Financial markets are in turmoil. Central Banks are doing their manipulate the money supply thing to keep everyone afloat. And it's all because of Central Banks doing their manipulate the money supply thing and Shiny Stupid People.

The Federal Reserve spends it's days trying to figure out the best balance between money supply and inflation. One of their primary tools is manipulating the Prime Rate. This is the interest rate that the Fed charges on money it lends to banks. Banks lend that money to their customers and charge a slightly higher rate on those loans - that's how they make money.

(Note: I know that this is a vastly simplified explanation for how it works, but that is all that is required here.)

A few years ago interest rates for home mortgages were at historic lows. You could get a home loan for well less than 4%. This made home buying more affordable for a lot of people. It also made it possible for people who could afford to buy a simple modest home to buy something bigger and nicer. Real estate prices soared. Home ownership reached all time highs. Every one was SHiny and Happy.

The problem though is that most of those mortgages were adjustable - some had a three or five year fixed period before adjustments began. This is where basic stupid overreaching comes into play. If home mortgage rates are at all time lows and you sign on to an adjustable rate mortgage, where do you think it's going to adjust?

If you answered down, congratulations there's probably a foreclosure in future!

A lot of people over-borrowed thanks to the Federal Reserve driving interest rates so low. When rates started going up, and those temporary fixed periods of many mortgages started expiring, people were suddenly finding it difficult to make that monthly mortgage payment. They began to default. Lenders began to suffer. The housing bubble sprung a leak.

The response of the Fed was to lower interest rates again. I wouldn't have done that. I would have left the rate where it was and let the lending industry take the hit for their poor lending decisions. And shake some of the bad debt out off the economy. That's just me, and my predilection for letting people suffer the consequences of their own choices. Besides, I know a bit about this from the perspective of the Shiny Stupid People.

A few years ago we bought a new house. The house itself was well within our budget and it was a chance to move to a better neighborhood. Away from the high-traffic close-to-the-highway street we lived on previously. My wife and I both had great, well paying jobs so we set about making some changes to the house.

The biggest change involved adding a bedroom to the second floor and residing the entire house. In the middle of this, my wife went on long term disability due to very serious back problems. She was now bringing home 60% of her previous salary. We had financed the house for a very low adjustable rate, and when her disability began, we went making a the full payment to the minimum they would accept. This put us in a condition called "negative amortization." The difference between what we were paying and the full payment was added to the principal of the loan. If you've ever looked at an amortization schedule for your mortgage and been shocked to see how slowly the principal goes down in the early years of the loan, imagine looking at one and seeing the principal go up!

The rate on our loan had not gone up very much and we had little choice but to ride it out until we got past the three year early pay-off penalty. As soon as we could, we refinanced the mortgage and rolled into it the equity loan we had taken out to finance the renovations. We got a fixed loan, at a slightly higher rate than we would have liked rate, but as you can imagine, the whole negative amortization episode was not that great for our credit rating.

Now we have a fixed mortgage that is at the limit at what we can afford to pay. But it is fixed. We know what the payment will be every month for the next 30 (29.5) years. And for now our income future looks solid enough that each successive year the gap between our income and our obligations will widen and things will get easier. We did not go over the cliff as many who over-borrowed have, but we were standing at the edge checking out the view.

We made the sacrifices necessary to keep our home and to remain solvent. We have delayed purchases. We have cut back on "discretionary spending." We cancelled plans for a family vacation, and haven't made any for next year. We bit off if not more than we can chew, at least right up to the limit and have had to swallow hard to get through. Our shiny new fixed rate mortgage is a big part of being able to back away from the edge.

We don't have a market determined rate because the Fed insists on manipulating interest rates for the benefit of Shiny Stupid People. Maybe they should try putting the economy on a fixed rate for a few years.

Posted by: Stephen Macklin at 05:01 AM | No Comments | Add Comment