Thursday, March 1, 2007

Debt – A Personal Finance Crisis Emerges

With the proliferation of credit cards and easy access to borrowed money through home equity loans, debt is becoming one of the primary detractors to personal financial health in the US. From young adults still in college to senior citizens, and all ages in between, Americans are accumulating debt at an alarming rate. College students are borrowing on their credit cards to help pay for what seems to be an endless rising cost of higher education. By the time they are out of college, they are so deep in debt that they have little hope of ever catching up, and in some extreme cases their credit rating is ruined for a very long time, prohibiting them from taking advantage of one of America’s most important financial investments – home ownership. Families that have borrowed against their home equity when home prices seemed to be going up forever are now facing the prospect of having negative equity as home prices start to decline. Seniors who struggle to deal with ever increasing health care costs are resorting to credit cards to make ends meet. Without experience in handling credit card bills, by the time they realize it, many seniors are in so deep that they can never recover. We seem to be heading towards an unprecedented personal finance crisis.

The USA Today reported the story of Todd Townsend, a 25-year old with a total student debt of $47,000 who works at a job that does not pay enough to even make the minimum payments. Like many young people, Townsend resorted to moving back in with his parents. This seems to be a common trend these days. A recent pool shows that 19% of twentysomethings have moved back with their parents in order to cut expenses. Townsend’s problems started when he noticed his friends borrowing to the max against their credit cards, which enticed him to do the same. He also obtained student loans without really understanding the term of those loans, and ended up being stuck with variable loan rates as high as 14.25%. His credit rating is now ruined as he missed payment on the cards, on the student loans and on his car loan. To make matters worse, he has no chance of refinancing his high interest rates loans because no bank is willing to lend him money with such as low credit score.

The continuous rise in home prices that we have witnessed since the beginning of the new millennium and until recently, combined with the increased availability and access to unconventional mortgages and home equity loans have created a perfect storm. As home prices rose, households saw their home equity increase, which allowed them to borrow against their equity at relatively low interest rates in order to finance their insatiable consumerism. In a low interest rate environment, potential home buyers kept bidding on ever increasing home prices and used unconventional loans such as Adjustable Rate Mortgages (ARMs) and interest only loans to allow them to buy what otherwise would have been unaffordable houses.

As the economy started heating up and inflationary pressures began to build, the Fed reacted by increasing interest rates. Consequently, mortgage rates increased, and the overpriced houses became unaffordable, resulting in a significant decrease in home sales. In a buyers market, home prices started to decline, and home equity percentages began to decrease. Home owners who used adjustable rate mortgages are starting to see their loans adjust to much higher rates, making their current mortgages unaffordable. In a slow housing market, these home owners are stuck between living with an unaffordable mortgage and trying to sell their houses at a loss. Home equity loan borrowers are starting to see their equity decline, and in some cases they are starting to approach the dangerous negative equity zone which may result in the loan being called by the bank, exacerbating the problem. We have only begun to see the consequences of a housing market gone mad, and of the irresponsible lending practices of our financial institutions.

In a separate article, the USA Today reported how seniors are becoming the face of the indebted. Sadly, in many cases this is happening because they have no choice. As healthcare costs keep rising, seniors with fixed incomes have to resort to borrowing money in order to cover their expenses. In the last 12 years, the percentage of households 55 and older with accumulated debt grew faster than the overall population growth. The average debt load for those 75 and older has risen 160% in this time period, averaging $20,234 according to a research conducted by the Employee Benefit Research Institute. Credit card debt for households 65 and older has more than doubled to $4,907 in the same time period, according to Demos, a think tank.

Credit card debt is one of the top reasons for seniors seeking bankruptcy protection. In many cases seniors didn’t understand that when they accepted a credit card offer they would have to pay the principal with interest, unless they paid the entire amount due every month. The interest rates and penalty fees on some of these credit cards are so high that seniors many times feel that they pay and pay but the debt hardly goes down. Mortgage debt is also on the rise for seniors as they’ve turned to reverse mortgages in order to receive an extra stream of income.

What is most disturbing is the laissez-faire attitude towards borrowing that has been spreading throughout this nation. People are postponing many things in life such as marriage and having children, and it seems that they are also deciding to pay for their expenses later in life. The spend-now and worry-about-it-later attitude is part of the ongoing trend that has caused debt loads to mushroom out of control, endangering the personal financial health of many people.