Ask Chuck: Subprime Loans

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Dear Chuck,

My husband and I would love to buy a home before our second child is born next spring. We are seriously considering a subprime loan since we don't have a down payment. We have a few years left on our student loans, and a car payment. We've been told that renting is like throwing money away every month. What are your thoughts?

Primed for a Home

Dear Primed,

Well first, congratulations on the good news that you have another child on the way!

A subprime loan is a mortgage loan offered to those who wouldn't be eligible for a conventional mortgage for a number of reasons, including a low credit score, or in your case, no down payment. Because these loans are offered to individuals who pose a higher risk to the lender, they also come along with high interest rates, dramatically increasing what you pay over the lifetime of your loan.

To be straightforward, subprime loans are not a good idea and I would strongly advise against one. I want you to carefully consider the dangers of a subprime loan and some of the options I offer below.

Background and Trends

A decade ago, Lehman Brothers Holdings Inc. collapsed when mortgage delinquencies and the market slump turned their assets sour. It propelled the government and central bank into rescue mode. But, today there are rumblings of new risks on the horizon, including another recession.

In 2006, real estate prices began falling and by 2008, many homeowners owed more on their house than it was worth. They were "underwater" due to job loss, other bills or insufficient income to begin with, and could not sell the homes to pay off the mortgage. So, many defaulted.

Today, similar to 10 years ago, the more highly leveraged the household, the greater the possibility of default or foreclosure. In more basic terms - the more you owe the bank, the less likely you'll hold on to your house, especially in the case of economic turbulence. Any tremor or shock in the economy can totally disrupt a homeowner's ability to cover expenses.

Consider your Options

I'm familiar with the common advice that you should avoid renting since it's just "throwing money away" and while I understand the intention of this advice, I think it oversimplifies a complicated decision.

First of all, your rent pays for a place for you to live, which, in my opinion, is a dollar well-spent! Your rent is not building any equity for you, but it gives you flexibility if your job or income changes, exempts you from condo/HOA fees, and puts the responsibility of any maintenance and repairs on your landlord. Your insurance is cheaper, you don't have closing or selling costs, and you're not on the hook if your dishwasher breaks. Often (and hopefully) your monthly rent is less than a mortgage would be, so it should allow you to save and live with financial margin.

Furthermore, home ownership is not for everyone and comes with a laundry list (pun intended) of responsibilities and financial commitments. Before you apply for a single loan, take the following into consideration.

Principles of Borrowing

In recent decades, debt has become a way of life for many people. Personal, corporate, and government debt have skyrocketed, putting families, companies, and citizens at risk.

God's Word doesn't specifically say, "Do not borrow." However, it does contain warnings about borrowing. Following are some principles that you, as a borrower, should know.

Debt is not normal. The U.S. economy has become virtually dependent on a constant expansion of credit. But God's people should manage their finances differently. Instead of being servants of lenders, we need to be servants of God.

Avoid long-term debt. In Israel, the rule was: "At the end of every seven years you must cancel debts" (Deuteronomy 15:1 NIV). Today, the typical mortgage is for 30 years. Christians should make every effort to pay off a mortgage early.

Avoid surety. Proverbs 6 warns against accepting an obligation to pay for someone's loan if you lack a guaranteed way to make the payments. The only way to avoid surety is by backing up what you borrow with collateral that covers the debt if needed.

Pay what you owe. Paying back a debt may be painful, but it will add great blessing to your life when you maintain your credibility by paying everyone that you owe.

Questions to Answer Before Buying

Is my job stable?

Are my health and marriage secure?

Do I have enough financial margin to make payments and cover maintenance, repairs, landscaping, decorating, HOA fees, and utilities?

Do I plan on living here more than 5 years?

What is the cost of living and the economic outlook for the area?

What is the rate of real estate appreciation or depreciation in the area? At what rate are prices and rents expected to increase or decrease in the area over the next several years?

Are home prices falling?

Buying Guidelines

No more than 40% of your Net Spendable Income (your income after tithe and taxes are taken out) should be allocated to housing.

Make sure you understand everything you need to know about mortgages.

Make a large enough down-payment (at least 20%) to avoid Private Mortgage Insurance (PMI) and save thousands of dollars over the life of your mortgage.

After down payment and closing costs, you should ideally have 3-6 months of living expenses in a savings account. This will allow you to take care of unexpected expenses without depending on a credit card.

If you can buy as cheaply as you can rent (considering all costs of home ownership) then buy. But, be mindful of the guidelines above to minimize your risk of long term financial stress and loss!

Your home is a lifestyle decision that requires prayer, research and counsel. This is the largest financial decision most families make. Seek the wisdom and experience of others who have gone before you. Be patient and don't get caught in the comparison trap or assume you're missing out by renting.

Keep in mind these Biblical warnings:

"The rich rule over the poor, and the borrower is servant to the lender." (Proverbs 22:7)

"Without counsel plans fail, but with many advisers they succeed." (Proverbs 15:22)

Thanks for the question and may the Lord direct your steps.