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What To Make Of The Recent Increase In Consumer Debt

By on January 25th, 2012

The Federal Reserve noted in its latest release of consumer credit data on January 9, 2012 that outstanding consumer debt increased at an annual rate of 10% in November 2011.  This represents a substantial spike in a trend of increased consumer debt that began in the fourth quarter of 2010.  Total outstanding consumer debt has increased by $84.1 billion over that time.

Many explanations offered for increase in consumer debt

Some economists see this increase in the use of credit as an indication of improved consumer confidence in the economy.  Consumers see indications of economic growth and are willing to borrow to spend now in anticipation that the economy will produce the jobs and income necessary to repay the debt in the future.

Other economists are not so certain of this analysis.  Household incomes have been declining when adjusted for inflation since 2007.  Consequently, there is no justification for the increase in consumer debt.  They believe this trend is premature and unsustainable without an increase in household income.

Another explanation for the increased use of consumer credit is that households are using debt pay for day-to-day living expenses to offset stagnant wage growth.  Increased borrowing from 401k and other retirement assets is cited as evidence for this conclusion.  Another trend supports this idea that credit is being used to pay for living expenses:  Fewer Americans with overextended credit are seeking debt relief, credit counseling, or filing for bankruptcy.  This may be an indication that some consumers see no hope for their financial future other than to continue to borrow.

I’m sure that some of this increased use of credit is due to pent-up demand.  American consumers had been paying down debt for two or more years while hearing that a robust economic recovery was just around the corner.  I think many of them got fed up with waiting for better economic conditions.  They decided to go ahead and spend a little extra this Christmas to take some of the edge off of the financial sacrifices they had been making.

Others may be indulging in wishful thinking about a stronger economy, because they desperately want to return to the spending habits they enjoyed during the years prior to the Great Recession.

All represent a denial of reality

Whatever the reasons for the increase in outstanding consumer debt,  they all have one thing in common, a denial of reality and a sense of entitlement.  Consumers expect their financial lives to return to the way they were prior to the Great Recession.  They want to go back to spending more than they make and living the illusion of a prosperity they cannot afford.  Some have gotten impatient.  Some are taking whatever they can get on credit.  All must face the reality that those days are over.  Our economy will not totally recover from the fallout of this recession for years to come—if ever.  A highly leveraged standard of living is a thing of the past.

Live smaller and save

Americans are reluctant to accept that they must roll back their standards of living and downsize their lifestyles to survive in this new economic environment, but that is what they must do and the sooner the better, for them and for the economy.

The way to prosper in a slow-growth economy is to reduce overhead and accumulate savings, not take on more debt to expand an unsustainable standard of living.  It means spending less and saving aggressively, so you can eventually make a transition to pay-as-you-go living and enjoy true prosperity.

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

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Trouble Comes In Three’s

By on January 23rd, 2012

Last Tuesday, Rosa and I planned to take our mini-van to the mechanic for some routine maintenance and to check out some strange noises.  As we were preparing to leave, we made one last trip to the bathroom.  That’s when our sewer line backed up.  We abandoned our trip to the mechanic and called the plumber.  Three hours and $ 134.oo later our sewer was running free of obstruction.

The next day, we took the mini-van to the mechanic.  The routine maintenance and the diagnosis of our other concerns cost $148.00.  A ventilation motor is the source of the noise coming from under the dashboard.  It will cost approximately $100 to replace it once the part arrives.

In two days, we were hit with almost $400 in expenses over and above our normal monthly bills.  And now it appears that I may have to undergo surgery to correct a hernia.  Fortunately, we plan for these unpredictable expenses in advance by setting aside some money each month in anticipation of them.  Consequently, we have the money to pay for them without resorting to debt, and the money won’t come from our emergency fund.  It will come from our house maintenance and repair,  automobile maintenance and repair, and our medical out-of-pocket and deductible budget categories.

The reality of unpredictable expenses

The point is that unpredictable expenses come at the worst of times and usually in three’s.  Even if you don’t plan for unpredictable expenses, you can probably manage somehow to handle one without going into debt, provided it isn’t catastrophic.  But can you handle two or three in quick succession?  And can you handle an unpredictable expense that follows on the heels of a major expenditure, such as the purchase of a house, an automobile, a dream vacation, or even a major appliance?  Probably not.  But you know what?  That’s exactly what happens in real life.

Why is it that your home air conditioner breaks down the day you return from the hospital after major surgery, or a hail storm destroys the roof on your house just days after you purchased new furniture?  And then shortly after these events, there is a death in the family that requires you to purchase airline tickets on short notice so you can attend the funeral.  I can’t explain it, but that is how it often happens.

How to plan ahead for unpredictable expenses

The best defense against unpredictable expenses is to acknowledge reality and plan for them in advance.  You know that sooner or later you will have expenses for home repair and maintenance, automobile repair and maintenance, appliance repair and replacement, and medical co-pays and deductibles.  You just don’t know when.

It’s easy to plan ahead.  Create a budget item for each type of unpredictable expense.  Set aside a sum every month in each category.  To get an idea of how much to budget each month, go back at least a year, preferably three years or more, and add up all of your expenses for the budget categories in question.  Divide the total by the number of years you went back to give you an average annual expenditure.  Now divide that amount by twelve to determine a monthly amount.  Accumulate the monthly allotments from month to month.  Many months may pass before you have an expense, but when you have one, it will likely be large.  You will need the accumulated cash to pay for it.

Planning for unpredictable expenses is really a form of short-term, targeted savings designed to keep you out of debt.  It works.  The money will be there when you need it, if you plan ahead.

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

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Debt Consolidation Cautions

By on January 21st, 2012

From my friends at LegalShield(sm), formerly Pre-Paid Legal, here are some things to be aware of when considering a debt consolidation offer:

  • If you have a poor credit rating, your consolidated debt may end up with a higher interest rate than you are already paying.
  • Beware of built-in fees.  Make sure you know exactly how much of your new monthly payment will be going towards the consolidator’s fees and how much will be going towards payment of your debt.
  • Debt consolidators have been known to miss or make late payments.  When your monthly payments are not in your hands, you run the risk of the third party missing the payment or paying it late, which will negatively affect your credit and could result in additional fees.
LegalShield(sm) notes that you should consider other sources of debt relief, such as balance transfers to lower- or zero-interest credit cards and bankruptcy.  Another alternative is to do your own debt consolidation by refinancing your debt over a longer period of time.  This will produce one monthly payment on your debt instead of several, and that monthly payment will be substantially lower than the total of the monthly payments of the debts you consolidate.

Consolidating and refinancing your debts is simple provided you can obtain a loan. Some suggested sources of financing are a home equity loan, a personal loan from a family member or friend, or a loan from a credit union or other financial institution. Use the proceeds from the loan to pay off your existing debts.  That leaves you with one loan and a single, lower monthly payment.

These alternative means of debt relief come with their own sets of risks.  LegalShield(sm) recommends seeking the advice of a competent professional before proceeding with any debt relief plan.
From my personal experience, there is more to getting one’s finances in order than debt relief.  In fact, if you are to take advantage of debt relief, you will need to establish a budget that controls spending, plans for unpredictable expenses, and captures the additional cash flow that debt relief produces.  You will also need a comprehensive plan for getting out of debt, and more importantly, for staying out of debt.

Have a budget and a plan in place before you seek a debt relief solution of any kind, whether it be via debt consolidation or some other means.  If not, there is a good chance that you will fall into the trap of using the additional cash flow from debt relief to leverage even more debt.

    You may discover that a budget and a plan to get out of debt and stay out of debt is all you really need to get your finances in order.
    K.C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages