As I’ve looked into buying a home recently, I’ve come to discover that the US mortgage market seems to be completely detached from reality. Due to the Federal government regulations and a prevalence of standardized products, lending standards have become extremely mindless, with a heavy focus on wage income and gross debt. This is “mindless” because these two attributes are not necessarily the most important ones in accessing the ability to repay, or the overall risk of a loan.
A Better Way to Access Risk / Reward
If I were a lender and we were in a free market mortgage system, I’d analyze a real estate purchase in the exact same way I’d analyze any other business. Real estate is an investment, and it should be examined based on the potential profitability; the income-producing alternatives; the character, creditworthiness,and resources of the borrower; as well as the ability to repay.
The first thing I’d look at the potential income produced by the property. Could the borrower theoretically rent out the property at a significant higher rate than the mortgage payments? If so, the property itself may be lower-risk. If the situation is reversed and the mortgage payments were twice that of the potential rental value, I’d consider that high risk. It’s irrelevant whether the borrower wishes to actually rent out the property or not, because rental is merely an alternative action that helps access the true level of risk. If the borrower has a very good alternative action, they are very unlikely to default, since they would give up profit to do so. Even if they do, the bank is unlikely to lose as much money, since the property value likely increased in order to eliminate the arbitrage opportunity in the market.