To understand home foreclosures, you need to understand how bank mortgages are structured. Once you do, it will be easier to see how I view the problem of dealing with losing a home because you will see there is no “bank”, there is only a conduit through which depositors – waitresses, business owners, factory workers, teachers, doctors, lawyers, and accountants – lend their money to try to combat inflation.
Imagine that on Monday, your friend asks to borrow $50 from you. You agree, on the condition that he repays you the $50 plus $5 for the time you didn’t get to enjoy your savings. A year later, he uses the money to buy a stock that falls to $20.
[mainbodyad]He knocks on your door and says, “I’m sorry. I know that I owe you $55 because I borrowed $50 of your savings plus $5 for the cost of renting those savings for the past year, during which time you didn’t get to enjoy your money. Unfortunately, things didn’t go my way. Had I enjoyed a gain, I would have kept all of the profit for myself. I didn’t. I lost $30. Thus, here is the $20 I have left. Take it. I think it is wrong of you to demand the other $30 I promised, plus the $5 I agreed to pay you. You aren’t getting that money. It’s your responsibility to subsidize my losses.”
That kind of behavior would be sociopathic. To behave in such a way would require such an unfathomable lack of empathy it is almost hard to imagine. If you are like normal people, the chances are good you wouldn’t remain friends for long. It not the fact that your friend couldn’t repay the debt, it is the fact that he thought it was your responsibility to bail him out of his mess.
Home foreclosures are not pleasant but they are not the end of the world.
Image published under Creative Commons Attribution-Share Alike 3.0 Unported license by Vincent van Zeijst
Understanding How Bank Loans Work Are Key to Understanding Home Foreclosures
In this scenario, banks are like you. They lend money to people. The difference is, for every $100 a bank lends to someone, maybe $8 or $10 belongs to the bank owners (stockholders). The other $90 to $92 belongs to savers who deposit their cash for safekeeping. The bank’s job is to take those savings and conservatively lend them to people who have a good chance of paying back the money, plus interest. That interest, penalties, late fees, and service charges are then divided up by the bank into one of five piles:
- To cover losses on loans that go bad and are only repaid in part,
- To pay its own expenses (salaries for tellers, bank officers, expanding or renovating branch offices, etc.),
- To pay the local, state, and Federal government taxes for streets, schools, military, Social Security, Medicare, and other programs,
- To generate a return for the owners of the bank who risked their own savings to build the institution in the local community, and
- To pass on interest income to the savers who own the certificates of deposit, money market mutual funds, checking accounts, and savings accounts held on the institution’s books.
That is it. All of the money a bank makes has to go to one of those five categories. As a society, we have some safety procedures in place to protect the depositors. For smaller amounts, up to certain limits, the banks have to take part of the interest and kick into the FDIC fund. This fund pays out like insurance to depositors who don’t get their money back from borrowers during bank failures. If the FDIC fund runs dry, taxpayers step in and dip into the money sent to the IRS to pay the insurance claims.
Expanding the Lesson to the Home Foreclosures of the Housing Crisis
Now, take a few moments to think about the process when you buy a house. Say you purchased a $200,000 home and only put down $20,000 of your own savings. You finance the remaining $180,000 by taking out a mortgage. What really happened?
- $20,000 of the home purchase price came from your savings
- $14,400 of the home purchase came from the savings of the bank owners (shareholders)
- $165,600 of the home purchase came from the savings of bank depositors; the retirees, factory workers, small business owners, corporations, soldiers, waitresses, executives, teachers, politicians, doctors, and lawyers who put their money in checking accounts, savings accounts, money market mutual funds, and certificates of deposit. This money includes vacation funds, retirement funds, college funds, allowances given to kids, etc. 1
You agreed to pay rent on the $180,000 you borrowed ($14,400 from the bank owners and $165,600 from the depositors). In addition, you agreed to give the bank and the depositors a right to seize the real estate as a last resort in the event you break your word. That way, the bank and depositors can sell the house and recapture some or all of their savings. You also agreed to allow penalties and fees to be added to the debt to compensate the savers for breaking their promise to return their money, plus interest, on time.
You Don’t Have a Right To Stay In “Your Home” and Avoid a Home Foreclosure If You Don’t Return the Savings You Borrowed
No one made you borrow money. Until you have repaid the savings you rented, it is not “your home”. You don’t own it. You never owned it. You won’t own it until it is your name on the title deed, free and clear. That happens once you’ve fulfilled your promised and returned the savings you borrowed. It is incredibly simple. There is nothing complex about the situation.
Yet, I sometimes get messages from incensed readers, wanting to know what to do because the bank “refuses to work with them”. The bank is going to “steal [their] house”.
[mainbodyad]It is not the bank’s fault you borrowed money. It is not some Wall Street CEO’s fault that you borrowed money. It is not your employer’s fault that you borrowed money. You made a choice, like an adult, to rent other people’s savings. Now, you screwed up or you had bad luck. That happens. It doesn’t make you a bad person. Going forward, you have a choice. Either: 1.) Return the savings you borrowed, or 2.) Give up the collateral that you pledged (the house) so the bank can recover the savings it lent for its owners and depositors. It is their money that bought the house. They have first claim over you. You knew that at the time, you agreed to it at the time, and had housing prices skyrocketed, you were going to keep all the gains for yourself. On the flip side of the Janus coin, it seems a bit hypocritical to be upset.
Make a decision and get on with your life. The bank, acting on behalf of its owners and the depositors whom have entrusted their savings, has no obligation to “help” you. If you can’t live up to your promises – and that does happen in life, don’t beat yourself up over it – accept the bargain you struck, forgive yourself, learn from the mistake, and get over it. Study the experience so that you never have to go through it again. If ever there were a time to act rationally in life, this is it.
Don’t Destroy Your Life and Family Trying to Avoid a Home Foreclosure
Instead, I see people destroy their families, their finances, and their happiness by trying to save a material possession. You know the old saying attributed to Jesus Christ in the gospels, “life does not consist of an abundance of things”? It is just a house. It is wood, gypsum, marble, wool, and grass. To cling to it to the point of self-destruction is a level of materialism I just do not understand. Your kids grew up there? Your parents own it? That doesn’t matter. The house is not your kids. The house is not your parents. I’ve watched members of my own extended family make this mistake. They inevitably lose the house to foreclosure, anyway, but only after having depleted everything they worked for in life.
Take a lesson from Paula Cole. She penned one of my favorite lyrics, “I am not my house, my car, my songs. They are only stops along my way.” Your life consists of your choices and your relationships. Those are the things that matter. So what? You have to move into a two bedroom rental for a few years as you rebuild your life. The only thing it hurts is your pride. People will destroy any chance at long-term success just to avoid wounding the first of all sins.
Get over your materialism. Get over your pride. Get on with your life.
1. Technically, a portion of these savings come in the form of fractional reserve entries since that is the foundation upon which the modern banking system relies. Practically, since most deposits are guaranteed by the FDIC, this portion of the funding is represented by a claim on the future interest income of bank depositors taken in the form of an insurance premium at the institution level or the taxpayers of a nation as a whole, in the event the insurance pool needs to be supplemented from tax receipts paid into the Treasury. A discussion of those factors would be beyond this article.
Reader Comments (11)
Comments are presented chronologically, with replies indented beneath the comments to which they respond.
Gilvus
June 17, 2012
Smells like entitlement to me. No me gusta.
Teal Thoman
June 17, 2012
Nice post. I wish more people saw it that way, the way it really is.
Anon
June 17, 2012
Very good post. Just a couple of points:
1) The individual really does own the house. He or she is listed as the grantee on the deed. What happens is that he or she is also the grantor of a deed of trust whereby the loan for the purchase of the house is secured by the house. What I'm saying is that yes, realistically you don't own the house until it's paid off in full, but legally, in really oversimplified terms, you own the house as soon as the seller gets his or her money and that deed is filed/recorded.
2) Agreed on the disdain for people upset that the bank is refusing to "work" (i.e., an after-the-fact discount) with them. On the other hand, though, to be fair, the reverse does happen from time to time. For example, an auto company might force its employees to "work" with them and accept reduced benefits. "Working" with people is a good chunk of the bankruptcy code, to an extent. It's "you made a mistake (lending to me, promising me too much) and now you're going to suffer a little." I guess it's just the way things work.
fran
June 17, 2012
Replying to Anon
Interesting points. "Working" with people after the fact may be "the way things work " especially when a person or company gains bankruptcy protection. But is this really fair or just? Too often, I think it is not. I guess for a creditor or an employee, getting some money is better than none. I am sure declaring bankruptcy may be unavoidable for certain situations. But I think bankruptcy protection is too often used as financial maneuver by people or corporations that want to have their debt forgiven even though they could survive otherwise.
Anon
June 17, 2012
Replying to fran
I think it depends. Plainly speaking, I don't think it is fair. But it's just the way things go. Better to have some unfair rules than no rules at all or mediocre rules across-the-board, I suppose. Yes, sometimes the bankruptcy code is used to avoid painful financial damage that could otherwise be absorbed by an individual or company over a long period of time. For example, an individual with $30k in credit card debt could pay off the last penny owed right before he or she kicks the bucket. As always, better to be neither a lender nor borrower. And if you must, put an end to it as soon as you can.
Ian Francis
June 19, 2012
Replying to Anon
I'd say you are granted the right to live in the house once you purchase the house, but by no means do you own the home. You are, in essence, renting the house from the bank, with the expectation that you will own it outright in the future. This gets you some additional right/responsibilities over renting, but financially the house is property of the bank. The percentage you have paid towards your loan is roughly the percentage of the house you own, so a $100,000 loan with $50,000 left due on a property valued at $120,000 nets you $10,000 after sale. Likewise, the same loan on a house valued at $80,000 nets you -$10,000. However, no one with a mortgage should consider their house to be "theirs". You may have the right to live there, the right to remodel, the responsibility to care for the property, but you equally have the responsibility to pay your loan, or else the bank has the right to kick you out.
soggy
June 19, 2012
From a "morality tale" standpoint, I'm with ya. But a bank's job, like you mentioned, is determining who is and who is not a good bet to repay a loan, and this risk assessment is where they utterly failed during the financial collapse. They assumed they could eliminate risk by packaging diverse bundles of mortgages and quickly selling them, on the belief that home prices wouldn't drop everywhere simultaneously. Ironically this led to much easier financing, which led to overbuilding of new homes, and when coupled with a slowing economy... voila, catastrophe created!
I think if your $50 lender had gone down on the street corner and handing out $50's and discovered that a year later he was having a harder time collecting than he'd anticipated, there would be much less sympathy for him than if he'd only lent to his best friend. Banks since then do seem to have learned their lesson, however...
Ian Francis
June 19, 2012
Replying to soggy
It may be the bank's responsibility to only loan to those worthy for the sake of their bottom line, but it is equally the consumer's responsibility to only accept loans and loan terms they can afford. Bank's assumed (poorly) that their complex loan packaging would shield them from risk, and they have since learned (to some degree) from their mistakes. Consumers continue to rely on the banks to determine whether they can afford a loan, and once banks start lending more freely again there will be an increase in people taking loans they can't really afford. People want to blame the banks for their problems, but both sides are equally at fault. If the consumer is not willing to accept their share of the fault, they are doomed to repeat the same mistakes of old.
Jack
June 19, 2012
Let's not forget that banks were REQUIRED by the government to make loans to unqualified minorities or face discriminatory lawsuits from the Justice Department.
spingus
June 23, 2012
This reminds me of a civics class way back in middle school. The teach asked for a show of hands for who's parents owned their homes. About half the class raised their hands but I wasn't sure and wavered. My parents had a mortgage and I knew that was a loan from the bank so they of course didn't really own; I was really confused because I also knew that they were 'on the way' to owning the house.
The teacher then explained to me that a mortgage wasn't the same as renting and that it meant my parents owned the house. It's hard to combat the misconception when we get told young that mortgage=ownership.
Anonymous
July 5, 2012
Jack, I don't think minorities were the only unqualified ones receiving loans. At the worst my block was half empty, and they're weren't many "minorities" on my block. As far as losing a home, or car, or whatever, things happen in life. You look forward, use it as a learning experience and move. If anyone thinks they're going to make it through life without some type of obstacles, good luck.