Thinking like a Mortgage Lender

Once in a while I ponder upon a chapter in the book The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition).Last week I went thru the chapter "Defensive investor and common stocks".Note on the concept of risk portrays a very interesting aspect of Investment psychology.It shows how we think differently about risk when it comes to stocks and bonds and always think about the latter as more safe and former as risky.But if we carefully analyze then a bond can be risky and a stock can be safe.Following is a little example that explains this fact.

"THINKING LIKE A MORTGAGE LENDER"I guess this might be one of the most startling articles you have read , given the present scenario of the sins of mortage business and its after effects felt throughout the world.No matter how much we curse these so called "Mortgage experts", we cant ignore the fact that the spectacular growth of USA economy since world war-II has been because of the rapid growth in housing and auto industry.

A house and a car are two biggest assets held by any average person.The lenders for these are always focussed on there interest and principal payments.Till they are getting that every month they are happy.Let us take the following case study.

John , who was 30 years of age in 1984 bought a house in California.He takes a loan of $100,000 for buying it.The bank charges 6% interest and expects the payment of the whole principal in 15 years.By 1999 John Fullfills all his obligations and at the end both John and his bank are happy.

But if we analyze the time period from 1984 to 1999.The things were not always great.In 1990 the housing market crashed.John's house lost 30% in value.And he also was unemployed temporarily for 6 months.Being a financially conservative person, he had ample resources to weather the storm.

What if the bank would have leant money to Tom who was a party animal always living off paycheck to paycheck.The moment tom would have lost his job, the bank would have required to foreclose his property and in the process would have been forced to take a hit.

So the lesson learned from this deal is that if we as an investor think like a mortgage lender, lets re-phrase it as "A CONSERVATIVE MORTGAGE LENDER", then in long run we will come out good.But only if we avoid :

1. Being forced to sell at a time when its not good for selling.
2. Lending money to aggressive guys who donot maintain a cushion for the tough times.