Wednesday, September 7, 2016

Thrifty Thinking: Consumer Debt

I recently had a chance to interview Ben Woolsey of about consumer debt.

1.       How did consumer credit card debt get up to $12 trillion? Consumer credit card debt is only a small subset (less than $1 trillion) of the $12 Trillion total household consumer debt (which includes mortgage and other types of debt, like auto, personal and student loans).  Credit card debt has been growing in recent years, but is still not quite to the level it was prior to the financial crisis.  The main difference between then and now is that consumers are better able to handle credit card debt as evidenced by historically low delinquency rates, which wasn't the case prior to the great recession.  The reason it has grown in recent years is that the economy is better and we are almost at full employment, which gives consumers the confidence to spend more and carry more debt.
2.       Why does this particularly hit consumers with low credit? Lower income people are typically hit harder by credit card debt because they must pay higher interest rates due to being considered higher credit risks by lenders.  This segment of the market also tends to pay more in annual fees and late fees and are more squeezed by their financial conditions, making it harder to pay off balances in full and are more often left to carry balances and pay those higher interest charges.  This can cause a downward spiral of debt that can reach levels where people can't even pay their minimum amounts due and potentially go into default.
3.       How can people break the habit of credit card debt? Credit card debt can insidiously build up over time, especially when only paying the minimum payment due and adding to the balance with new charges each month.  To break that cycle it's best to stop using credit cards to pay for things that one can't afford to pay cash for to begin with.  Paying by credit separates the purchase and payment process and psychologically makes it easier to spend more over time, as it feels like less of a sacrifice vs. spending cash.  By focusing on paying off existing card balances over time without adding to them is the best way to break that cycle.
4.       What if people are struggling to get by - how can they start to reduce their debt? Only paying for essentials and using cash or checks or debit cards for payment methods can help keep people within their financial means while avoiding the use of credit cards to borrow to pay for everyday living.  Many things that seem essential are really quite discretionary when money is tight - whether it's an iPhone, cable TV or daily Starbucks coffee things that seem like imperatives can be cut out without causing undue hardship and often have lower cost or free alternatives.  Bottom line - the only way to get out of debt is to live below one's means and use the savings to chip away at outstanding debt balances.

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