Monday, October 24, 2011

In theory, older people and people with higher levels of education should be more financially stable and have an easier time affording their homes. New research from the University of Iowa suggests that's not the case.

Jerry Anthony, associate professor in the UI School of Urban and Regional Planning, examined data collected by the Consumer Bankruptcy Project at Harvard University of households from across the United States that filed for bankruptcy in 2007. He assessed the "housing-cost burden" — the ratio of housing costs to income — of families trying to save their homes from foreclosure, looking at factors such as age, income, race, and marital status to see who was hit hardest and why.

Jerry Anthony

Since the late 1980s, financial experts have considered up to 30 percent of income an affordable housing-cost ratio; households that spend more on housing expenses are considered housing-cost burdened.

Anthony found that nearly half of the bankrupt homeowners had exceeded the 30 percent rule of thumb. Three-fourths experienced at least a 30-percent jump in housing-cost burden in the months before bankruptcy filing, often because they took on home-equity loans, missed payments, and ultimately watched the situation snowball into bankruptcy.

"Financial literacy in the U.S. was at an all-time low before 2007-08," Anthony said. "Banks and mortgage companies had been downplaying the risk of borrowing too much, saying that the more you borrow, the more prosperous you will be. They convinced people that their house was an ATM, and the equity in the house was for their spending pleasure. The public has got to be smarter than that."

Older homeowners hit harder

One might assume that older folks would be less burdened by housing expenses. With their mortgage payment remaining unchanged while their income generally increased, the house should be paid off — or close to it. Anthony found evidence to the contrary as the chance of being "housebroke" was much higher if the oldest adult was 65 or older than if the oldest adult was 40 or younger.

Anthony attributes the finding partly to a growing trend among middle-aged and older adults to be in more debt than previous generations. He also blames predatory lending, aggressive marketing by lenders to older people, who took out second mortgages and lacked the income to pay off home equity loans.

"During the run up to the housing crisis, sometime in the early 2000s, mortgage companies targeted people with equity in their homes, enticing them to borrow with statements like, 'This is a great time to tap into your equity to buy that boat or take that around-the-world cruise you've always wanted to go on,'" Anthony said.

That person may have their house paid off, but has limited income as a retiree, perhaps living off of a pension and Social Security checks. While the monthly payment on the equity loan might only run $200, unexpected expenses like medical bills could throw things off. A couple of missed payments balloon because of late fees and interest charges, and before they know it, the retirees are in deep financial trouble.

"For $200 a month, they lost their home that they had paid on for 30 years," Anthony said. "It's tragic. They worked hard, they had solid jobs, and they achieved the American dream. But they wanted to improve their quality of life a little more, and the American dream became the American nightmare."

Too smart for their own good

More education is usually associated with better financial outcomes, but Anthony found that households with less education were better off, at least in terms of keeping housing costs reasonable.

Comparing households with two or less years of college to those with four or more years, Anthony found that the group with less education was half as likely to exceed the 30 percent ratio.

Anthony says the issue is that homeowners with more education outsmart themselves. They consolidate other debt, like credit card balances, into the mortgage loan because the interest rate is lower, and the interest can be deducted on income tax returns.

The down side is that move increases their housing cost ratio and puts them at risk for losing the house.

"They put all of their eggs in one basket by securing all of their loans with their house," Anthony said. "They didn't think that if they miss a few credit card payments, the credit card company won't come after their house. But if they miss a few mortgage payments, the mortgage lender will."

Who's to blame?

Anthony says there's enough blame to go around for the foreclosures: federal and state governments that failed to regulate effectively, ruthless banks and financial institutions that sought short-term gains, and naive consumers who took on more loans than they could handle.

"People think, 'If a bank gives me a mortgage loan, it surely believes that I can repay that loan.' That's absolutely naive," Anthony said. "Banks often didn't have an expectation that you're going to pay off the loan. They were just there to originate the loan, make some money on the origination and then bundle the loan with other loans and sell it off.

"That said, Iowa banks have generally been much better, more scrupulous and far less greedy than banks in the rest of the country. And in the wake of the foreclosure crisis, banks all over the country have become very cautious about mortgage lending, and this is good."

Anthony encourages people to rethink whether home ownership is the way to go for everyone. He suggests that renting might be a better option for some people at certain points in their lives. Renting is better if your rent is very low, or if you plan on moving within a few years.

Preliminary work on this study was done during a 2009 summer seminar at the UI Obermann Center for Advanced Studies. The study will be published in December as a chapter in the book, Broke: How Debt Bankrupts the Middle Class (Stanford University Press). The book's editor is former UI law professor Katie Porter, a faculty member at the University of California at Irvine.