Time to Revisit Prudent Lending Standards
Ok, I just posted and my reading, this $4 trillion overhang of mortgage debt, has me going on the stupidity of the policy/rules that made this mess.
If you haver never read my post Low Interest Rates -- As Destructive as Usury, I would suggest reading it. Higher interest rates have an unearned bad rap, but all things equal, they enable people to take control of their debt in a way that low interest rates prevent by making modest changes to spending to apply the difference to debt. Those same modest changes make hardly any difference to reducing debt when interest rates are low. This is based on the insane lending rules that allow a percentable of household income to be applied to mortgage regardless of the rate.
When you examine the issue, prudent policy says you must lower the percentage of income to mortgage or lower the years of the term of the mortgage as rates decline. I tried to explain this in Sensible lending laws.
My thoughts are to qualify for a mortgage no more then 30% of income should go to mortgage and taxes and the mortgage should be based on a 20-year term at 10%. That should be the base standard of what you qualify to borrow. I don't disagree with some room to borrow more with lower rates, but if you read my Six Degrees of Leverage, for a 30-year mortgage with $100k of household income you could borrow $310k and at 4% it increases to $524k.
$524k is 69% more then $310k. When rates are lower, you can afford to borrow more actual dollars then when rates are high, but reducing it to simply a percent of income takes away that important ability to control debt and pay it back early and free up cash to spend on other things in the economy. Both mortgage examples have the same payment, but with the higher interest rate far more of what is being paid is interest and paying extra onto debt can enormously reduced the interest burden. With low rates it is mostly principal you are paying and there is no way to reduce the principal repayment burden.
I see nothing wrong with starting at the standard I have suggested and then adding an extra 3-5% to what you can borrow for each 1% decline in rates. So, in this 30-year example you could borrow an extra $56 to $93k rather then the insane extra $214k the current rules would allow.
But the other thing I would do is make the payment 30% of income if rates are lower and reduce the mortgage term. This would increase principal repayment and leave room for modifications in the future should the borrow's circumstances change. The mortgage would actually be paid back in about 20 years rather then 30 years and at 4% it isn't wise to be giving out 30 year loans to their maximum qualifying income even if they have the highest of credit scores. They will be debt slaves for life and it requires perfect living circumstances, no unexpected expense, or children, or job loss, or illness.