Debtors on Borrowed Time
By JOHN FROONJIAN Special Reports Unit, (609) 272-7273
Published: Tuesday, August 22, 2006
Debt is becoming the American way of life.
Forty years ago, hardly anyone had charge cards. Mortgages financed homes, not vacations. Today, we borrow to buy groceries and fill our tanks. We borrow to go to college, to eat at McDonald's, to run our government. Credit offers clog our mailboxes. One credit industry estimate says there are four credit cards in circulation for every American. The average U.S. household has more than 11.
Average credit card debt has more than doubled since 1994. Consumer debt is at a record $2.2 trillion - not including home mortgages. Last year, Americans spent more than they took home. That had not happened since the Great Depression.
People are over-extended at a time of rising interest rates and incomes falling behind the cost of living. Bankruptcy lawyers, analysts and credit counselors are seeing more families in credit trouble. And they believe a lot more are going to get hurt.
Some people are borrowing to make ends meet. Russell Graves, who runs Consumer Credit and Budget Counseling in Marmora, Cape May County, said more low- to middle-income families are calling for help.
But increasingly, credit is financing a high lifestyle: luxury cars, mammoth SUVs, plasma TVs and ever-larger houses. Baby boomers want it all. They see credit as a way to have it.
Bill Wenz, 73, a Galloway Township retiree, winces when he hears what his grown children pay on their mortgages. After marrying in 1953, he and his wife lived in an attic apartment in Norfolk, Va. - "Oh, it was so hot," he recalled - until they could afford a down payment on a home.
"This generation wants everything right away: the house, the car, the air conditioning," he said.
Jeanette Gmitter, of Consumer Credit Counseling Service of South Jersey, remembered one client who had $80,000 of debt. "He said to me, 'Doesn't everybody?'"
In "Hamlet," Shakespeare's Lord Polonius said, "Neither a borrower nor a lender be." Today's consumer philosophy is closer to the 1980s bumper sticker: "He who dies with the most toys wins." Polonius would be laughed out of the home electronics superstore.
The credit card come-ons arrive in bulk at the Camden County mail processing plant. The envelopes, crammed into plastic and cardboard trays, stack 6 feet high on pallets carried by forklifts. Postal workers deliver the credit-card applications across southern New Jersey. Often the shipments arrive twice in a day.
"The banks and companies send them out thousands at a time," said Michael Behringer, a Post Office spokesman.
Nationwide, 5 billion applications went out last year. Many households receive several per week, along with mortgage refinancing and other credit offers. The mailings are so pervasive, even the son of an aide to U.S. Sen. Robert Menendez, D-N.J., received a credit card offer. The child is 2.
Eric Clayman, a bankruptcy attorney with offices in Atlantic City, marvels at the sophisticated marketing used by companies.
You're a bowler? Apply for the Bowling Platinum Mastercard. You like Philadelphia football? Show your true colors by using the Eagles Extra Points card. There are specialty cards for movie buffs, e-Bay users, L.L. Bean customers.
"These cards line up with your interests, your sports team, your favorite hobby," Clayman said. "The companies push that more than they explain what 19.9 percent compounded interest does."
Clayman has seen the effects of debt: bankruptcies, lost homes, emotional stress. His firm, Clayman and Jenkins, handles more bankruptcy cases than most others in New Jersey - a state where bankruptcies have soared 80 percent over the last decade. Nearly 50,000 were filed in the state last year.
"I've had a couple clients with $200,000 in credit card debt. And they have not accumulated a lot of assets," Clayman said.
How does that happen?
Clayman and Gmitter said problems start when people make only the minimum payment required on their bills. Almost all of their debt carries over, and they are charged interest on it. If they make only minimum payments for a while, they pay interest on that interest. They make little headway on the original charge and end up paying more than twice as much in interest. If the person keeps charging new items, the debt only grows.
But it gets worse.
If a payment is missed or late, an extra fee is charged. And the company raises the interest rate, sometimes as high as 30 percent.
But it gets worse.
A company might raise your interest rate even if you pay on time but miss a payment on a different credit card.
"It's called universal default," Gmitter said. "You can fall behind on one card. If another company pulls your credit report and sees that, they feel they can raise their interest rate.
"It starts a downward spiral," she said.
Nobody wants to talk about his or her failed finances. Debt may be the last bastion of shame in America. Counselors and lawyers asked numerous clients to be interviewed for this story. All refused. But credit-card horror stories fill Internet message boards, where the indebted can commiserate anonymously.
One woman on the Shopping Addicts Support board confessed: "While I make reasonably good money, I have absolutely no savings at all. In fact, I have accrued over $100,000 in debt in credit cards and school loans, from small purchases (in) $200-$300 shopping sprees."
"Jeni" said she opened credit accounts behind her husband's back. She charged $40,000 within three years.
Her problem with credit cards, she wrote, was that "when I would use them, I would not think of that as actually spending money. For some reason in my head, I couldn't relate that I would have to eventually pay that money back."
Cardweb.com, a credit-card industry Web site, says average debt per card-holding household more than doubled from $4,300 in 1994 to $9,300 in 2004. Most families' debt is much lower, the Federal Reserve says. But that high average suggests the families who do get into trouble are carrying huge debt.
And debt of only $2,000 to $3,000 can still hurt low- and middle-income families. Their debt is increasing; it grew 10 percent from 2001 to 2004. Meanwhile, median income declined 1 percent when adjusted for inflation during those years. Add soaring fuel prices to the mix, and it's no wonder Gmitter sees counseling clients come in frantic over debts of $3,000.
New federal rules require cardholders to pay at least 1 percent of their debt principal each month. The result: higher minimum payments.
"That requirement has caused a lot of people to pick up the phone and say, 'Help!'" said Graves of the Marmora counseling agency.
"Just in the last month, I've gotten more calls asking about bankruptcy," Atlantic City attorney Edward Thompson said. "People can't afford to pay their minimums."
Gmitter's counseling agency, with offices in Egg Harbor Township and Absecon, negotiates with lenders to lower interest rates and helps debtors create payment plans.
Clayman said credit card debts could be wiped out if a debtor declares bankruptcy. Record numbers of bankruptcies were filed last year. Debtors rushed to beat a new federal law that made it tougher to wipe out such debt.
But some homeowners can't escape credit card debt because they have turned it into mortgage debt. They took out home equity loans to pay off creditors. That's happened a lot. Nearly one-third of equity loans in 2004 went to pay off debt, according to the Federal Reserve.
Shifting credit debt to mortgage payments usually lowers the interest rate. It allows interest to be deducted on income tax returns. Still, draining equity out of a family's main asset may be a sign of credit problems. It's especially troubling if a family runs up its credit cards again.
Clayman and other attorneys say there are fewer bankruptcies when housing prices are high and interest rates are low. Higher equity helps manage debt.
Unfortunately, the lawyers look at mortgage and interest trends, and predict that more families' finances are living on borrowed time.
Home sweet home
Some buyers could not afford a big down payment in the roaring housing market of recent years. The mortgage industry created no-equity loans. The buyer keeps payments low by paying only interest until he sells the house at a profit. Some buyers took loans with "negative equity." They borrowed more than the house is worth.
Lenders also provided adjustable-rate mortgages, which start with a low interest rate that changes according to market trends. Seventeen percent of adjustable mortgages sold in 2004 and 2005 offered a starter rate of 2 percent or less.
Two problems have developed. Housing prices have started declining. And the Federal Reserve keeps raising interest rates to fight inflation.
Higher interest rates will affect millions of adjustable-rate mortgages. Rates are expected to increase on a quarter of all outstanding U.S. mortgages either this year or next, according to Economy.com.
Many recent buyers' adjustable mortgage payments could double.
Christopher Cagan, research director for First American Real Estate Solutions, studied the possible impact of rising interest rates. An increase from 1 percent to a 6 percent market rate could rocket a monthly payment from $965 to $1,800.
Even if it took a few years for rates to rise that high, Cagan said, many people would lose their homes. If a homeowner holds no equity and his house has lost value, he would make nothing if he sold it.
Cagan's report estimated that one in eight adjustable mortgages sold in the last two years could default. About 5 million households nationwide and $300 billion in loans could be affected.
"The safety net of home equity is not going to be there," attorney Clayman said. "The number of bankruptcy filings over the next couple of years will probably go up."
Nationwide, the number of foreclosures is running one-third higher than a year ago, according to RealtyTrak.com.
Cagan concluded that while individuals and families would suffer, the defaults would not hurt the $10 trillion-per-year U.S. economy. But one New Jersey economist, A. Gary Shilling, fears the damage could be significant.
Shilling studied 44 boom-and-bust housing cycles occurring in 18 countries since 1970. Inflation-adjusted prices rose an average 28 percent in the five years before a housing bubble burst. Home prices fell 22 percent in the five years afterward.
If housing values dropped 20 percent or more, Shilling said, "there's no question we could have a serious recession in the United States. Then it could spread globally. U.S. consumers are supporting the world.
"If the consumer pulls in his horns after he's been on a spending and borrowing binge for the last 20 years, the effects could be pretty dramatic.
"This is heavy duty stuff," Shilling said. "I think this huge debt level is going to be a serious problem."
Don't blame consumers too much for their spending habits. They're following the lead of their Uncle Sam.
The federal government has spent more than it has taken in all but four years since 1969. The U.S. public debt was less than $1 trillion in 1981. It was $8.4 trillion at the end of May. Foreign governments and investors own nearly one-quarter of America's public debt.
The red ink has seeped down to the state level. The debt of all state governments has increased by an average 11 percent in each of the last three years. New Jersey is third in state debt, having borrowed for years to finance highways, build schools and plug holes in the state budget. New Jersey taxpayers are directly responsible for $28.6 billion in debt, according to a Moody's Investors Service report.
New Jersey economist Allen Grommett of Cambridge Consumer Credit Index said government and consumer debt are linked. When government runs a deficit, more money becomes available. Consumer spending does stimulate the economy, Grommett said.
But just as the government has spent its surplus, consumers are dipping into savings. In the 1970s, Americans saved $1 of every $10 they earned. In recent years, that number has dropped to about 30 cents. Last year, the savings rate was negative 0.5 percent. That means Americans spent 0.5 percent more than they earned.
Half of all U.S. workers have less than $25,000 in their 401Ks, including 40 percent of workers age 55 and older.
Analysts distinguish between debt that grows in value and spending that doesn't. On a personal level, buying a house that appreciates or getting an education that helps your career are valuable investments.
On the other hand, if government borrows to buy "fuel and bombs, once it's spent, it's spent," Grommett said.
"There's no real long-term benefit to the economy. When it's spent on education and research, there is a long-term return. We need to get our one-time expenditures under control."
Having it all
When Bill Wenz was a young man, he wanted to finance a TV purchase. But credit was hard to obtain. His parents wouldn't co-sign a loan. Wenz couldn't provide a credit reference the store wanted.
"I showed them my checkbook and said that I could pay for that TV," he said.
Wenz, who is on the homeowner board at the Four Seasons at Smithville development in Galloway Township, recently discussed credit's role in society with other board members. They agreed: Times have changed.
"We were lucky if we had one TV in our house," Wenz said. "Now, they have one in every room."
Jerry Hauselt, 67, said he faced difficult choices while raising five children. Once there was enough money to either pay for insurance or buy one child a bicycle. His solution: Work a second job.
"That's the biggest difference," said Tony Annacone, 61. "Today they do both and go into debt."
Annacone said he believes baby boomers want their kids to have it all. "Unfortunately, this generation is racking up a lot of debt to do that," he said.
That is what author Shira Boss found when she researched her new book, "Green With Envy: Why Keeping Up with the Joneses Is Keeping Us in Debt."
"There was an attitude shift about raising children after World War II," Boss said. "Children became the center of the universe. It became about giving children everything.
"And this (debt) was the way we get everything," she said.
As baby boomers grew more comfortable with credit, they started using it to subsidize their lifestyle, she said. They charged restaurant meals, furnishings, clothes. News reports last year said some people cashed equity out of their homes to pay for big-screen TVs and vacations. The trend spreads because of social pressure, Boss said.
"We see the things people have, and we feel we need to have them. So we charge it," she said.
Bankruptcy lawyer Bruno Bellucci, of Linwood, agreed. He said medical problems or divorce drive many of his clients into debt. But he has seen people go broke trying to live the high life.
"We see stuff on TV and we want it," he said.
Boss said one difference from past generations is that people now accept large debt more casually, and some even expect to live in debt. For her book, Boss chronicled a well-to-do suburban family who bought a big house in a gated community, joined a country club and spent on lavish vacations. Their lifestyle was built on debt. They had $100,000 in credit card charges. They paid the debt down to $40,000, then ran their cards back up to $100,000 before heading into bankruptcy.
"I think the response should be: I can't believe people are such idiots," Boss said. "But nobody else seems to think that.
"People say to me, 'I can relate to that.'"
Al, a computer programmer in suburban Philadelphia, said his parents gave him whatever he wanted when he was growing up. "I was pretty spoiled as a kid." He got his first credit card while in college in 1978. Soon he owed $3,000.
"I would go to my parents' house. After dinner, I would well up the tears, say I couldn't pay my bills. And Dad would write me a check."
The pattern continued on and off for years. Al, who didn't want his last name identified, realized his spending was like an addiction when he began to steal from his father.
In 1993, Al's family began caring for his father after a stroke had partially paralyzed him. Al managed his father's finances. He filled out a credit application in his father's name - but didn't tell him. Soon he was purchasing computer equipment and meals with that card. Eight months later, Al's wife opened her father-in-law's credit card bill by mistake.
"She saw $4,000 in charges," Al said. "She asked how my father could charge that much while sitting in his bedroom all day."
Al's wife convinced him to attend Debtors Anonymous, a 12-step, faith-based program that helps people with spending compulsions. Today, Al is a trustee of Debtors Anonymous of Southeastern Pennsylvania and New Jersey. He repaid his father. He no longer uses credit cards. He saves out of every paycheck and pays cash for everything he buys. Al keeps reserves for emergencies.
"I saw a guy open his wallet and he had 15 credit cards. They were probably all maxed out. That's why he needs 15," Al said. "You're living to pay off your creditors. That's not a life."
Get out of debt
Al said he could not have gotten debt-free without Debtors Anonymous and help from a "higher power." There are many counseling groups, debt relief programs and Web sites that help debtors. But it's a case of buyer beware.
On May 15, the Internal Revenue Service said an audit of 63 credit-counseling companies showed that 41 of them existed mainly to profit off debtors. The IRS said it would revoke the unidentified groups' tax-exempt status.
Jeannette Gmitter said debtors looking for help should go to nonprofit agencies with counselors certified by the National Foundation for Credit Counseling. They should beware of companies that charge high fees.
U.S. Sen. Robert Menendez has proposed federal legislation to rein in credit card practices after hearing of college students becoming overwhelmed with debt and consumers being treated unfairly.
His proposals would:
* Ban random credit card solicitations to people younger than 21
* Prohibit companies from raising interest rates when a customer misses a payment to an unrelated account
* Require companies to use the postmarked date to determine when a bill payment is late
* And establish a financial literacy program in schools.
Graves, of the Marmora counseling agency, said education is needed because most schools don't teach money management. Graves said a grant from Chase and Bank of America has allowed his agency to offer financial literacy seminars in high schools, but few are signing up.
"I explain to students that the real permanent record for their life is not their high school transcript or SAT score," Graves said. "It's their credit score."
One exception is Ocean City High School, where all freshmen are now required to take a semester of financial literacy.
Al, of Debtors Anonymous, agreed that debt should be discussed, not treated as a dirty little secret.
"People will talk about their alcoholism. They will talk about their sex lives, their gambling. But they will never talk about their money problems," he said. "They're afraid people will think they're weak."
Shira Boss said Americans should talk more about the social reasons we overuse credit, and not envy those with more than us. But she admitted that even though writing her book clued her in to the dangers of debt, the lure of materialism can be strong.
She and her husband were shopping for a TV. Boss couldn't understand how people were able to afford thousands of dollars for a set. She asked her husband, "Why are we the only ones shopping in the picture tube aisle?"