Two Steps Forward, One Back

I've been doing the media rounds of late talking about Never Too Late and how important it is to save for the future. Interviewers inevitably want to talk about the debt problem we're facing and how much trouble we're actually in. I keep pointing out that the flaw in the system is the credit score and how it's been used to replace sensible credit adjudication. And as for using debt service calculations based on gross income, isn't it time the system got with reality? It's a case of "the chicken and the egg" paradox, really. Have people's borrowing habits created the debt crisis, or is it lender's propensity to give too much credit the real problem? Here's a case in point. I just received this letter:

I desperatley need your help! My family is sinking in debt, I am becoming more and more depressed and feeling like there is no way out. We recently purchased a home that is in major need of repair and we do not have the funds to fix it because our debt load is too big and our income too small. I dont know how to repay this debt without having to use what we pay on it every month because there is just not enough money to go around.

Here are the details.

Mortgage: $325000 @ 2.48% amtz 30yrs
LOC: $65000 @ prime plus 1%
LOC: $8000 @ prime plus 2%
Visa $1000 @ 11.49%
Visa $15000 @ 19.9%
Car Loan $15000 approx and not sure of int rate
Our Gross Monthly Income is $5962

So how does a family with a gross income of less than $6,000 a month, which means a net monthly income of about $4,600 depending on their province, qualify for a new $325,000 mortgage on top of a preexisting $104,000 in consumer debt?

Since Total Debt Service calculations usually limit borrowing to no more than 40%, on a gross income of $5962, the banks would be happy to qualify you for $2,384 in monthly payments. Hold on now. With a net of just $4,600, that'd leave you with just $2,216 to pay for everything else in your life AND save. Houston, we have a problem!

So here we have a family that is $429,000 in the hole and unable to bear up under the weight of all that debt. And we have lenders who are willing to give said family all the rope it needs to hang itself, which it has done. So, now, who pays?

The family can't. You can't get blood from a stone. So they'll go bankrupt and as long as their mortgage is in good standing, they'll get to keep their home. But they might lose everything else. And the lenders will lose, and then use that as their excuse for keeping consumer interest rates higher than they should be in the current relatively low interest rate climate.

This family should never have qualified for a $325,000 mortgage. Currently their monthly mortgage payments are about $1300. When they have to renew this mortgage, assuming they go with the current 5-year rate, their mortgage payment will jump by almost $500 a month. Where are they ever going to find that extra money?

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