Proof Banks Caused The Financial Crash: The Cancer Of MORE

Room With A ViewApplying for a mortgage in 2014 has truly been one of the most eye-opening financial experiences ever. I now know why many consumers had absolutely NO CHANCE in making sound financial choices when it came time to borrowing money from banks before the crisis. Consumers are still being led astray today.

Roughly 25% of homes nationwide are purchased for cash, probably due to the difficulty of getting a mortgage, institutional investors, and a rise in cash rich baby boomers looking to downsize. In San Francisco, the cash buying figure is closer to 35%. I told myself many times during the mortgage qualification process that I would just pay cash. But I soldiered on and swallowed my pride because a 2.5% rate for a 5/1 Jumbo ARM was just too enticing to pass up.

FREEING UP MONEY AND MAKING BETTER USE OF SPACE

I’m currently thinking of doing what many retirees do: downsize. I like to call my move “right-sizing” as it sounds more positive. I think the ideal square footage per person is roughly 700 square feet i.e. family of two = 1,400 sqft, family of three = 2,100 sqft, etc.

I’m not down with McMansions as it doesn’t feel good to have a lot of unused rooms when there are people out there just looking for shelter. Having a house too big feels like paying $29.99 for an all-you-can-eat buffet, but only eating $15 worth of food because you just ate lunch three hours ago.

In addition to wanting to right-size my home, I also want to free up some cash flow in my pursuit to generate $200,000 a year in passive income just in case one of my financial buffers fails. Generating income is supremely important for those of us who no longer work full-time jobs. It’s nice to have a good amount of assets, but generating a healthy passive income stream is what financial independence is all about.

THE SHOCKING RESPONSE FROM THE MORTGAGE BANK

Any rational person would view right-sizing their home in retirement or semi-retirement as a logical thing to do. We often think we’ll grow into our homes, but sometimes we never do. I’m also looking for a change of scenery and a home with a view in Golden Gate Heights after almost 10 years in my existing home. I’m amazed at how much more you can get outside of the north end of San Francisco (Marina, Cow Hollow, Pacific Heights, Presidio Heights, Russian Hill).

Take a look at this e-mail from the mortgage underwriter to my mortgage officer during the final weeks of the mortgage approval process. I found a pretty sweet home in Golden Gate Heights and told my bank the address and the pricing so I could arrange appropriate financing. This letter is proof that banks caused the financial meltdown.

I have an issue with the occupancy. The proposed home of purchase is smaller and would require significant improvements to be in similar condition as his current home. I looked up the current residence on the internet to get an idea of what his home looks like. Borrower indicated he wants to move to a different, less busy area with a view. He is not selling the departure residence and its value is double the value of the proposed home. He owns two additional rental properties, one a vacation rental and the second a condo. This just doesn’t seem to make sense as a primary residence. But I need a Risk opinion. – Mortgage Underwriter

In other words, the underwriter has a PROBLEM with me downgrading to a home that’s worth 50% less because she thinks I’m up to something. What kind of cockamamie bullshit is this? I suspect the underwriter thinks I’m really just buying a cheaper home to remodel and flip or rent out, which I’m not. For your info, primary home mortgage rates are generally 50 bps lower than rental property mortgage rates.

If I was a lender, I’d be pleased if one of my long-time clients decided to generate rental income equivalent to double his existing home mortgage, while downsizing to a new home with a smaller mortgage. The underwriter is baffled that I could ever think about living with less.

The curious thing is that I think the new Golden Gate Heights view home is just as good as my exiting home that costs twice as much. I’ve always wanted panoramic views of the ocean and I’ve finally found it. Sure, the proposed home is 300-400 square feet smaller, but I can still raise a family of three or four comfortably.

THE SOLUTION TO THE UNDERWRITER’S PROBLEM

My mortgage officer said I needed to write an ADDITIONAL LETTER (first letter was a 750 word letter saying why I wanted a mortgage) highlighting the following “concerns”:

1) Smaller home
2) Dollar amount of improvements and renovations to make it my primary.
3) Repeat again why the area is great.

What was I supposed to do? Not write a letter at the tail end of this arduous mortgage application process? No. Of course I had to respond. Here’s my second letter to the bank:

Dear Bank Of More, More, More,

I believe the secret to building wealth and achieving financial freedom is to live below one’s means. For almost 10 years, I have been living at my existing residence. The house has been fantastic, but I’ve finally realized it’s simply too large for me.

I’ve enjoyed my area in my 20s and mid 30s, but I feel it’s time to “right size” my living situation with a smaller dream home with panoramic ocean views. I think ~1,800 sqft with three bedrooms and two bathrooms is ideal. The house can easily accommodate a family of four, and if I wanted more space I can simply build out another 1,000+ square feet since the lot is more than double my existing lot. I plan to spend some money remodeling the place to make it perfect.

I believe I found my dream home in Golden Gate Heights. The broker is 70 years old and is from out of town. He didn’t put any pictures on the MLS and had a simple black and white flyer. The only reason why he got the listing was because he grew up in the house next door and knew the family. I believe if the home was properly marketed by a SF broker with professional photography and staging, the home would have easily sold for $150,000 more given the large lot and views. Fortunately, I drove by the home one evening, randomly shot the broker an e-mail, and put in a competitive bid based on what he had at the time, which was only one other bidder who had to sell their house to buy this house.

I believe Golden Gate Heights is the next gem of a neighborhood to be discovered by San Francisco buyers – very much like Noe Valley was discovered 10 years ago. Most all of the property in Golden Gate Heights are single family homes. The street is quiet and the access to Highway 1, 101, 280 is very convenient with 19th avenue close by.  Public schools are also outstanding in the area with Lowell High School, Alice Yu Elementary, and Clarendon Elementary, all rated 10 out of 10 online.

I’m surprised the “drive by appraisal” for my existing primary residence came back with such a high amount. I think a more realistic value is 30% lower given the proximity to a busier street. The appraiser used comps that are in more prime locations. So as you can see, the spread between my new home and my existing home value isn’t as large as it seems, especially if I do some remodeling.

I don’t plan to sell my properties because I’m not in current need of the money and property prices have shown to appreciate over the long run. Furthermore, the potential rental income from my existing home is enticing.

I plan to make this new Golden Gate Heights home a “forever home.” When you’ve found a $3 million dollar view for less than half, you’ve got to seize the opportunity. Thanks for your consideration.

Regards,

Sam

Not a bad letter right? I was trying to contain my annoyance, but I wanted to lead off strongly with living below one’s means to knock some sense into the underwriter. I’m pretty positive this underwriter is not financially independent, otherwise, he wouldn’t have questioned my desire for less.

After several days, my mortgage was finally approved.

BANKS ARE JUST AS AT FAULT FOR THE MORTGAGE MELTDOWN CRISIS

We read a very candid perspective from a loan officer who basically blames homeowners for welching on their mortgage obligations for causing the world’s financial destruction in 2008-2010. I can see the logic. If nobody ever defaulted on their mortgage, the meltdown never would have happened.

Now that I see how absolutely BACKWARDS mortgage underwriters are in their way of thinking, I completely believe banks were very much at fault for causing the financial crisis by pushing unnecessary levels of loans towards borrowers. My bank’s thinking was set in only one direction: more. People can only upgrade their homes with more square footage, bigger lots, and fancier features rather than downgrade. That’s absurd.

Until the risk departments at banks start realizing that not more is not necessarily better, I fear that once again, borrowers are getting in over their heads again.

Recommendation: Shop around for a mortgage. LendingTree Mortgage offers some of the lowest mortgage rates today because they have a huge network of lenders to pull from. If you’re looking to buy a new home, get a HELOC, or refinance your existing mortgage, consider using LendingTree to get multiple offer comparisons in a matter of minutes. When banks compete, you win.

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. Mr. Green says

    I was in the market for a home November – April and was looking very hard and went ahead and got pre-approved in January. I applied for a loan amount of up to 250k, after they ran all of my information they called and asked me why I was only asking for 250 when I could be approved for much more. I knew what game they were trying to play but I wanted to see what they might approve me for, the lady told me “probably around $500k.” Needless to say I was not in the market for a home that large, so I asked to stay with the 250k and was approved later that day.

    The house I got approved for I lost in the bid war. Then for 3 months could not even get a bid in on any house I liked because everything was already under contract even though the homes were just listed on MLS that morning! I was keeping a spreadsheet of home prices, areas, price/sqft and just saw it steadily climbing on almost a weekly basis. I am personally going to rent for probably another year before I buy a home. But the mortgage team offering me double my loan amount, and even during the interview asking me why I was only borrowing “so little” just raised some red flags.

    Like you said Sam, I bet those people are not financially independent so they do not understand how money works. They are just doing their job, which is get to people to borrow as much as possible.

    • Financial Samurai says

      Your example really makes me believe the banks really are the culprits for housing bubble.

      Why not bid another 5% more when the bank is pushing easy, cheap money that doesn’t need to be paid back for 30 years right?

      After a while, it all becomes funny money until everything collapses.

  2. Tom says

    Sam,

    Something similar happened to me when I bought my last home. I found a nice all brick home that was banked owned because the previous owner walked away from it. It was 1500+ sq feet but needed some work and it would be 2700sq feet, 3 bed 2 bath. When I went to get a loan and the loan officer tried to talk me into getting a “better” house because I could afford much more. It wasn’t like he just mentioned it, he kept bringing it up over and over again. Now that I have finished all the repairs I have probably increased my homes value by 60%.
    I think banks helped cause the crisis but homeowners who get themselves in over their heads are just as much to blame. Just because someone can make the monthly payment on a house doesn’t mean someone can necessarily afford it

    • Financial Samurai says

      Nice job fixing up your home. That’s the way to do it for those who have the know how, connections and patience.

      I was in the “borrowers are at fault camp” but with this recent example, I believe banks pushed greed onto consumers too aggressively.

  3. Scott says

    I had the same issue when downsizing. Since my previous home was worth twice as much as the new home they didn’t believe I would use it as a primary residence and thought I was trying to get primary residence status for a rental.

    I signed a notarized letter assuring them I was going to make the move within 60 days of completing the purchase and that seemed to be enough. The mortgage broker brought it up again at closing that he was going to come see me in my new house to make sure I wasn’t getting one by them.

    Downsizing, especially early in life, can be difficult.

    • Financial Samurai says

      Amazing they made you sign a notarized letter.

      I don’t think downsizing early is difficult. I think it’s much better. Like figuring out what you want earlier in life so you can live a more congruent, better life.

    • vpfreedude says

      Wow…I would have walked from that jerk’s mortgage and gotten one with another lender.

      Just did a quick google search and in 2011 there were almost 8,000 mortgage lenders/underwriters in the US. I wouldn’t put up with the attitude given how much money the average mortgage amortization pays the lender.

  4. Mark Ferguson says

    I can see why the underwriter had an issue. It is their job to find an issue on every loan, no matter how minor! That is a fishy situation where most people doing what you are doing may be trying to pretend to be an owner occupant, but are actually an investor trying to buy a rental or flip. In most cases the advantage of going owner occupant over investor loan is a much smaller down payment.

    This is why I prefer to work with local banks that lend their own money. They are so much easier to work with and keep financing my rentals.

  5. The First Million is the Hardest says

    I can see why the underwriter took issue. The majority of the time I believe his suspicions would have been right. Most people think they need a dedicated room for every person, pet and guest they may ever encounter, so someone who is legitimately “right-sizing” their living space probably isn’t something they see very often!

  6. Holly@ClubThrifty says

    #1 a family of four does not need 2,800 s.f. of living space. Noooooo. Just no.

    #2 I find it disturbing that your bank feels it is their place to question your motives. It is truly none of their business why you want to downsize. Maybe you’re tired of cleaning such a big space. Maybe you hate your neighbors. Maybe you want a better view, as you stated. It is none of their business! They should base their ability to lend money on factors that have something to do with your ability to repay, not your personal wants and desires. That is just weird.

    • Financial Samurai says

      Size is a matter of preference. The larger the family, the less space per person that is required. A family of four in a 2,000-2,500 sqft home sounds good.

      700/sqft/person is my idea of ideal with probably a cap at around 2,600 sqft for 5.

  7. MrsFinancialFreedom says

    This is also true in the UK. Several years ago when we were buying a house, the mortgage advisor kept saying that we could borrow a lot more and get a bigger house. When we said that the house would be big enough, he looked rather amused and said most young couples borrow up to their maximum limit.

  8. Done by Forty says

    We ran into a similar hurdle back in 2011 when we wanted to move into a different home in Tempe, just a few miles from our current house, and rent out our current one. The lender said they wouldn’t believe we’d move into the home, and would have to finance it as a rental property (more down, higher interest rate, more expensive appraisal, etc.) I said I could provide proof we were living in the home after we moved in and would be happy to have the underwriter over for dinner…no dice.

    • Financial Samurai says

      Wow, so no loan at all? It so, now I feel fortunate my bank went ahead, but the rent I will get is double the total mortgage payment including principal.

      What did you guys end up doing?

  9. Davey Pockets says

    Sam you are spot on! The banks have it all screwed up and a lot of good people are being forced to pay cash. Instead of measuring how likely someone is to pay off the loan in full, they look at a bunch of unimportant factors and ratios that make sense on paper but just don’t transfer over well to human beings.

  10. spiffi says

    I do see why they questioned it – on paper the house you have is larger, and you aren’t selling it, so you aren’t downsizing because of financial distress. As you said, the interest rates on primary residences are significantly lower – so the lenders are wanting to be sure that you are indeed going to live in the new house.

    I do think the lenders had a role in the financial collapse, by lending too much to borrowers. Though I firmly believe borrowers are adults who are fully responsible for making sure they understand the terms of the loan and that they can pay it back.

    When I started working with a mortgage broker to get preapproved for my mortgage back in mid-2010, I was told that it was “a lot harder” to get a loan than it had been, but I didn’t find it onerous – perhaps because I didn’t know any better. I talked to my broker, and explained the amount I was comfortable borrowing, she had me email her my financial statements etc, and then she said I was approved. She *did* say that I was approved for *far* more than what I had asked for – but she wouldn’t tell me how much, as she said it would probably just shock me :D

    • Financial Samurai says

      It’s OK for the bank to ask and due their due diligence. But to have me write a second letter explaining my situation seems a little too much given I told them why in my first letter what my plans are.

      If I wanted to cheat them, I guess I could. But my word is my word. And writing more words doesn’t change my word.

      Did you end up buying?

  11. Twins1987 says

    I know multiple people that work in the underwriting department of a large bank, they told me the exact same thing when I told them my plans of buying a similar size/price house that is just a bit newer (planned on renting my existing). I wasn’t trying to be sneaky, just trying to slightly upgrade because we don’t need anymore space and didn’t want to sell because of our awesome location.

      • Twins1987 says

        We are still in the house – going to start actively looking for a small upgrade to something newer and will have to figure out a way to make it work with the mortgage companies.

        The banks are making money, I would be making money – seems like a win-win to me, I dont see anything wrong with it

  12. Ravi says

    I suppose having W-2 income is the only way to keep the Underwriter Gods (more like demons) happy. :)

    In their defense, your situation is definitely odd… a guy in his mid-30s, three existing properties, no job, “online business”… from a certain slant (a goofy one, for sure) it would be strange… but in this country where the average savings rate is <5%, strange is good!!!

    • Financial Samurai says

      Yeah, two long term, high W2 income should be golden.

      But in my case, I not only have income, I have 100% liquid assets to pay cash for the property and don’t need them! I think that’s even more attractive since incomes can go away.

  13. krantcents says

    Bankers like cash flow, but they discount cash flow from rental properties. I remember going round and round with bankers because I was asset rich with apartment buildings despite the steady cash flow. I think the best situation is when you do not need them, they love to throw money at you.

    The collapse was caused by the house of cards lending policies of no income verification. Those policies increased prices and the borrowers defaulted.

  14. Chris says

    Same thing happened to me a couple years ago. I found a great deal on a foreclosure (<50% of last sale price) and the first bank didn't believe that I was downsizing and would use it as a primary residence. I grew so annoyed with them, I dropped them and went with USAA instead, who has always given me great service. Yep, still living in that property as a primary residence. I get it, surely people lie to banks to get better interest rates, but this bank questioned me no less than three times. I finally said enough and took my money and business elsewhere.

    My old boss had the same reaction, you should've seen the look on his face when he found out I was downsizing and not upsizing. Most people have a hard time with the idea of downsizing.

  15. G says

    Banking system needs to work for us, another bubble is not going to benefit anyone. Their assessment procedure is faulted if they don’t encourage those who downsize to build wealth. They lack actual experts who can make proper assessment of a person or organization’s financial well being, and try to use formulas that don’t quite work all the time.

    I am waiting for couple of months to try to get a preapproval since my current situation at my new work (less than 6 months) is still not looking good in their books despite my 0 credit card debts on almost 6 accounts, and paid all my monthly mortage payment with additional payment whenever I can. I will know in another 2 months and will share my story. I am planning to downsize too and can’t wait to get rejected again lol.

    • Financial Samurai says

      Here’s to getting rejected again for trying to right-size your living situation!

      I wonder if we should make it a requirement for all mortgage underwriters to either be financially independent or go through a course on living with less.

  16. Mike says

    I’ve really changed my tune in the last few years with square feet. We’re a family of five and we’ve had a 2,100 square foot house, and then a 3,600 square foot house, and we’re currently in a 1,900 square foot house with a partially finished basement not included in that total.

    Even with five people (and three growing kids), we’re staying under 3,000 square foot from here on out. We also favor green space, intelligent design, and a nice outdoor living area. I have no interest in theater rooms, separate dining rooms, etc.

    Many of the homes we’ve looked at online that have decent design seem to still favor “bigger is better,” so we might have to get creative when the time comes to move to a new house.

  17. Asset Grinder says

    Love your section on right sizing. I too am looking to right size. Family of 4 here. Currently I am in 3300 sqft home and its too big, more to clean, more to heat, more property taxes. I am looking to get in the 2400-2800 range and clear up some equity. Also I have a big lot I have no use for 10,000 sqft. Bout 5-6000 seems perfect.

    Also all this cheap money in the market is a lil scary. People always get too over leveraged in long bull markets and its scary!

    Great blog!

    Good Day and Grind On!

  18. Joe says

    Wow, that’s crazy. I like the suggestion of trying different lenders. There are a ton of lenders who’d love to have your business. I guess the W2 income is the big problem for you. We just applied for a mortgage for a rental and we didn’t have any problem. I guess because my wife still have W2 income.
    Your sq ft per person seems to have gone up. Didn’t you say 500-600 sq ft/person a few years ago? :)
    I like 500 sq ft per person. It’s more important for us to have amenities nearby so we can get out of the house.

  19. Syed says

    I really enjoy these posts giving some insight to the mortgage approval process. It’s a sad state of affairs when someone who wants less is “up to something”. What poor unfortunate souls. Congrats on the mortgage and best of luck in the future.

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