Who is to blame for taking a mortgage they can't afford?

Who is to blame for taking a mortgage they can't afford

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A fundamental term in accounting is the matching principle. This is the foundation of accrual accounting and revenue recognition. The matching principle describes that all expenses incurred in generating the revenue must be deducted from the revenue earned in the same period. Uses of this principle allow for better evaluation of actual profit and performance and lowers risks in mismatching. In accounts receivable recognizing for bad debt in the same period in which related sale revenue is recognized is an application of matching principle.

The mortgage companies extend credit to increase sales and make money off the interest of the loans. There is a risk in extending credit to a customer; the risk is that the customer will not pay them back. In order to eliminate the risk mortgage companies will set up guidelines and rules on who they will allow to take out a mortgage and how much. The company will do a credit check and verify income and basically run a quick Income statement for the customers. These checks help the company not to loan out too large of an amount that would make it impossible to pay back and be profitable at the same time. Sometimes people cannot pay their mortgage and the house will foreclose. This uncollectible accounts receivable is a loss in revenue recognized by recording bad debt expense.

Recently mortgage companies extended credit to less than fit customers which would increase their non-current Accounts Receivable and showing strong revenue. When the economy collapsed and the customers couldn't afford their mortgage they stopped paying and the mortgage companies suffered because they could not account for that much bad debt.

These companies then could not afford to stay in business which caused a collapse in many of the banks who allowed these loans. This was a huge domino effect removing jobs and businesses which caused more people loss of income. The downfall of the companies who gave out these loans now caused more problems in the economy than needed.

On the other hand the customer who is applying for the loan knows if they are taking on too much. Paying an only interest mortgage or an ARM mortgage hoping that they would be able to sell the house before the interest only payments were up or they just saw the bottom line that their monthly payment matched what their income could handle. These customers didn't look into their own financial statements or do the research what they could afford on non-current accounts payable. In the end, both sides took the risk on these mortgages.

So who is to really blame for taking a loan they can't afford? Let's look at a scenario in which a house was bought for $200,000 with a 5/1 ARM mortgage at 8%. The customer figured after the 5 years they will be able to refinance in hope the interest rates will go down by then. The first 5 years the customer pays its interest only payments, at the end of the 5 years the value of the house drops to $140,000, making it near impossible to remortgage at a lower rate because they don't have enough equity in the house.

Now the customer can't afford the payments and the mortgage company is going through the legal actions to try to get the money that is owed to them. They have exhausted every option and got very little back from the customer and then have to write off the fact they will not receive any money for this account.

Both parties are responsible in determining if they can afford the debt. The loose guidance the mortgage companies used while the housing market was on a high, caused for many mortgages not to be paid and many houses on the market drop in value close to 25% - 40%. The downfall of many companies not following a strict regulation when giving out credit can affect many others in many ways.

Many banks from this time period have been bought out or closed. The guidelines in getting the mortgage now are much more strict and tough to receive. This is to protect the banks investments as well as the people trying to purchase a home.

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