The next credit crunch? - As home loan market tightens, mounting credit card debt could spur new crisis
The next credit crunch? - As home loan market tightens, mounting credit card debt could spur new crisis
By Susan Chandler
Copyright © 2007, Chicago Tribune
August 26, 2007
Now that the easy money in home mortgages is all but over, consumers may soon be caught in a financial squeeze with their credit cards.
That's the worry among some economists and credit counselors as home lending has shifted abruptly into low gear this summer. That leaves homeowners owing big sums to Visa or MasterCard without an important escape hatch—the ability to pay down the plastic by dashing off a check from their home equity line of credit or rolling the debt into a new, bigger mortgage.
"You're not going to be able to get that mortgage loan. You'll be stuck with the higher interest credit card debt," warns Carl Steidtmann, chief economist with Deloitte Research. "We will have to live within our means. I know it's a troubling phenomenon. But we're not going to be able to spend at levels well above our income levels."
Home mortgages have become much harder to get this summer as a wave of overleveraged homeowners, many of them with adjustable-rate loans, have defaulted on their home loans. As foreclosures soared, numerous lenders had difficulty raising new capital, and some have closed up shop. Others have tightened their requirements on borrowers and bumped up interest rates, which could decrease how much money a prospective buyer can borrow.
Mortgage debt and credit cards have become closely linked in recent years as interest rates hit post-war lows, and consumers were barraged with offers to use their home equity to pay off their high-cost credit cards. It was billed as a clean slate, but many homeowners went out and ran up new balances.
No shame in debt
It's not just a problem for the working poor, credit counselors say. Many middle- and upper-class households have come to view credit card debt as a reality of modern life.
"The psychology about carrying credit card debt has changed. What used to be a shame is just an additional way to buy stuff, and stuff is the operative word here," said Catherine Williams, vice president of financial literacy at Consumer Credit Counseling Service of Greater Chicago.
Freda Price, a divorced mother of two in Bethlehem, Pa., is trying to get her credit card debt under control. Five years ago, Price had a $49,000 mortgage and no significant credit card balances. But she now is struggling with $100,000 in mortgage and credit card balances because she has refinanced and used the cards to pay for attorneys in a long-running dispute over child custody with her ex-husband.
Price is close to hitting the maximum borrowing limit on her four credit cards, which are consuming about $300 a month in minimum payments. She finds herself charging gas and groceries on the cards, which she doesn't like.
"The sad thing is I never had any of this debt before," she said. "I have to pay the minimum because I can't afford much more."
Price's credit cards also are preventing her from saving for retirement. She is contributing only 1 percent to her 401(k) plan even though her insurance company employer matches up to 3 percent.
"I'm just between a rock and a hard place. I pack my lunch. I get the newspaper at the house. We don't go out to eat. We don't do much of anything," said Price, 51. "I was always very thrifty, but I don't know where else to cut."
Those who have given up the fight are showing up in the offices of bankruptcy attorneys such as Melvin Kaplan of Chicago. Kaplan's business was off by about 70 percent last year after the new bankruptcy law was passed. But within the last few months, "the phone is ringing off the hook," he said.
"It's brought about by credit cards and foreclosures," Kaplan said. "The credit cards have increased their minimum payments. They have all these teaser rates. They send out these checks and say, 'Use them.' But the first day you're late, you're paying 28 percent."
A credit card crunch could develop even faster if homeowners use those handy cash-advance checks attached to their monthly bill to catch up on delinquent mortgage payments.
Those advances, which may carry 3 percent transaction fees as well as interest rates of 20 percent-plus, will quickly increase the homeowner's financial distress. More than $900 billion in adjustable-rate mortgages are due to reset from next month through December 2008, which means lots of homeowners will be scrambling to come up with extra cash.
"This just scares the daylights out of me," said Williams. "This is a call to consumers to rein in their discretionary spending. Your home was never intended to finance your tennis shoes or allow you to carry an $800 designer bag."
Plastic for basics
Credit cards should be used to pay for only durable items such as appliances and possibly furniture, she said. Consumable items such as groceries and gas should be paid for with cash or a debit card. Never pay your mortgage with a credit card. If you are at the end of your financial rope, consider taking a loan against your 401(k) plan at work, Williams suggested.
Yet there is growing evidence that plenty of consumers are paying for basics with plastic. Discount chain Target Corp. reported its profit from credit cards rose 34 percent in the second quarter, although same-store sales rose by only 4.9 percent.
The credit card industry doesn't seem particularly concerned. It points to the fact that credit card delinquencies were relatively unchanged in the fourth quarter of 2006, at 4.56 percent of accounts, and bad-debt write-offs by card issuers are at a decade low.
Experts also take comfort in the fact that outstanding credit card balances have grown at a relatively modest 6.9 percent annual average over the past 10 years and haven't been in the double digits since 2000, according to the Nilson Report, a California credit card newsletter.
But that doesn't account for the fact that many consumers were rolling their credit card debt into their homes. No one knows precisely what that figure is, but Nilson Report publisher David Robertson estimates it might have added $288 billion to the $880 billion in outstanding credit card debt at the end of 2006. That would mean credit card debt had increased by about 225 percent in the past decade.
Even so, Diane Swonk, chief economist at Mesirow Financial in Chicago, isn't worried.
"Much of the shakeout in credit quality occurred in the 1990s," she said last week. "It's really amazing not to see the default rate for credit cards track mortgage defaults, but that isn't happening."
Not yet.
Ironically, credit card companies often do best right before the industry is about to tank. That's because consumers who are stretched are making only minimum payments and racking up heaps of interest on their unpaid balances, trying to keep all their financial balls in the air. But things can worsen quickly when an unexpected expense arises or their adjustable-rate mortgage payment increases. When people hit a wall, they begin missing payments or not paying anything at all. They eventually may find themselves seeking the advice of bankruptcy attorneys.
Average income shrinking
It would be easy to blame the free-spending ways of consumers for the mess their finances are in. High-priced Louis Vuitton handbags have been adopted by the masses, along with iPods, plasma-screen TVs and sleek mobile phones. Americans have closets jammed with clothes, and they eat out much more frequently. The U.S. savings rate was negative last year.
But the overconsumption explanation may be too one-dimensional.
Americans earned a smaller average income in 2005 than in 2000, the fifth consecutive year of decline, the government reported recently. That occurred even as the cost of health care increased for many U.S. workers, and the burden for funding retirement continued to shift onto their shoulders.
Meanwhile, median home prices in the U.S. have increased from $119,600 in 2000 to $213,900 in 2005, a 79 percent increase, boosted in part by middle-class families that have paid premiums to purchase homes near good schools.
"The real problem lies in the basics: Median-earning families simply don't have enough money to pay the mortgage, buy health insurance, pay for transportation and day care and still put groceries on the table," said Elizabeth Warren, a Harvard law professor and author of "The Two-Income Trap."
"Others can make it day to day, but when a child gets sick or the transmission falls out of the car or there's a cutback in overtime, their cushion is so small that they can't manage even the smallest mismatch between expenses and income.
"Families have been making up the shortfall with credit and someday, perhaps someday very soon, the credit music will stop."
schandler@tribune.com
By Susan Chandler
Copyright © 2007, Chicago Tribune
August 26, 2007
Now that the easy money in home mortgages is all but over, consumers may soon be caught in a financial squeeze with their credit cards.
That's the worry among some economists and credit counselors as home lending has shifted abruptly into low gear this summer. That leaves homeowners owing big sums to Visa or MasterCard without an important escape hatch—the ability to pay down the plastic by dashing off a check from their home equity line of credit or rolling the debt into a new, bigger mortgage.
"You're not going to be able to get that mortgage loan. You'll be stuck with the higher interest credit card debt," warns Carl Steidtmann, chief economist with Deloitte Research. "We will have to live within our means. I know it's a troubling phenomenon. But we're not going to be able to spend at levels well above our income levels."
Home mortgages have become much harder to get this summer as a wave of overleveraged homeowners, many of them with adjustable-rate loans, have defaulted on their home loans. As foreclosures soared, numerous lenders had difficulty raising new capital, and some have closed up shop. Others have tightened their requirements on borrowers and bumped up interest rates, which could decrease how much money a prospective buyer can borrow.
Mortgage debt and credit cards have become closely linked in recent years as interest rates hit post-war lows, and consumers were barraged with offers to use their home equity to pay off their high-cost credit cards. It was billed as a clean slate, but many homeowners went out and ran up new balances.
No shame in debt
It's not just a problem for the working poor, credit counselors say. Many middle- and upper-class households have come to view credit card debt as a reality of modern life.
"The psychology about carrying credit card debt has changed. What used to be a shame is just an additional way to buy stuff, and stuff is the operative word here," said Catherine Williams, vice president of financial literacy at Consumer Credit Counseling Service of Greater Chicago.
Freda Price, a divorced mother of two in Bethlehem, Pa., is trying to get her credit card debt under control. Five years ago, Price had a $49,000 mortgage and no significant credit card balances. But she now is struggling with $100,000 in mortgage and credit card balances because she has refinanced and used the cards to pay for attorneys in a long-running dispute over child custody with her ex-husband.
Price is close to hitting the maximum borrowing limit on her four credit cards, which are consuming about $300 a month in minimum payments. She finds herself charging gas and groceries on the cards, which she doesn't like.
"The sad thing is I never had any of this debt before," she said. "I have to pay the minimum because I can't afford much more."
Price's credit cards also are preventing her from saving for retirement. She is contributing only 1 percent to her 401(k) plan even though her insurance company employer matches up to 3 percent.
"I'm just between a rock and a hard place. I pack my lunch. I get the newspaper at the house. We don't go out to eat. We don't do much of anything," said Price, 51. "I was always very thrifty, but I don't know where else to cut."
Those who have given up the fight are showing up in the offices of bankruptcy attorneys such as Melvin Kaplan of Chicago. Kaplan's business was off by about 70 percent last year after the new bankruptcy law was passed. But within the last few months, "the phone is ringing off the hook," he said.
"It's brought about by credit cards and foreclosures," Kaplan said. "The credit cards have increased their minimum payments. They have all these teaser rates. They send out these checks and say, 'Use them.' But the first day you're late, you're paying 28 percent."
A credit card crunch could develop even faster if homeowners use those handy cash-advance checks attached to their monthly bill to catch up on delinquent mortgage payments.
Those advances, which may carry 3 percent transaction fees as well as interest rates of 20 percent-plus, will quickly increase the homeowner's financial distress. More than $900 billion in adjustable-rate mortgages are due to reset from next month through December 2008, which means lots of homeowners will be scrambling to come up with extra cash.
"This just scares the daylights out of me," said Williams. "This is a call to consumers to rein in their discretionary spending. Your home was never intended to finance your tennis shoes or allow you to carry an $800 designer bag."
Plastic for basics
Credit cards should be used to pay for only durable items such as appliances and possibly furniture, she said. Consumable items such as groceries and gas should be paid for with cash or a debit card. Never pay your mortgage with a credit card. If you are at the end of your financial rope, consider taking a loan against your 401(k) plan at work, Williams suggested.
Yet there is growing evidence that plenty of consumers are paying for basics with plastic. Discount chain Target Corp. reported its profit from credit cards rose 34 percent in the second quarter, although same-store sales rose by only 4.9 percent.
The credit card industry doesn't seem particularly concerned. It points to the fact that credit card delinquencies were relatively unchanged in the fourth quarter of 2006, at 4.56 percent of accounts, and bad-debt write-offs by card issuers are at a decade low.
Experts also take comfort in the fact that outstanding credit card balances have grown at a relatively modest 6.9 percent annual average over the past 10 years and haven't been in the double digits since 2000, according to the Nilson Report, a California credit card newsletter.
But that doesn't account for the fact that many consumers were rolling their credit card debt into their homes. No one knows precisely what that figure is, but Nilson Report publisher David Robertson estimates it might have added $288 billion to the $880 billion in outstanding credit card debt at the end of 2006. That would mean credit card debt had increased by about 225 percent in the past decade.
Even so, Diane Swonk, chief economist at Mesirow Financial in Chicago, isn't worried.
"Much of the shakeout in credit quality occurred in the 1990s," she said last week. "It's really amazing not to see the default rate for credit cards track mortgage defaults, but that isn't happening."
Not yet.
Ironically, credit card companies often do best right before the industry is about to tank. That's because consumers who are stretched are making only minimum payments and racking up heaps of interest on their unpaid balances, trying to keep all their financial balls in the air. But things can worsen quickly when an unexpected expense arises or their adjustable-rate mortgage payment increases. When people hit a wall, they begin missing payments or not paying anything at all. They eventually may find themselves seeking the advice of bankruptcy attorneys.
Average income shrinking
It would be easy to blame the free-spending ways of consumers for the mess their finances are in. High-priced Louis Vuitton handbags have been adopted by the masses, along with iPods, plasma-screen TVs and sleek mobile phones. Americans have closets jammed with clothes, and they eat out much more frequently. The U.S. savings rate was negative last year.
But the overconsumption explanation may be too one-dimensional.
Americans earned a smaller average income in 2005 than in 2000, the fifth consecutive year of decline, the government reported recently. That occurred even as the cost of health care increased for many U.S. workers, and the burden for funding retirement continued to shift onto their shoulders.
Meanwhile, median home prices in the U.S. have increased from $119,600 in 2000 to $213,900 in 2005, a 79 percent increase, boosted in part by middle-class families that have paid premiums to purchase homes near good schools.
"The real problem lies in the basics: Median-earning families simply don't have enough money to pay the mortgage, buy health insurance, pay for transportation and day care and still put groceries on the table," said Elizabeth Warren, a Harvard law professor and author of "The Two-Income Trap."
"Others can make it day to day, but when a child gets sick or the transmission falls out of the car or there's a cutback in overtime, their cushion is so small that they can't manage even the smallest mismatch between expenses and income.
"Families have been making up the shortfall with credit and someday, perhaps someday very soon, the credit music will stop."
schandler@tribune.com
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