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The Debt

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November 20, 2011 – Comments (8)

Financial Armageddon has a post that shows a graph for debt from the 1950s to now.

The debt levels started taking off in the 80s, right when Greenspan started stepping down the interest rates.  I think  of debt as taking from future jobs.  The money you have to pay back is not available for goods and services that would provide work for people.

The entire policy around lending based on being able to borrow to a level of debt that can be serviced with a fix percent of income when rates are not fixed and further, their properties as they change are not linear, but exponential is insane and completely lacks numeracy common sense.

Overwhelmingly when you read about the the issue the problem being reported is the debt levels, however, that isn't the problem, it is a symptom of bad policy.  The problem is how what you qualify to borrow is calculated.  The entire policy shows low numeracy in terms of the dynamic nature of interest rates.

What you qualify to borrow should be a fixed number times the income.  I would suggest that it should also be say 3 times the higher income partner and 1.5 times the income of the second person in a relationship.  So, if you have a couple with $60k and $40k, the maximum debt would be $240k.  The reason I don't think both incomes should contribute the same is that couples tend to have families and have one partner not making income for periods of time and relationships break up.

Now, working within the maximum amount you are allow to borrow based on a multiplyer times income, then the policy on the maximum that you can pay should be based on a fixed percent of income.

Looking at the example of the couple with $100k of household income that qualify to borrow a maximum of $240k and then for simplicity say the maximum of income that you can have going to debt servicing is 30%, so you can have $30k of mortgage payments per year or $2500/month.  At 4% if you opted to pay the maximum allowed you'd have about an 10 year amortization for the mortgage.  At 12% you'd have about a 27 year amortization paying the maximum.  That same family at 4% could also choose to pay say $1200/month and have an amortization of about 28 years.

But I also think the maximum years for amortization should be less when interest rates are lower 30 at 12% and one year less for each 1% decline in the interest rates, so maximum of 22 years at 4%, which would give a monthly payment around $1375.

Long term debt is simply bad for the economy.  I can guarantee at 12% people are motivated to reduce debt and will make sacrifices to reduce that debt and they will dramatically reduce the amortization period without policy forcing it down.  At 12% increasing the payment by 10% would make the amortization period go from about 27 years to just over 17 years.  The interest savings is over $200k for a relatively small sacrifice.  At 4% there isn't the same motivation which is why it is important to reduce the maximum allowed amortization period for lower rates.

 

8 Comments – Post Your Own

#1) On November 20, 2011 at 1:47 PM, wolfman225 (62.68) wrote:

+1.  I agree that one of the  biggest causes of our current fiscal problems is the over-leveraging of the past made possible by overly relaxed lending standards.  It used to be common rule of thumb that the typical mortgage should total no more than 2.5x gross annual income, with the modification that the total of all housing expenses should total no more than 25-30% of NET income levels.  And this was after the standard requirement that the prospective borrower come to the table with a minimum of 20% down.

Keeping interest rates artificially low, while simultaneously relaxing standards to promote "easy money" to unqualified borrowers has proven to be disastrous both to individuals who got in way over their heads trying to keep up with the Jones's and to the general economy when all those failed loans came to be a drag on the rest of us.

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#2) On November 20, 2011 at 2:32 PM, chk999 (99.97) wrote:

What you qualify to borrow should be a fixed number times the income.  I would suggest that it should also be say 3 times the higher income partner and 1.5 times the income of the second person in a relationship.  So, if you have a couple with $60k and $40k, the maximum debt would be $240k.  The reason I don't think both incomes should contribute the same is that couples tend to have families and have one partner not making income for periods of time and relationships break up.

This is a very hetero-normative paragraph and I find it just slightly offensive. 

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#3) On November 20, 2011 at 3:35 PM, TheDumbMoney (37.82) wrote:

F^%k with the heteronormative stuff!  Did you read Ebert's review of the new Twilight movie, too? I've hated that term since the 90s and now he's just making it even more mainstream. It's all over the place today.  'Heteronormative' is a very acedemo-normative term, and as such it offends my non-academic sensibilities.

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#4) On November 20, 2011 at 3:51 PM, zzlangerhans (99.78) wrote:

Someone needs to retake Irony 101.

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#5) On November 20, 2011 at 4:40 PM, TheDumbMoney (37.82) wrote:

zz, that someone is you maybe?

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#6) On November 20, 2011 at 5:00 PM, ikkyu2 (99.27) wrote:

Pardon me, would you have any Gay Groupon?

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#7) On November 20, 2011 at 6:18 PM, materialsman92 (34.85) wrote:

@ dumberthanafool

I find your comment ironic

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#8) On November 21, 2011 at 7:41 AM, outoffocus (22.82) wrote:

Seems like everyone posts funny comments now to all the blogs.  A sharp contrast from the angry comments from 2008-2009.  Glad to see everyone has their humor back.

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