American Households Take On Record Debt

It took nearly ten years, but with $ 12.73 trillion in total outstanding debt, American households have finally exceeded the record amount of debt they held prior to the financial crisis of 2008, which was triggered by a mountain of loans of dubious quality, mostly home mortgages. We are told by the experts not to worry about this record household debt; it is different this time.

The mix of outstanding debt is different

Mortgage debt is less as a percentage of total debt than it was at its peak: 68% vs 73%. However, student loans and auto loans have made up the difference. Student loan debt as a share of total outstanding debt has more than doubled to 10.6%, and auto loans as a share have increased from 6.4% to 9.2% compared to 2008.

Households are in a better position to service debt

Delinquency rates are relatively low, 4.8% overall, but credit card debt along with student loan and auto loan debt are experiencing increasing delinquency rates. Nearly 1 in 10 persons with outstanding student loan debt are behind on their payments.

Despite worrisome delinquency rates for some types of loans, the experts assure us that this is not a sign of an imminent economic crisis. The economy is in a period of expansion and loan payments as a percentage of income are less than at the height of the financial crisis, so households are better able to service the debt than they were 10 years ago.

We have heard this song before

But wasn’t the economy expanding prior to the Great Recession that began in 2007? Weren’t we assured at that time that although debt was at record levels it did not present a problem? It was manageable. Yes, they said, mortgage debt is at record highs but real estate values nationwide always go up. Sure there might be some markets where real estate values temporarily decline, but overall the prices of houses always go up. There would be no nationwide crash in real estate values. Didn’t households manage to service their debt until the housing bubble burst, credit seized up, and the economy went down the tubes?

The truth is, no one knows if this record household debt is a sign of consumer confidence or a desperate attempt by households to maintain or increase living standards in the face of stagnant income and limited employment opportunities.

All household debt is a gamble that income and employment will remain the same or improve over the term of the loan. Debt, after all, is spending money that has not yet been earned. It is literally borrowing from future earnings with the expectation that there will be sufficient future earnings to service the debt and pay current living expenses. If income is reduced, interrupted, or lost altogether, there is trouble. A majority of households do not have enough assets to cover their outstanding debts; some do not have enough savings to make payments on outstanding debt if their income is interrupted or lost. A majority of American households are just a paycheck or two from financial ruin, despite the appearances of prosperity financed with debt.

People who buy now and pay later are always playing catch up. That is why they find it so difficult to get ahead. Economists and policymakers love credit and those who exercise it; it gives the illusion of prosperity until credit runs out and debts have to be repaid.

Do not follow the crowd; save rather than borrow

An expanding economy is a time to build savings, not increase debt. The financial crisis of 2008 and the Great Recession should have taught us something about saving and debt. For a time, it appeared as if we had learned our lesson, but here we are again at record levels of outstanding household debt.

Those who save during good times are reviled by economists and policymakers because savers don’t buy into the illusion. Savers live in the real world. Their standards of living are supported by accumulated wealth, not debt. They prefer financial security and sustainability to an imaginary prosperity. They represent the real economy. They get ahead. Slowly but surely, through good times and bad, their wealth grows. When the borrowers are tapped out, it is the savers that continue to spend at sustainable levels during the darkest hours of a recession. They are the ones who can afford to retire early and open up a job for someone else. They are the life support of a depressed economy until economists and policymakers figure out some new way to expand credit and breathe life into the illusion of prosperity once again.

Do not follow the crowd; take a different path. Review your spending with an eye to reducing or eliminating low-priority expenditures. Use the money freed up by reduced spending to increase your rate of saving. Pay down current debt and avoid new debt. Tailor your standard of living to reflect the amount of savings that underwrites it. You will soon be living in the real world, and you will find that you can enjoy financial security and prosperity in both good times and bad.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages

Automated Finances: Proceed With Caution

Technology has made it possible to automate many financial tasks, and most personal finance experts will suggest that you automate as much of your finances as possible to take you out of the process. You set it and forget it with forget it being the key phrase.

By taking you out of the process, negative factors such as ego, procrastination, disorganization, and emotion cannot sabotage progress toward your financial goals. Automation replaces self-discipline.

While automating some tasks such as contributions to retirement and saving accounts makes sense, automation is not a silver bullet for those who are unorganized or who lack self-discipline. Effective management of personal finances still requires the conscious attention of the one who is responsible.

Automated contributions to retirement and other saving accounts

Where automation shines is in the area of saving. Automating contributions for retirement saving and other saving accounts works because the decisions whether to save and how much to save are only made once. In addition, with automated contributions to saving accounts, the saver never has an opportunity to spend the money because it is deposited into saving accounts before the saver even knows it exists: out of sight, out of mind. Automation makes saving painless.

However, do not set it and forget it. Automated contributions to saving accounts should be reviewed and updated once a year with an eye toward increasing the rate of saving by a percentage point or two each year.

Automated bill payment

Having all your bills paid automatically is convenient but also a bad idea. Bills for products and/or services whose monthly balances fluctuate with usage such as utility bills and credit card statements should not be automated. You need to review those bills and statements for accuracy and to keep abreast of usage trends.

It is much easier to dispute a charge or amount of usage before the bill is paid rather than after. When you dispute a bill before you pay it, you hold all of the cards. The organization that issues the bill will give your dispute immediate attention because they want to get paid. With automated payment, there is little chance that you will catch an error or question a charge, and if you do, the bill will have already been paid. With payment in hand, there will be little incentive for the billing organization to take your complaint seriously.

Reviewing utility bills and credit card statements prior to payment is a good way to discover opportunities for cost cutting. Automated bill payment gives you no reason to even look at the bill or statement; they have already been paid. You lose out on potentially valuable information about your finances.

Think twice before you automate the payment of semi-annual and annual bills such as premiums for homeowner’s insurance, premiums for automobile insurance, subscriptions for software licenses or services, memberships, and so forth. Automatic payment or renewal opens you up to price increases that may go unnoticed. You will be less inclined to consider shopping for a better deal or to evaluate the continued use of a software or service when renewal is automatic because you have been taken out of the process. You probably won’t even notice a price increase.

Monthly billing for products or services with a set amount such as car payments, mortgage payments, and other loan payments, rent, life insurance premiums, services such as Netflix, internet ISP fees (provided you are not subject to data usage charges), cell phone fees (provided you are not subject to data usage charges), and so forth do make good candidates for automated payment. Many of these bills have to be paid, so it is best to make payment automatic. If you decide to cancel a service, you only risk one monthly payment.

Forced automatic renewal for annual fees

What about software licenses or services that require automatic renewal for yearly fees or annual membership? Forcing customers to accept automatic renewal indicates to me that the company behind the software or service is not confident in the value of its product offering. Most of these businesses offer steep discounts to entice new users to enroll. From my experience, the discounted price is what the software or service is actually worth. Annual renewals are charged at the full price, and most often, with no advance notice and no opportunity to cancel and receive a refund. This is where the automatic renewal comes into play. These companies hope you will forget about the automatic renewal so they can overcharge you for the next year’s subscription or membership.

The best thing to do to avoid being surprised by automatic renewal is to mark a date on your calendar that is a couple of months before your subscription or membership renews, then cancel your subscription or membership at that time. Do not worry; the balance of your subscription or membership will still be in effect until it expires, but you will be off the automatic renewal hook. Don’t wait until the last minute to cancel. If there is a glitch in the cancellation process (website is down, error message), you may not have time to correct it before your account automatically renews. Also be aware that there may be a discount for automatic renewal and by canceling you may lose out on this discount if you decide to continue with the software or service for another year.

Remember that you are ultimately responsible for timely payment. If your automated bill paying service makes a mistake, you are on the hook. Do not assume your automated payments are processed correctly each month. Pay attention to confirmation emails and reports that document automated payment. You can set it but do not forget it.

K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages

Measure Your Financial Health With Power Percentage

Peter Dunn (www.petetheplanner.com), author and speaker on personal finance, has developed a helpful tool that he calls Power Percentage. It is designed to give the user an objective measure of financial health. The tool measures how much of a person’s gross monthly income is spent on consumption. Less money spent on consumption produces a higher Power Percentage result. Those with higher Power Percentages have healthier personal finances because they are living farther beneath their means.

Calculate your Power Percentage

Here is how to calculate your Power Percentage. Total all of your monthly saving activity such as:

  • Contributions to retirement plans, including employer match, if any.
  • Contributions to a college fund.
  • Deposits into savings accounts that will not be spent in the immediate future.
  • Deposits into other investments.
  • Contributions to a qualified Health Savings Account that are not earmarked for a specific procedure in the immediate future.

Now add to your saving activity the total of your monthly debt repayment activity such as:

  • The principal amount only of your mortgage payment (exclude interest, property taxes, and insurance).
  • Payments on medical and student loan debt (principal and interest). Do not include interest-only payments.
  • Payments on credit card debt, but only on credit cards you are not currently using.
  • Monthly payments on any other debt except auto loans.

The final step is to divide the total of your monthly saving activity and debt repayment activity by your gross monthly income (the income figure before any deductions are made). Now you have your Power Percentage. As an example, say the total of your monthly saving and debt repayment activity is $2,000 and your gross monthly income is $6,000. Divide $2,000 by $6,000 to get your Power Percentage which is 33% ($2,000/$6,000 = 33%). In the example, two-thirds of the monthly income was spent on consumption while one-third was invested in saving or debt reduction. Note: The repayment of mortgage principal is both debt reduction and saving as the repaid principal becomes equity in the house.

What your Power Percentage means

Where do you rank on the Power Percentage scale?

  • Less than 10%: Poor. Nearly all of your income is spent on consumption
  • 11% to 20%: Fair. You are dedicating some income to saving and debt repayment but not enough.
  • 21% to 34%: Good. This is a healthy mix of saving, debt reduction, and consumption.
  • 35% and over: Excellent. You are on your way to financial independence.
  • Rating the Power Percentage tool

    The Power Percentage gives a snapshot of your finances that provides a useful measure of the constructive use of monthly income to improve your finances. The idea is to increase the Power Percentage by lowering the amount of gross monthly income that is spent on consumption.

    The Power Percentage tool does not distinguish between saving and debt repayment, treating both equally. As a result, it may give a somewhat misleading indication of financial health. Using our example above, a person with a gross monthly income of $6,000 who is on an aggressive debt retirement program might pay off $2,000 of credit card and other debt each month and contribute nothing at all to savings and register a 33% Power Percentage while another person with no debt contributes $2,000 of her $6,000 monthly income to savings and has the same 33% Power Percentage. But the financial health of these two people is not the same. The person with no debt who saves $2,000 per month is in a much better financial position than the one who is paying off $2,000 worth of debt each month with no money going into savings.

    In addition, the Power Percentage is no indication of a person’s financial liquidity or net worth, two critical factors in determining financial health.

    Spending less and saving the rest is a core principle of a cash-based lifestyle and a frequent topic on this blog. It is the key to improving your personal financial health and security. The Power Percentage can help you evaluate and track your progress in this area.

    K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages