Sorry folks, but time to call “horseshit” on yet another study linking a lack of financial literacy to financial ineptitude. According to a recent study that focused on the relationship between financial literacy and mortgage delinquencies, individuals’ limited ability to make complicated financial decisions contributed importantly to the sharp rise in mortgage defaults.
The study hypothesizes that indirect evidence points to the possibility that cognitive limitations play an important role in the choice of a mortgage instrument.
Reductio Ad Absurdum
Reductio ad absurdum is a Latin phrase that means “to reduce to the absurd,” which is exactly what this 65 page study accomplishes! The study attempts to use economic arguments to arrive at a ridiculous conclusion like in the example below:
In other news, Alcoholics Anonymous® recently came out with their own study that hypothesized those who drank stood a better chance to become alcoholics than those who didn’t. They surveyed current and past AAA members as well as Bar and Liquor Store owners to arrive to this conclusion.
See what I mean? Reductio ad absurdum indeed!
He Said What?
Stephan Meier, one of the report’s authors and a behavioral economics expert and professor at Columbia Business School said one of the big takeaways of the study is that defaults were not driven by the mortgage choices people make.
He was also quoted as saying “Even if you gave this group a plain vanilla, 30-year fixed mortgage, this group would still have difficulties” to which I say “horseshit” and here’s why .
Mortgage Instrument as Much to Blame or More
During the subprime boom, many loan officers and mortgage brokers steered their credit challenged borrowers into subprime loans. That particular mortgage instrument wasn’t necessarily the problem; rather the problem was that it wasn’t a “plain vanilla, 30-year fixed mortgage “.
The fact that the mortgage instrument was only fixed for 2 or 3 years (a.k.a. 2/28 and 3/27) with harsh pre-payment penalties should you refinance before the fixed period ended, was a huge reason why these loans defaulted!
Math-challenged Americans more likely to end up in foreclosure?
Bob Sullivan, columnist for the Red Tape Chronicles goes over this topic in his recent blog post but is more parrot than he is journalist. He writes:
Can you imagine? All of the people Meier and his quorum quote in this study are very involved in the Financial Literacy Movement, yet after almost 20 years, the needle has barely budged but these academics can come to the determination that if you can’t answer 5 simple math questions, you’re headed for foreclosure? Amazing!
Real Life vs. Hypothesized Life
This study goes on to hypothesize that indirect evidence points to the possibility that cognitive limitations play an important role in the choice of a mortgage instrument. Horseshit!
After participating in over 600 plus mortgage transactions and having been in credit and lending for over 20 plus years as well as currently being a Realtor, here’s typically how someone chose a mortgage instrument in which to finance a home purchase before the real estate crash:
Client: We really like this home we saw on the internet and I want to get pre-approved for a mortgage
MB: OK Mr. and Mrs. Client, are you currently renting or buying your current residence?
Client: We’re renting and we pay $1800 dollars a month for a 3/2. My wife and I both work and Joey and Cindy go to middle school.
MB: Well Clients, let me take a look at your credit, income, and assets, as well as find out how much down payment you have and I can give you an idea how much house you can afford based on your specifications and buying objective.
MB: Oh-Oh Clients; your credit has some dings and issues we need to address and your credit scores will prevent you from getting a conventional loan. The good news is I can still get you a loan; the bad news is the rate will be a little a higher than a conventional loan and you will have to refinance this loan in 2 to 3 years when those credit issues are handled and your credit score has gotten better (if they do at all).
Don’t worry, the way the market is going, you’ll have gained great equity in your home after just 2 or 3 short years. Then we’ll put you into a conventional 30 year fixed with a better rate!
Client: Why can’t I refinance before then?
MB: Because the bank has made it cost-prohibitive by including a harsh pre-payment penalty if you refinance before the fixed period is over.
Now here’s a question the Client never asked and the Mortgage Broker never brought up; WHAT IF? The conversation should have continued this way;
Client: What if something happens and I can’t refinance after 2 or 3 years?
MB: Then your payment will triple, the loan becomes adjustable, and you’re in trouble!
Real Life Conclusion: You see; these people weren’t choosing to take a 2/28 or a 3/27 mortgage instrument in which to purchase their home because of cognitive limitations or because they couldn’t answer 5 simple math questions as the real life challenged academic Mr. Meier hypothesized.
They were taking it because the White House Administration under President George W. Bush at the time was making an extreme push for all Americans to live the American dream of home ownership and this was the mortgage instrument created by banks that was going to help them achieve it!
When is $1800 Dollars not $1800 Dollars?
I’m so tired of reading how people bought more house than they could afford or were buying a home with no money down and those are other reasons why we had so many mortgage defaults. Really? Well let’s take a look at that.
If you were paying $1800 dollars a month in rent and replaced that rent with a mortgage of $1800 dollars a month, that money would have gotten you around a $225,000 dollar mortgage and you’d be a Homeowner building your net worth as opposed to renting.
No money down? That’s another lame-stream media myth as well. If you bought a home with an FHA backed loan and only put 3.5% down but negotiated 3.5% back at closing from the seller, how much money have you put down? And all you past and present mortgage brokers and Realtors like me reading this article know for a fact this happens more times than not with these transactions!
So to answer the question “when is $1800 dollars not $1800 dollars”, the answer is; when you don’t have a “plain vanilla, 30-year fixed mortgage “!
This Study Brought To You By….
I have no idea why this study was created and for who’s benefit, but I can tell you that asking academia who have been leading a failed financial literacy movement in this country over the past 20 years to create this absurd report with its absurd hypothesis left me incredulous.
All you had to do is ask people who came from the mortgage industry. Here, let me help Mr. Meier and crew with a few quotes from industry professional themselves that could clarify how and why we had so many mortgage defaults:
More Financial Literacy Hocus-Pocus
No truer words have been spoken than those of John Robbins above. Think many of the people who defaulted on mortgages during our financial meltdown might have been professionals with college degrees, academics, or any other respected profession who were specifically educated to bring rational decision-making skills to problems? You better freaking believe they were!
So in honor of Mr. Meir ‘s 5 question simple skills math test created for his study, I created a simple 2 question “what if” test that would be a greater indicator of future mortgage default than his nonsensical math skills test:
1: What if you or your significant other is hit with long-term loss of income or unemployment or is hit by a catastrophic and debilitating health issue; do you have a minimum of 18 months in reserves that could cover all of your housing and living expenses to get you through that time?
2. What if instead of taking a “plain vanilla, 30-year fixed mortgage”, you take an adjustable rate mortgage which is fixed for 2, 3, or even 5 years to save a little on the rate right now; can you comfortably make the payments if the rate doubles or triples after the fixed period if circumstances dictate you cannot refinance?
If you answered NO to one or more of these questions, then in our new economy, you’re an excellent candidate for not only mortgage default, but a complete financial crash and burn!
More Financial Literacy Is Not the Answer
So here we are again, led to what I think is at the heart of this report; pushing more failed financial literacy initiatives! As I wrote in a previous post about Financial Literacy being an illusion: success can and should be measured by failure!
As in by how many Americans, despite their level of education, incomes, and perceived level of knowledge with financial literacy, continue to “crash and burn” financially – year after year. Even after almost 2 decades of the mountain top screamers yelling “teach more financial literacy” like I believe Mr. Meier and his co-authors are trying to accomplish with this study!
3 Pillars of Financial Life Building Skills
Through my very own financial crash and burn and mortgage default, I have come to the definitive conclusion that without learning and mastering the 3 pillars of Financial Life Building Skills, the system has you exactly where they want you; set up for failure!
I invite you to read the Amateur Consumer’s Manifesto and learn how by mastering these 3 pillars of financial life building skills, you will stop being a slave to emotional stimulation and compulsive behavior and learn to ask “what if” using a technique I call “pause and reflect.”
You need to learn how to free yourself from consumerism, bad decision making and its consequences, and learn how to live an advanced and sustainable life! This is how you avoid mortgage default and financial ruin!
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