purchase Price. On average, homes in foreclosure cost more than $50,000 than homes with mortgages where the owners make timely payments. Leading up to the housing crisis, home prices skyrocketed. Most families emerging into affluence saw prices rising at an alarming rate and felt pressured to buy quickly, before home prices spiraled further out of reach.
Warning bells should sound anytime you feel pressured to buy because of rising prices. It might also be a sign that the market is coming to a peak and could collapse. It’s not a guarantee that markets will settle or become more reasonably priced, however, that nagging feeling is probably the rational side of you trying to tell you that you are getting in over your head.
Lower Income Sometimes an extra $5,000 a year in income makes a big difference. While those in foreclosure paid 25 to 33 percent more for their homes, they also made nearly 10 percent less in income than the average mortgagee who in sync with their mortgage payment.
It’s important to think realistically about our current and future income prospects. When there is something we want, the tendency to put on rose-colored glasses and begin counting eggs before they hatch is strong. We start predicting the future raise that isn’t reasonable or the tax return we’ve always wished for.
Financial Over-Reach. Those who find financial ruin are not the type of people you would expect. It’s not those who are unemployed who fill the dockets of bankruptcy court, but those with jobs. Fed researchers found that those with the brightest financial future were people who suffered most during the housing crisis, and this can be explained by our tendencies to financially over-reach. The best way to avoid foreclosure: be realistic. You can always upgrade your living situation later. Save up for what you want, and get it when you truly feel comfortable.
JP is a writer for the money blog 20's Finances. He is an MBA and the financial officer for a nonprofit organization.