In 2006, Ernie and Edith Garcia began building their dream home on a Fountain Valley lot his grandparents had purchased decades earlier.

Six years, one recession and one layoff later, the mortgage on their home has become an anvil around their necks.

“The American dream?” Ernie Garcia asks. “This has turned out to be the American nightmare.”

The Garcias have a lot of company. Unnoticed amid the housing boom and bust, millions of California families entered risky territory, paying once unthinkable shares of their income for housing.

Today, some 2.7 million California households – homeowners and renters – pay at least half their income for housing. That includes the Garcias and about 200,000 other Orange County households. The numbers have nearly doubled in the past decade, according to the Census Bureau. A much bigger group – 4.6 million California households – is paying 35 percent or more, above the traditional 30 percent norm, up by 1.7 million in a decade.

They have little money available for savings, retirement or the unexpected. Mortgage or the rent takes most of their cash. They are caught in a housing crunch.

As their ranks have grown, lenders have redefined upward how much is too much to pay for housing.

REDEFINING THE LIMIT

The 30 percent benchmark stood for decades after World War II.

But “30 percent doesn’t seem to click with reality in Orange County,” said Glenn Hayes, president of Neighborhood Housing Services of Orange County, which counsels prospective homeowners and people in trouble on their mortgages. “Historically, we used to try to do 28 or 30 percent, but you couldn’t buy in Orange County for that.”

Mortgage giant Fannie Mae sets standards for conventional lenders through its rules for purchasing loans. Earlier in the decade, it said borrowers should pay no more than 36 percent of their income for housing, though lenders could go higher. In December 2008, Fannie Mae changed the rules to let borrowers take on more debt.

Under the new rules, lenders qualifying borrowers by hand could go as high as 45 percent for strong borrowers, such as those with excellent credit or big cash reserves. Lenders with automated underwriting could start at 45 percent and go, in exceptional cases, to 50 percent, Fannie Mae spokesman Andrew Wilson said.

The evolving loan standards recognize a reality: Income has not kept pace with housing.

From 2000 to 2010, median household income – the broadest measure of income – rose by 21 percent in California while rent and monthly owner costs rose by more than 50 percent, according to the Census Bureau’s 2010 American Community Survey.

While lenders adapt to this new reality, others warn of dire consequences right around the corner.

“When you’re paying 50 percent of your income for housing, you’re primed and ready to fall,” said Ginna Green of the Center for Responsible Lending in Oakland, a nonprofit advocacy group that fights predatory lending. “You are one illness, you are one car emergency, you are two overtime shifts away from a default.”

Natalie Lohrenz sees a lot of homeowners in trouble as counseling director at Consumer Credit Counseling Service of Orange County. Before they reach her, homeowners have frequently made many bad decisions.

“Not only are they not saving for their future, they’re robbing from their future” by raiding their retirement savings, Lohrenz said. “Many of them have let everything else go in their struggle to keep their homes.”

LEGACY

Ernie Garcia remembers back in the 1960s when the side roads off Ward Street in Fountain Valley were unpaved and Marine copters landed at what is now Mile Square Park. Years earlier, his grandparents, Salvador and Olympia Gonzales, had bought the land where he grew up and still lives.

His grandmother planted and grew two big avocado trees from seeds; he tore those trees down to build his own house. His mother was born in the house behind where he now lives. You can see her little house if you climb a ladder in his back yard.

“The property is our legacy that we can’t ever sell,” he said. “This is the last of our family’s property. I’m not going to roll over on it.”

Ernie and Edith Garcia, 50 and 49, have known each other since kindergarten. She moved to Northern California at age 11, married someone else, had three kids, divorced, moved back, reconnected with him, and they married in 1999. They rented a condo and started saving for a house.

It took them three years to build their dream house. Unexpected cost overruns boosted the price tag by $100,000 more than they had budgeted. Final tab: $647,000. They moved in September 2009.

The payments, including insurance and taxes, came to $4,025 a month. At the time, Ernie, a custodian for the Fountain Valley schools, and Edith, a customer service director in a clinical lab, were making a combined $123,000. Their house payment consumed just under 40 percent of their income.

It would be manageable, if nothing went wrong.

UNHEEDED ADVICE

Cheryl Knight was in love.

She loved a townhouse across the street from her Fullerton condo in a garden complex lined with small lakes. And the price in mid-2006 just before the market peaked, $480,000, was within her reach, barely.

“I fell in love with it,” the editor and writer said, “which was why I went against my Realtor’s advice and bought it when she said it was overpriced.”

Knight, 43, also ignored the implicit advice of her lender, who rejected her first two loan applications.

The loan she finally got was a five-year, interest-only adjustable for $390,000. She borrowed the remaining $90,000 on a line of credit. The seller refused to wait for Knight to sell her condo. It would take Knight nearly a year to sell the condo.

Her monthly payments, including taxes, insurance and homeowner association fees, came to $2,510 – about 60 percent of her income at the time.

A few months after moving in, the company where she worked as an editor sent her to a conference in Omaha, Neb. She attended a session on financial planning and heard the speaker say that no one should spend more than 30 percent of his or her income on housing.

“And I was paying double that,” Knight said. “I almost started laughing. It was a shock.”

A single mother with a son in high school, she was spending virtually all her money on the house and her son.

Then one day at work, she got a call from a company called Debt Barter. They claimed they could modify her mortgage.

Her boyfriend, Chad Wilson, told her to ignore them. But the $1,500 fee seemed a cheap price for relief from endless bills. She paid.

DOMINOES FALL

In 2010, the year after Ernie and Edith Garcia moved into their dream home, Edith was diagnosed with breast cancer. Over the next two years, her eldest son drowned and Ernie’s mother died.

Unexpected bills threw their carefully balanced budget awry. They fell three months behind on their mortgage.

They got a loan modification in March 2011, reducing their interest rate. But with the overdue payments added to the principal, their monthly payments grew by $131 to $4,156.

Then in November, Edith was laid off. She had been the family’s primary breadwinner.

They tried negotiating another loan modification, all the while falling farther and farther behind.

DOWN THE RABBIT HOLE

Even before it cold-called Cheryl Knight, Debt Barter had come to the attention of California regulators. The state Department of Real Estate issued a desist-and-refrain order against the company on Jan. 9, 2009, for conducting real estate activities without a license.

Debt Barter quickly adapted, allying itself with Santa Monica attorney Mohammad Nadim since lawyers at the time were allowed to collect fees in advance for loan modifications.

Debt Barter told Knight not to pay her mortgage and to let them deal with her lender.

Then in July 2009, she was laid off. Desperate for information, she called her lender. They told her they had denied her loan modification in April – and told Debt Barter back then.

“I feel embarrassed,” Knight said. “A lot of my work involves research. And here I went into this” without doing any research.

She spent months trying to get a loan modification on her own. In early summer 2010, the bank rejected her request but said she could do a short sale, keeping a foreclosure off her credit record. Relieved, she went out of town in August.

Knight returned to find her home had been foreclosed. Within two weeks, she was out, living in a 1,000-square-foot apartment. She’s paying $1,450 a month in rent – more than half her now-reduced income.

“In the process of losing my property and my life savings,” Knight said, “I’m trying to become more positive that someday I’ll be a homeowner again.”

STATE ACTION

Months after Debt Barter signed up Knight, in October 2009, the state Legislature virtually banned advance-fee loan modification operations.

“There is a legitimate market here somewhere (for advance-fee loan modifications),” said Department of Real Estate spokesman Tom Pool. “But for every legitimate operation, there were probably 100 illegitimate ones.”

The state bar has prosecuted 166 attorneys who participated in loan modifications, disciplined 100 of them and won disbarments against 21, state bar spokeswoman Laura Ernde said.

A state bar court judge placed Nadim on the involuntary inactive list in December, forbidding him from practicing law in California, based on his work for Debt Barter and other misconduct. Nadim is awaiting disbarment by the state Supreme Court.

REPRIEVE

Ernie and Edith Garcia quickly learned that there were no sure bets in loan modification. Did her unemployment insurance count as income? Should they continue paying their mortgage? The answers differed depending from day to day, from person to person.

In April, Edith’s ailing ex-mother-in-law, with whom she had remained close, moved in and began contributing to the family budget, boosting their income at a critical moment.

They went to Consumer Credit Counseling Service of Orange County for help negotiating a loan modification.

One day, Edith called the bank to ask about her application. The answer: Still working on it.

The next day, on a whim, she called again: You’re approved.

Their new loan begins with a three-month trial period. They made the first $3,977 payment – $177 less than their former payment – a week before the Aug. 1 deadline.

With Edith still unemployed, it amounts to about 45 percent of their income. But they are determined to stick it out.

“A short sale doesn’t work – not with this house,” Ernie said. “We can’t fail. All of our savings have been drained into this house.”

Despite the setbacks, Ernie is still optimistic about his dream home.

“I’ve waited my entire life to be a homeowner,” he said. “It’s still an exciting place for me.”

Contact the writer: 714-796-5030 or rcampbell@ocregister.com