Tips on Mortgage Math

I have been writing this month on what has gone wrong in the mortgage industry and mistakes lenders and homebuyers have made. Here are some tips about mortgage numbers that consumers should know to protect themselves.

Home Prices: Speculation abounds in the media on when the mortgage market will bottom. My research suggests that the magic number for a fair sustainable housing market is 3. That number is the ratio of the median home price to the median household income in the United States. An examination of census data shows that from 1987 to 2002 that ratio remained unchanged at 3, even though home prices and income rose steadily during that time period. In 2002 home prices began increasing much faster than household income causing the ratio to shoot up to nearly 5 at the peak of the housing market in 2006.

The fact is home prices cannot rise substantially faster than household income or soon everyone will be priced out of the housing market and there will be no more buyers. At the beginning of 2008, the U. S. median home price—$195,900—divided by the median household income—$50,233—was equal to 3.9. That means more time is needed for income to rise and/or home prices to fall for that ratio to go back to its historical average of 3.

Monthly Payments: The number 3 is important in another way. Total monthly payments for principal and interest should not exceed 1/3 of after-tax household income. Many people think that at higher income levels a greater fraction of income can be allocated toward the mortgage. My last post profiled people who were willing to allocate more than half of their take-home pay to monthly mortgage payments. I imagine they thought that their income was so large that all additional living expenses could be funded with 30% - 40% of take-home pay.

But, ownership costs scale with the price of the home. The more square footage bought, the more it costs to heat, cool, maintain, insure, furnish and pay property taxes. All of those additional costs rise with inflation. If you take out a 30-year fixed-rate mortgage and live in the house a long time, there will come a day when the monthly cost of owning the home will exceed the monthly mortgage payment. That will be true for just about any size home.

Mortgage Options: Creative financing has risks. Recent years have seen an explosion of exotic mortgages. You can choose ARMs, interest-only mortgages, 40-year mortgages, mortgages with balloon payments and many other combinations and payment structures. But, the common element in all of these financing schemes is to make the initial monthly payments as small as possible by postponing actual debt reduction. That’s not a problem in a rising market, but it can be a disaster in a falling market. When prices fall it’s easy to find yourself “upside down” meaning that you owe more than the house is worth, while payments adjust upward to level that you can’t afford. If you are considering a mortgage without a fixed rate, figure out what the monthly payment will be in a few years after the interest rate adjusts. If you can’t afford to make that higher payment now, chances are you won’t be able to afford to make it in the future.

Plan for maintenance: Set aside money equal to about 1% – 1.5 % of the value of the home each year for maintenance, repairs and improvements. It’s easy to be optimistic, but the fact is things will break on a regular basis. When you think of all the things in a house with finite lifetimes that are essential—furnace, water heater, air conditioner, refrigerator, roof, plumbing—you realize that repair and replacement will be an on going expense. It is better to budget ahead of time those expenses with money set aside in a separate bank account. Repairs should not be a financial emergency requiring borrowed money every time they happen.


Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Motivations Behind Bad Loans

I’ve written columns for the Baltimore Sun on the mortgage crisis and the emails I received from readers included these comments:

“It is hard to feel sorry for folks who got in over there heads, knew it and now what us to bail them out.”

“You are omitting the fact that the majority of subprime borrowers are in their current situation due to fiscal irresponsibility or carelessness.”

My response to these comments is that the goal of my writing is to educate consumers so that they are able to make better decisions. Markets do not work as intended if the consumers do not understand the contracts they sign.

But, for the people who write these comments, their underlying assumption is that homebuyers do know or at least should know what they are doing when they sign a loan agreement. The mortgage crisis is the result of character defects—greed, irresponsibility, over consumption, and so on. Pick one or several character flaws from a list and that explains the problem.

Of course, attributing misfortune and/or good fortune, on one’s character is as old as the Bible. Outcomes do depend on character, although not always. More personal failures and successes result from chance than most people would like to believe.

But the issue of character is an interesting one and I’ve been pondering it after recently reading two profiles of homebuyers facing foreclosure. In both cases the numbers involved in the loan agreements were so outrageous, it’s hard to believe any reasonable person would be party to such a contract.

A July 30, 2008 article in the Baltimore Sun profiled Veronica Peterson, a single mother of four who operates a home daycare in Columbia, Maryland. She is loosing her $545,000 home to foreclosure after the rate adjusted from 8.25% to 11.25%. The article provides few other details on her income and mortgage payments. However, if I work with the numbers provided and assume a 30-year loan, such an increase would mean monthly payments changing from $4094 to $5293 per month, an increase of $1199 per month. This does not include taxes and insurance that must add an additional $500 to each monthly payment.

I cannot image how a home daycare operator could generate the kind of income needed to support monthly payments that high; especially since the State of Maryland limits the number of children home daycare providers can care for to no more than eight. The average cost of daycare in Columbia, Maryland is about $1000 per month. That means by law she cannot gross more than $8000 per month and she must still pay income taxes. Living in a half-million dollar home while paying no taxes is sure to raise questions from the IRS. She said her mortgage broker inflated her income. I wonder what number was stated for her income on the loan application and how it compared to her tax return.

Another profile I read was in Jay Hancock’s August 8 column on Kimberly Thomas who showed up at a closing to find the interest rate on her mortgage from Wells Fargo Bank changed from 7.13% to 10.65%. The change resulted in the monthly payment going from $3000 to $4667. Her monthly take-home pay is $5000. The title company agent conducting the settlement told her to sign the documents anyway. It was 6 PM and no one else was present or available to contact. He assured her the bank would correct the “mistake” the next day.

But the next day Wells Fargo insisted that there was no mistake and that she was bound by the terms of the agreement. Because she couldn’t afford the terms, she ended up not taking possession of the house or making a single payment. The mortgage went into foreclosure immediately. She sold the house for which she paid $505,000 for a $95,000 loss and spent tens of thousands on legal fees. Eventually a jury agreed that Wells Fargo had acted fraudulently and awarded her $1.25 million in damages. Wells Fargo maintains they did nothing wrong and are appealing the verdict.

So what is it about the character of these people that results in situations where the numbers in the agreements are so ridiculous as to be unbelievable? My own take is that it is a combination of optimism bordering on wishful thinking, wanting to please others, and willingness to trust people presenting themselves as “professionals.” Homebuyers want to believe what the agents and brokers are telling them. And, the agents and brokers are very good at telling people what they want to believe. The fake friendships that develop allow the brokers and agents to take advantage of people who want to please others. Homebuyers do not want to anger people by scuttling deals at the last minute and willingly believe that everyone is acting their best interest.

Brian Paul, the lawyer for Kimberly Thomas, said: "She honestly believed there was a mistake in the terms that could be fixed after the fact."

I remember my own experiences with home buying. The real estate agent told me: “It’s impossible to overpay for a house because it has to be appraised. The bank will not allow you to pay more than the appraised price.” I’m sure all the homebuyers he works with get that same line and many believe it.

I remember a refinance of my house where the day of closing, a settlement sheet was faxed to me with a completely different set of numbers than previously agreed to. I took a hard line telling the broker the deal would not happen unless the numbers were changed back. Within an hour a new settlement sheet appeared with the original numbers. But many people are reluctant to “cause problems” at the last minute. It is also easier to walk away from a refinance than a home sale.

So, is believing the best about ourselves and others a character flaw? It can be when it allows us to be taken advantage of and enter into agreements not in our best interest. As I warn in my book The Two Headed Quarter, the lender and realtor profit from immediate sales, not the long-term financial health of the borrower. If the government, or some other investor backs the loan the lender is at no risk. That means homebuyers must look out for their own interests. Don’t believe the agent when he or she tells you that a bank would never loan you money if you couldn’t repay it.

In fact the real crux of the mortgage problem is the ability for agents, brokers, and executives to profit by gambling with money that is not their own. That is the point I made in my previous post. Wells Fargo and its agents don’t care if a loan is paid back because they will collect commissions and fees while selling the loan to other investors. The loan would become somebody else’s problem, not theirs. The homebuyers might have character flaws but the behavior of the lenders in these cases is criminal.


Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

The Dream World of Mortgages

I dreamt the other night of being at a casino. I sat at a $5 per hand blackjack table and began playing. As the dealer flipped the cards across the felt strange events started to happen. Each time I lost a hand the other casino patrons would take up a collection to cover my loss. Then someone would rush over to add more chips to my stack. But each time I won I got to keep the money. I simply put the chips I won in my pocket. Wow, I thought; I should try this at a more expensive table.

I moved to a $10 per hand table and the same thing happened. Next I tried $50 per hand and then $100. No matter how large a bet I placed or how long a particular losing streak lasted, the lost chips would magically reappear. But, any win was mine to keep and no one seemed to care. An attractive waitress came to offer a drink. I asked for some Grand Marnier and tipped her with a $100 chip. She rushed back with the drink, a seductive smile and a food menu. I kicked back and doubled-down on a hand blackjack players call a hard-16. (Yes, I know that is a stupid play, but I might win and it doesn’t cost me when I lose.) I think I’ll just stay here. No need to go back home and return to that activity called work.

Then I awoke and regained my senses. Real life isn’t like that; or so I thought. I made some coffee and as I sipped and savored the aroma my eyes focused on the morning newspaper. I read about the government bailing out near bankrupt companies with names ending in Mae and Mac. Wait, I must still be dreaming. Is the caffeine working this morning?

Indymac, Freddie Mac and Fannie Mae were run as private companies with stockholders and highly compensated executives. The executives made a series of large questionable bets on real estate that for several years paid off handsomely. But now fortunes have changed and the bets are losing big time. Like many problem gamblers, these executives did not know how to control risk, stay within a budget, or quit before going completely broke. But it didn’t matter to them because while they got to keep their winnings for the bets that paid off, ordinary citizens are being forced to take up a collection to cover the bets that lost.

Government talk and action on the financial crisis caused by bad loans is completely disingenuous. Political leaders extol the virtues of free, unregulated, private enterprise motivated by profit seeking executives and corporations. But when these private businesses fail, our leaders tell us that taxpayers must step in to prevent the entire financial system from collapse. It turns out that the Maes and Macs performed a necessary public service, much like a utility. But Marylanders already know what happens when utilities are deregulated and run for profit. We pay extra on our electric bills every month for that improvement.

IndyMac grew rapidly during the real estate boom by specializing in so-called “Alt-A” loans. These loans did not require homebuyers to actually document the income or assets they claimed. After its failure the FBI launched an investigation of the company for possible fraud. I’m just shocked, shocked to think that without documentation, bank officials might have just made up the numbers on loan documents.

Private enterprise works well with private money. But, in the mortgage business we have a system that allows private gain to accrue from risking unlimited amounts of taxpayer money. The result is that since March authorities have indicted more than 400 people who worked in the real estate industry. We the taxpayers are now footing the bill for massive amounts of collusion and outright fraud.

In Maryland, I know of no legal blackjack games. Neither the state nor federal governments trusts its citizens to play the game responsibly. But, while casino blackjack is stacked against the player, at least it’s regulated in states where it is allowed. Many tax-paying citizens were financially ruined in the poorly regulated real estate market. But, the government says that they should have made more responsible choices. Do they think this is a dream world?


Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Numbers Used to Quantify Writing Styles

At the end of May, Microsoft gave up in the race with Google to digitize all the world’s printed books and magazines. The motivation for these ambitious projects is to allow search engine technology to reach inside the pages of every book in print. These corporations envision a future with no need to actually thumb through a book at a store or library in search of information. Search engines will perform the task much faster and return the exact location inside of any book for any text or keyword a user is seeking.

Whether such a future is a good or bad one for writer and publishers remains to be seen. Publishers have been less than enthusiastic about these digitization projects because of fears of copyright infringement and potential loss of sales. My own view as a writer is that exposure is a good thing. Obscurity is a greater threat to a writer’s livelihood than copyright infringement.

The Microsoft explanation provided for the decision to abandon the project came in classic corporate-speak. On a Microsoft blog, Satya Nadella, Senior vice president for search portal and advertising, wrote:

“Given the evolution of the Web and our strategy, we believe the next generation of search is about the development of an underlying, sustainable business model for the search engine, consumer, and content partner. For example, this past Wednesday we announced our strategy to focus on verticals with high commercial intent, such as travel, and offer users cash back on their purchases from our advertisers.”

If I ever need to write a parody of a corporate memo these sentences are a good starting point. Just how many buzzwords—evolution, development, strategy, sustainable, verticals, model, etc—are packed into just these two sentences with 65 words of prose? Actually with digitized books, questions such as that can be answered. In fact Google and Microsoft have been playing catch up with Amazon’s “Search Inside the Book” program launched in 2004. Publishers are now encouraged to submit electronic copies of printed books for Amazon to digitize and make searchable.

But, Amazon’s “Search Inside The Book” program allows for more than just keyword searches. You can now look at statistics about the writing style of a book before you purchase it. I checked Amazon’s listing for my book—The Two Headed Quarter—and discovered all sorts of numerical facts that I did not know. My book has 672, 289 characters arranged into 99,104 words. As expected in a book about deceptive numbers, the word “number” appears frequently—567 times, but it is the second most frequently occurring word. I had no idea that the most frequently used word in my book, appearing 709 times, is “years.”

But most fascinating is the statistical summary of my writing style that Amazon provides. Potential buyers can view the “readability” and “complexity” analysis of the text. My book rates as highly readable with a Flesch-Kincaid index of 7.2, meaning that you only need a 7th grade education to read it. According to Amazon 77% of all the other books are harder to read and in the category of personal finance books, 93% are more difficult to read. The easy reading arises in large part because the complexity analysis reveals that I have a simple writing style averaging only 8.6 words per sentence.

Now that last number threw me. I opened my book to some random pages and I found myself hard pressed to find sentences as short as 8 to 9 words, let alone enough sentences less than 8 words that would allow 8.6 to be the average. Amazon’s number for my average words per sentence just didn’t seem reasonable to me. I decided to run my own check using Microsoft Word’s analysis tools on some chapters from the original manuscript. I had never done that kind of analysis on my writing before, which shows you how much I think about readability statistics when I’m writing. The results:

For Chapter 1:18.0 words per sentence, Flesch-Kincaid index —10.1
For Chapter 2: 17.2 words per sentence, Flesch-Kincaid index —10.7
For Chapter 5: 18.9 words per sentence, Flesch-Kincaid index —11.4
For Chapter 8: 19.3 words per sentence, Flesch-Kincaid index —10.8

This means the readability of my writing is consistently at a 10th to 11th grade level (not 7th grade) and about average in complexity (according to Rudolf Flesch, co-inventor of the Flesch-Kincaid scale, the average words per sentence found in reading material is 17).

So how can Amazon’s statistics be so skewed? I don’t know but I have a good idea. Again, my book is about numbers and there are many numbers in the book. There are figures and tables with numbers along with worked examples containing numbers that allow readers to figure out numerical answers to many common financial questions. Many of the numbers in the book contain decimal points. My hypothesis is that the software Amazon uses to perform readability analysis cannot tell the difference between a period and a decimal point. After all, there is no difference between the two characters. Only an actual reader who can interpret the meaning of a sentence knows that a decimal point inside a number does not terminate a sentence.

I find it ironic that a book about deceptive numbers has an Amazon listing with a bunch of deceptive numbers to characterize its readability. Another example of companies spending time and resources to compile and publish useless numerical information. By the way, according to Amazon’s site my book has 3348 words per ounce and if you buy it you will receive 4715 words for each dollar you spend.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Does showing up for work cost more than you earn?

The Sunday (July 13, 2008) Baltimore Sun this week had a front-page article about mothers: “Back to Work, Like it or Not” with the subtitle that “Women who left jobs for children find economy reverses the trade.” Reporter Jill Rosen writes “The soured economy—with its ever-increasing gas, food and utility prices, its sinking home values and its corporate downsizing—is forcing mothers who have traded careers for families to think about trading back.”

I can relate to the article because my wife will change from part-time to full-time work this fall. Energy and food prices have increased so much in the past year our budget no longer works as it once did. But our three children are teenagers and our current financial goal is getting them all through college. The Baltimore Sun article profiled women in much more difficult circumstances—mothers of toddlers and infants who planned on being stay-at-home moms. But, the article left me wondering if working for a paycheck outside the home is a financially viable option for many these women.

Women who can work professional salaried jobs will come out ahead financially by working outside the home. But women who work part-time or for lower wages might find that the same financial pressures forcing them outside the home might also make it impossible to realize any financial benefit.

How much money will these women have left after paying for commuting costs, daycare, work expenses, Social Security, and state and federal taxes? I’ve already seen television news reports about men with commutes so long it no longer pays to drive to work. I can imagine many common circumstances where stay-at-home moms would be hard pressed to increase the family income by working outside the home.

To assist families in figuring out how much additional income can be generated by working outside the home, I’ve teamed with my publisher to create a new calculator for the Compute Gas Savings Website. The calculator, at http://www.computegassavings.com/earningscalc.html, computes daily take home pay after subtracting all of the costs associated with showing up for work.

Consider a married mom in the suburbs with one child who finds a job in a city that pays $12 per hour. She must commute 25 miles each way in a family SUV that gets 20 miles per gallon. She manages to find daycare for $25 per day and finds herself spending an additional $5 per day on average for other work-related costs—coffee, snacks, clothes, car maintenance etc. Because she is married her additional income is not completely sheltered by deductions and exemptions. For this example we will assume a net federal tax rate of 10% and state tax rate of 3%. After entering all these numbers in the calculator it shows that she will take home just $36.17 per day out of her $96 per day net earnings or about $4.50 per hour.

Where did the money go? The combined cost of Social Security, federal, and state taxes takes one-quarter and the combined cost of daycare and gas takes one-third. That means it costs more than one half of her pay just to show up for work. This assumes she has only one child. Add the cost of daycare for a second child and daily earnings come to $11.17.

In fact it is easy to construct plausible scenarios where real earnings per day become negative. Keep the same tax rates, lower her hourly pay to $10, or $80 per day, give her two children so that daycare becomes $50 per day, make the distance to work 30 miles and the gas mileage 15 miles per gallon, and the real earnings per day becomes a negative $7.52. Going to work will cost her more than she makes.

I urge women looking to increase family income by working outside the home to test out different scenarios before deciding on a job. The hourly pay offered might not be the relevant number to compare when making a decision.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Oil Prices Are Not Dependent on Oil Sources

A reader of my post “A Tax By Any Other Name” felt that I was naïve to suggest that supply and demand sets oil prices. The reader believes that oil pricing is driven more by speculation than anything else.

I agree with the reader that speculation is a large part of the reason we are paying $4 per gallon for gas at the moment. In my post I stated the supply and demand for oil is only a part of what sets the price for gas. I was mostly writing on how the increasing supply and decreasing demand for dollars is contributing to oil price increases. But in the last six months the falling dollar and increased oil consumption cannot account for the sudden 50% price rise for a barrel of oil. Speculation is clearly part of the problem.

It is no secret that the banks, investment houses, hedge funds, and oil companies now conduct most the trading in oil futures on all electronic foreign exchanges (such as the InterContinental Exchange or ICE) that are out of reach of U. S. regulators. A CBS news story quoted Michael Greenberger, a former top staffer at the Commodities Futures Trading Commission, as saying that 25% -50% of the price per barrel might be due to speculation. Greenberger believes that “If you can trade out of the sight of U.S. regulators, you can manipulate these markets."

What is especially disturbing about “foreign exchanges” like the ICE is that it is not actually foreign. Among its founding partners are Goldman Sachs and Morgan Stanley, its headquarters is in Atlanta, its primary data center is in Chicago, and it settles most trades in U. S. dollars. Despite all of its U. S. ties, the ICE claims that because its energy futures business is conducted in London—whatever that means—U. S. laws or regulations do not apply to it.

But all this supports the crux of my earlier argument that the energy independence that politicians speak of achieving is a myth because oil companies “will always sell their product to highest bidder, wherever the bidder resides.” The price of oil has no relationship to its origin.

In 2007 the U. S. imported about 10 million barrels of oil per day and produced about 5 million barrels per day. According to the Energy Information Administration, the top three countries of origin for imported oil in 2007 were Canada (1.85 million barrels per day), Mexico 1.47 million barrels per day) and Saudi Arabia (1.36 million barrels per day). Canada and Mexico actually supply more oil to the United States than Saudi Arabia.

If the U. S. decides to increase its domestic production of oil through offshore drilling or other means, it will contribute to the world supply of oil and that additional supply will be factored into the world price. Any politician who claims we can be more energy independent by drilling for more oil in the U. S. is being disingenuous. A far more relevant question to ask our political leadership is: Why are U. S. investment banks allowed to manipulate energy futures markets with no government oversight? I don’t think there is going to be a straight answer for that question.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

Deceptive Numbers Used to Described Floods

Of all the deceptive numbers in circulation, the most ridiculous, expensive, and tragic are the numbers the U. S. Army Corp of Engineers use to describe the levees that they build. I saw an interview with General Michael J. Walsh on the NBC news this past week. In it he referred to the rainfall flooding Cedar Rapids as a “500-year storm.” The levees were not designed for such a rare event. According to General Walsh: “A lot of levees have over topped. We don’t consider that a failure.”

He is consistent with other officials I’ve seen interviewed, who refer to levees as having “100-year” or “500-year” designs. The terminology means that according to the statistical models used to predict floods, water should top a 100-year levee about once every 100 years and top a 500-year levee once every 500 years.

You wonder how engineers and government officials can quote these numbers with a straight face. Does the U. S. Army Corp of engineers understand anything about what they are doing along the Mississippi. Clearly once levees are constructed along the river all the flood statistics become meaningless.

Timothy Kusky, director of the Center for Environmental Sciences at St. Louis University, described in an interview on NPR how before levees were built, the Mississippi River was 4000 ft wide at St. Louis. Today the river is 1500 ft wide. As Kusky stated: “It is a simple concept; confine the river to a narrower channel and there is nowhere for the water to go but up.” The result according to Kusky is that we’ve had 15 hundred-year floods in the past hundred years, and many more 500-year floods in the past 150 years. Building structures changes all the statistics.

The other problem is that the flooding statistics are based on past events. Climate change models predict a 20% increase in rainfall in the coming decades for the Midwest. With that rainfall will come a 50% rise in the height of the rivers.

But, communities, developers, and home owners continue to invest large sums of money on the basis of the bogus statistical claims made by the Army Corp of Engineers. Chesterfield, Missouri now has the largest strip mall in the United States—3 miles long. The mall, along with 30,000 new homes, is built on land that was completely under 10 ft of water during the 1993 flood. The developer erected a “500-year” levee for protection and declared the area safe.

Robert E. Criss, Ph.D., professor of earth and planetary sciences at Washington University in St. Louis has strongly criticized such development as “ignoring geological reality.” On a Washington University news website, Criss describes as an "absurd exaggeration” the claim that a levee will withstand floods for 500 years. “If some private company were making claims that they'll sell you a car that will run for 500 years, they'd be in jail. Somehow, the government feels justified making absurd claims that have no basis."

It appears that little of substance was learned from the 1993 floods. The conclusion that higher levees need to be built ignores the reality that all of the water must have some place to go. A higher levee in one location will force water over the top in another location. The statistics that are the basis for the levee building and development become meaningless. But government officials and developers still rely on these absurd numbers and the result is heartbreaking for the people affected.

Joseph Ganem is a physicist and author of The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy