Personal Responsibility is the Cornerstone of Financial Literacy

The most obvious failure of our education system is the number of ‘educated’ people who are financially illiterate and seem to have no concept of personal responsibility.

This story was recently presented at KARE11 news about the Nelson family.

The Nelsons jumped at the chance to take more than $100,000 in equity from the house they originally purchased in 1999 for $117,000. The new 2005 mortgage was for $240,000. They applied for another 30-year fixed-rate loan, but they say their broker told them they only qualified for an Adjustable Rate Mortgage (or ARM).

They “jumped” at the chance to dig themselves $123,000 deeper into debt on an adjustable rate mortgage? I barely passed the 8th grade and I know that’s foolish. At 25, when I purchased my first home, the broker told me I could buy a bigger house in a better neighborhood if I took an ARM instead of a conventional mortgage. I saw the obvious risks and said no. But this next paragraph really gets me…

They had been lured in with a so-called teaser interest rate of 6.9 percent. The monthly payment was about $1500. It was steep, but Shawn and Roxanne managed. They didn’t realize that the rate would jump to 8.9 percent after just two years and readjust every six months after that. Shawn sighs, “Signing all those documents, I couldn’t tell you what I signed.”

They were lured? To me “lured” is what a pervert does to a child using a bag of candy. It implies something sinister and immoral. Wouldn’t “offered” be a little less biased?

Then… He couldn’t tell you what he signed? Whose fault is that? He didn’t say the lender lied to him, he said he didn’t know. Whose responsibility is it to understand what you are signing? I bought my first house when I was 25, my wife slung hash at a burger joint, I drove a truck, and I had enough sense to pay an attorney $400 bucks to come to the closing and look at every piece of paper I signed and explain it to me. It was worth it, because he saved me over a $1,000 in closing costs and prevented me from signing several unnecessary agreements.

In the fine print of one of the documents they signed in 2005, was a pre-payment penalty. It would cost the Nelsons an additional $3,000-$4,000 to pay off the ARM with another mortgage. It is money they don’t have.

He didn’t know there was a penalty for early payment? Whose fault is that? Did he ask? Did he read the documents?

The biggest problem facing Shawn and Roxanne is a move by their mortgage company that they caught them completely by surprise. The lender ordered an appraisal of the house in 2005, but only notified the Nelsons of the amount in 2007. The house was appraised at $268,000. The effect of that appraisal is to make any new refinancing almost impossible. The Nelson’s spoke with realtors who told them the house could sell for no more than $225,000. Since the Nelsons’ mortgage was for $240,000, there is no equity left in the home.

He didn’t ask to see the appraisal value before he signed the mortgage? They make it sound like he didn’t understand the amount of his loan, the interest rate, the payment terms, and the value of the home. Maybe he didn’t. But whose responsibility is it to ask? The article goes on to blame the mortgage company for the $268,000 appraisal, but home values have dropped since 2005. Having a mortgage that is higher than the value of your home is always a risk, especially with nothing down. It’s common sense.

“We cannot afford that at all. At this time, I’m the only one working. My husband’s a teacher and he’s laid-off at this time.”

Earlier in the article, he says he has a degree and is working on his masters… I’m sorry… but cmon’… I live in Minnesota…unemployment is very low. He could find a way to make some money, it might not be the teaching job he wants, but he could contribute financially. There is a way.

Shawn lowers his head. “The hard part for me is knowing that I’m supposed to be providing for my family. We got ourselves into this situation, but it’s not because of something we did on purpose.”

Huh? Shawn may not have planned it this way, but his decisions caused it.

Who took out a $240,000 ARM without an income?

Who failed to question the interest rate and the risks?

Who failed to ask if there was a penalty for early payment?

Who failed to question and understand the appraisal?

I am baffled by this. While I can’t believe any lending institution would borrow loan Shawn this amount of money, I am equally baffled by an educated teacher who understands so little about personal finance. I could understand if it was an elderly person, or someone mentally deficient, or even someone unfamiliar with our language and culture, but this guy has no excuse.

I met another guy last year who told me a lender offered him a $300,000 ARM with nothing down which would have created a 55% debt to income ratio. Think about that? After SSI, medicare, income taxes, and your mortgage payment you’d be living on 10-15% of your income (the home maintenance alone will cost another 10%). It is irresponsible to make these loans, but it is also irresponsible to take them when it is clear you can’t afford them.

When I started looking for a new home in 2004, I hadn’t shopped for a mortgage in 10 years. In 1994 lenders would not allow a borrower to extend themselves past a 32% debt to income ratio. So in 2004 when I asked my mortgage guy how much I could afford, I was stunned when he said, “pretty much whatever you want.”

I asked for clarification, “I can borrow any amount I want? 700K? 800K?”

“Yes”, he replied.

“What about debt to income ratio?” I asked.

He said, “Don’t worry about it, we can find a way around that. It just doesn’t matter as much as it used to.”

I instantly realized that game had changed in the last 10 years. While the lender used to show restraint on loan amounts, now I needed to show restraint and judgement. We decided not to extend ourselves past a 25% debt to income ratio and we bought far less than we could afford.

In retrospect, I still paid too much for my house because similar houses in the area are now selling for less than we paid. But that was the insanity of the 2004 market – everyone was paying too much and it happened to be the year we needed more square feet to expand Christine’s home business. But we’re still okay financially because we didn’t buy the home as an investment, and we didn’t over extend ourselves.

The housing market correction is going to be painful for many people, but most have no one to blame but themselves. No one forced them to pay over-inflated prices with risky mortgages; they did it voluntarily. They may have done it because of financial ignorance, but for educated people in the information age, there is little excuse for financial ignorance.

Sorry if that came across and little mean and arrogant… but sheesh! These “victims of a predatory lender” stories drive me nuts.

37 thoughts on “Personal Responsibility is the Cornerstone of Financial Literacy”

  1. I love your remarks on the story. Those have been my exact thoughts lately on the stories of “evil” lenders taking advantage of people. Give me a break, if borrowers don’t have enough common sense to read the documents they are signing, then sadly they get what they deserve and the rest of society pays the price when the housing market stumbles. Lenders shouldn’t allow people to borrow amounts they could never hope to repay though.

  2. I agree with you on having little sympathy for people who overextend themselves, but the mortgage lenders share no blame for the housing bubble?

    Responsible people who want to buy a house to start a family simply can’t because irresponsible lenders have cheapened money in a way that inflation statistics don’t account for…

    This is going to get ugly.

    And just look at the google ads.. low low mortgage rates!! Ooh shiny :)

  3. Uh, what happened to the 100,000 in cash they took out of the equity? Couldn’t that use that to buy back most of the mortgage?

    Or do they have a shiny boat, shiny Escalade, and shiny european vacation photos?

    Funny how the article does not mention that….

  4. Donut,

    I wondered the same thing. The article doesn’t state where the money went, but it seems to imply that they used it to pay down unsecured debt and pay for his masters degree. But again… I’m reading between the lines.

  5. Very good! I wish more people thought about it like you do instead of jumping on the victim bandwagon.

    SNL nailed it –

    “Don’t buy things you can’t afford”.

  6. Amen brother. What a great illustration of how pervasive the ‘victim culture’ is now adays.

  7. I agree with all of your comments and this couple was extremely stupid. However, it does not change the fact that houses are far too expensive these days. Particularly in the northeastern US.

  8. You can’t blame the education system for the family’s digging themselves into a hole while at the same time trying to absolve the lender of any responsibility.

    If you borrow money, it is your responsibility to see that you are living within your means and are being a responsible steward. Anyone with good sense knows that if something looks to good to be true, it usually is. From what you tell us here, this family doesn’t appear to have good sense. The guy is already apparently educated beyond his intelligence.

    But lenders do have a responsibility in this mess. It is their responsibility to their shareholders to see that money is loaned in rational ways. Their shareholders want money, not repossessed homes. I’ve signed two mortgages. Both times the contract was gone through point by point. I think there’s more going on here than what was said in the news report.

    Another thing that concerns me is that companies are advertising interest-only payment loans, with a balloon due at the end of the contract. If I remember, these are the types of loans that caused a lot of people to lose their homes during the Depression.

  9. Rick,

    I agree that the lenders are irresponsible too. So are many real estate agents.

    But I respectfully disagree about education playing a role.

    The first problem is his apparent inability to ask important questions. he just seems to take things as presented without digging deeper.

    If the story is accurate he obviously does not understand the concept of contract law and does not understand interest and debt. These are not difficult concepts and should be hammered home in any educational intitution.

    Adam,

    I agree that housing is too expensive. But part of the problem is this idea people have about borrowing money. They are paid too much because they borrowed too much and it drove the prices up and we will likely see big price correction in some markets. Buyers should have been hemming and hawing. If you bought in 04-05 with nothing down, it might hurt.

  10. “While I can’t believe any lending institution would borrow Shawn this amount of money,…”

    Well, see, they wouldn’t. The institution might LEND him the money, though. Sorry to be so picky, but it’s one of those things that Minnesotans say that drives me crazy.

    However, you’re spot on with the rest of the piece. Why would anyone blindly trust the mortgage company when their reason for existence is to make money off loans? Why bother to read the contract that’s legally and financially binding for 15 or 30 years? Unbelievable how foolish people are when it comes to money. Thanks for calling it like it is.

  11. Quoted text:
    >I am baffled by this. While I can’t believe any lending
    >institution would borrow Shawn this amount of money,
    >I am equally baffled by an educated teacher who
    >understands so little about personal finance. I could
    >understand if it was an elderly person, or someone
    >mentally deficient, or even someone unfamiliar with
    >our language and culture, but this guy has no excuse.

    Minnesota grammar point:

    The institution didn’t “borrow” Shawn this amount of money, they “lent” it to him. Shawn “borrowed” the money from the lender.

    I know the term “borrow” is used in this way frequently in the Midwest, but it’s just bad grammar.

    For the record, I’ve got many excellent friends and a wonderful spouse from Minnesota, just pointing out a grammar faux-pas.

  12. BTW, one thing to consider – a lot of the companies WRITING these loans sell them “back east” to various funds about 2.3 seconds after the ink dries. This allows the writers to pocket the “fees”, and removes them from having to deal with the consequences of underwriting bad debt.

    I remember my first mortgage in 1994 – I had to write a letter to an underwriting committee explaining my bad college-age credit card, that I had already paid off. Now you don’t need proof in income? Google “no-doc mortgage” and weep.

  13. I’m feeling contrary today, Steve. Personal finance may have been taught in the guy’s school. We don’t know. When I went to school it was available, but it was an elective. If I had my way it would be required, but so would driver’s ed, which many schools have seen fit to cut.

    Either way, it is an individual’s responsibility to learn all they can when they enter into a contract, just as you did.

    Re Adam’s remarks about housing being too expensive – real estate is worth what someone is willing to pay for it. It may not be affordable for you or me. That doesn’t mean it’s overpriced.

  14. Rick,
    I like it when you’re contrary. It makes me think. There is nothing more boring than having a discussion with a bunch of people that agree.

    I agree it is the individual’s responsibility and maybe that’s what needs to be stressed in school and at home. Maybe I just took another pot shot at the “system.” I like to do that you know.

    About prices,
    I agree with you about prices too. The price is what buyer is willing to pay, nothing more nothing less. My only point was… I believe they have spiraled beyond reason because of loose lending and irresposible borrowing. They’ll come back to earth… in some places.

  15. No doubt about the prices spiraling because of loose lending and irresponsible borrowing. And they will fall, with a lot of lenders and borrowers paying the price. You illustrated that very well with this family’s case.

    That still leaves the question of what to do about things like this, if anything. Write it off as some people are short-sighted? Regulate lenders to enforce responsible lending? Live with a boom and bust cycle? I don’t know the answer.

  16. As a real estate agent I see far too many people get in over their head. The sad thing is when I ask if the buyer will be alright financially or try to give them advice they don’t want to talk about it. I guess in a way it is none of my business, but I really hate to see people suffer with their new house payment. Buying a house should be an exciting time in their life. The worst thing you can do in my opinion is to stretch yourself to the breaking point.

  17. ” So in 2004 when I asked my mortgage guy how much I could afford, I was stunned when he said, “pretty much whatever you want.””

    I had a similar experience about six months ago when I was thinking of buying a 2nd home and renting out my 1st (paid off) house. It was at that point that I realized that something had gone terriably wrong since I last bought in the early 90’s. It was then that I decided to do a bit more research and concluded that housing prices are going to correct downward probably 20% or so over the next few years. So I’m no longer in the market to buy. Now I’m waiting the market out.

    Really, there’s a lot of blame to go around on both sides: yes this educated school teacher should have known better and he definitely got into this mess because of his own decisions. There are other cases I’ve heard about, however, where paperwork was altered after signing and pages were added to the top of the paperwork to make it look like they were signing for a fixed-rate loan when in reality it was an ARM (yes, even in those cases the buyer should have read all of the pages, but still, that’s quite deceptive).

    This mess isn’t going to end well for a lot of people. The silver-lining on this dark cloud is that housing prices will be getting back to being related to incomes. It’ll take a few years to get there, but waiting to buy will reward.

  18. Rick,

    I’m rarely in favor of more government intervention. I just wanted to point out the “culture of victim hood” in this article.

    What to do about… I don’t know. Maybe nothing… But something doesn’t seem right in this mess. The market will correct itself if the responsible parties feel the pain – in this case the borrower and the lender. I’m not sure they are both feeling the pain. We shall see.

  19. The lending industry has, IMO, changed from one of “responsible” lending in which the institutions tried to keep default rates low, to one of “acceptable risk” lending, where a default rate is allowed to rise as long as the profit margin covered the loss.

    Remember, a few years ago, Mitsubishi’s foray into financing all comers, even those with no or low credit scores? Brilliant ad campaign — lots of young people dancing in their new Mitsubishis, with emphasis on minorities.

    One year later Mitsu had parking lots full of repossessed cars. Ah well. They tried, right? No matter who got hurt in the process….

  20. A number of lending institutions would loan the money because they did not intend to keep the loans on their books. They would be bundled together with other mortgages and sold to someone else. Making the loan business for a lot of these companies a matter of volume with little risk.
    This is just to explain why they would get the loan. It does not absolve anyone from being personally responsible for their own loans of course.

  21. I agree with you. But I will note that there is a reason that the companies are willing to extend loans to risky buyers: they expect to make money on the foreclosed properties.

  22. I once had an ARM mortgage (5/1, no early repayment penalty, and I bought the property under market value in 2003) and must say they’re not bad if you understand what you’re getting into. It wasn’t hard to find out what all of the terms mean in the modern internet enriched world. I knew the options and picked the one that fit best.

    Now I keep seeing articles talking about “predatory lending” and wonder to myself what the problem is. The thoughts you express go through my head every time I read one of those articles. I’m even more confused as to why politicians want to help keep people in mortgages that they probably shouldn’t have had. Renting isn’t so bad – especially in a market like California where you’d pay more in interest on a mortgage for a property than you’d pay in rent for an equivalent one.

  23. Americans want bigger and better and simply don’t care about the details.

    As you say, the correction is going to be very painful for a lot of people.

  24. Let me first say, I appreciate that the thrust of this post was related to personal responsibility. From where I’m sitting this is the driver behind most of our social ills–from education, to health care, to personal finance, to the total lack of quality toilets choices at Menards.

    Too many people are too lazy or trusting (or something) to take care of themselves.

    And as far as education goes, I’ll be the first to take shots at it–but I feel I’ve earned that right. As a teacher I’m part of the problem. It’s easy to sit outside, spot holes and point them out. But that kind of discourse always irritates the hell out of me.

    Education schmeducation. You can point your finger (and I know it was a minor point, Steve, but still . . .) at me and the institution I work in, and I’ll take the blame if that’ll help. But let’s think critically for a minute. Let’s do what I’m trying to teach my students to do.

    You said,

    “The first problem is his apparent inability to ask important questions. he just seems to take things as presented without digging deeper.

    If the story is accurate he obviously does not understand the concept of contract law and does not understand interest and debt. These are not difficult concepts and should be hammered home in any educational intitution.”

    You’re implying the system should have done more to “hammer down” concepts of contract law, interest and debt. I say the system should have done a better job at teaching him to ask better questions.

    Either way “the system” can only do so much. If education actually worked the way you are implying, it would prevent people from making mistakes. Ergo if education worked, there would be no car accidents, drug and alcohol abuse, teen pregnancy or (insert your social ill here).

    Because Education (at least the schools I’m aware of) do hammer these things down pretty hard.

    Yet amazingly–people are still making mistakes.

  25. Chris,

    Thanks for stopping by and commenting. I really do appreciate your comments…

    I realize looking back, I realize that I went off half-cocked on this post.

    I didn’t mean to blame teachers for the problems in education. I had the same English teacher for three years in high school and I felt he was one of the best men I’ve ever met. John Taylor Gatto was a teacher for thirty years and he is part of the solution to the problem. The institution itself appears to be the problem. Have you read the underground history of education by Gatto? It is an amazing work. Blaming teachers for poor education is like blaming prison guards for abuses behind bars. Some are great, others are indifferent, and others are abusive – just like any other profession.

    What I recall about my education is that I wasn’t expected to take responsibility for anything except being told what to do. Someone told me what and how to do everything and it was my duty to do it. I was expected to trust the folks teaching me, and with a few exceptions, you weren’t allowed to challenge them. We were drilled for years to follow the syllabus and obey,obey,obey. Why can you do A work and fail a class for attendance alone? Because you are not expected to be responsible for your own education. Why is school compulsory? Because people are not expected to be responsible for themselves. So what are we teaching? Dependence and irresponsibility. I even question the title of “teacher.” Can anyone be “taught” anything? Isn’t really about learning and less about teaching? Anyway, I could go on for 10,000 words…

    What really pissed me off about this story, and it’s even more obvious if you watch the video, is that this family seemed to take no responsibility for their actions. Mr. Nelson’s vocation as a teacher just added fuel to it, because… isn’t a teacher supposed to understand personal responsibility? Isn’t that somewhere in the requirements for teaching children? Why do we have all this regulation and licensing, if we don’t even expect them to understand personal resposibility? I don’t know… Maybe I expect too much. Again this might sound mean… but I hope he doesn’t get another teaching job until he learns that he his responsible for his own actions.

    Anyway Chris – I appreciate a teacher to stepping forward and challenging me on this. I just checked out your blog again and I like what you’re doing.

  26. Steve,

    Sounds like your education sucked. For the most part, I feel mine sucked too. Rarely was I challenged to THINK. Rarely was I engaged.

    But here’s the interesting thing about that–from my perspective, it looks like we both turned out alright. By that, I mean it looks (at least on the surface) like we both think critically and take responsiblity for our own.

    Sooo. . . the billion dollar question is: Really, how important IS education (at least as we know it today)? What else are the contributing factors? As an educator, I’ll take responsibility for what I can–and bust my ass to fix what I’m able. All I’m asking is that, as a community, we start to take a look around for the other factors influencing our youth.

    Why did a relatively smart kid in my class to tell me that I had a “small penis” yesterday? How could he possibly think that might be an OK thing to say? Really. What in the hell is going on? I don’t think he learned that in school.

    Anyway–I hope I didn’t come accross as too “challenging” of this post. As I said, I appreciate that your major thrust here was Personal Responibility, and recognize that the education card just kind of got lumped in with it.

    Personal responsibility is a big deal with me as well. And often baffling. Looks like we’re on the same page there.

    ‘Nuff said. I could go on for 10,000 words as well.

    My blog? Meh. Its got a ways to go. Quite a ways. Thanks though. Your’s isn’t too bad either (he says, grinning at the understatement).

    Later,
    Chris

  27. Thank you for your article, I have been asking myself these very same questions. The very name of the loan Adjustable Rate Mortgage would be cause for an average person to ask “Adjustable?”.

  28. Whose fucking fault is this?
    We are in a great financial crisis and the future is not certain. Cries of lack of individual responsibly echo through the night, as if crucify all the liars who took out loans they couldn’t pay to telephone poles would protect us against any further excess.
    Who to blame, and how much of this is caused by personal irresponsibility?
    I used to listen to talk radio back in the day before I could afford a tape player. I was always amazed by people who called up with an argument and got eviscerated by the host. I thought to myself, ‘how hard is it to have a single point, express it quickly, and then get off?’
    What I didn’t see at the time is – talk show hosts are predators. They have trained and been educated in talking. They hone their skill with words over time. They have practiced in front of millions of listeners until the fear has left them. They also have self selected themselves to be where they are – good tones, confident postures and faces that on Radio would love, (think: ugly fat guys getting even with words for all the bruises popular guys gave them in high school.)
    It’s not a fair fight – callers are thrown to the gladiators in the ring of a telephone for blood sport and the amusement of others.
    People want to believe, they want Christmas, and they want to win the lottery. Many have grown up all their lives thinking that owning their own home is to have arrived. They fall into the ‘home or purpose’ reason for existence group.
    And it’s not as if people from Nigeria were telling them they could afford a home.
    Given a choice of something now, or something latter – and given a credit culture paid for by advertising and flash – individual responsibility for actions becomes a weakness that gets exploited, in the same way a teenager gets taken advantage of by a sophisticated predator.
    The people showing the houses, offering the loans, processing the paperwork, repackaging the loans so no longer identifiable, selling the packages and leveraging them 30:1, regulating the farce, taking the bribes, and pocketing the billions – all of them had more understanding of their actions, and more blood on their hands, than any person who thought with dreams in their eyes that Christmas had come for them, and come early, at last.

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