Credit Basics
Credit card debacle
Many regard credit cards as a source of supplemental income. Instead they might be viewed as a pact with the devil.
By Cheryl Allebrand • Bankrate.com
There's a financial side and a human side to debt.
Howard Dvorkin went from CPA to credit counseling service pioneer after experiencing firsthand the traps of the conventional American lifestyle.
A job transfer from Washington, D.C., to Palm Beach kicked off a seemingly innocuous chain of events: He got married, bought a house and used his credit cards for convenience. Charging everything from furniture to groceries, he ran up a monthly tab of $3,000 to $4,000 in credit card bills. Dvorkin realized credit card use was addictive and spent six months hunkered down in the library researching consumer debt trends and looked for help that was available to debtors. Finally, he came to the conclusion that a lot of people were getting into trouble, but there was little help available -- the only debt-counseling available in south Florida had a three-month waiting list.
Dvorkin designed an innovative business model that enabled him to help people immediately over the phone, an idea the industry widely embraced. Since then he's counseled 40,000 to 50,000 people personally. Now he has close to 200 trained counselors working for him, freeing up some of his time for public outreach initiatives to educate consumers about personal finance.
He shares his perspective on the state of the consumer debt situation with Bankrate.
Consumer debt is skyrocketing, bankruptcies are up: How bad is the consumer debt situation?
A : Debt has been skyrocketing and bankruptcies have been increasing: That's nothing new. The problem now is that people are getting squeezed between mortgage rate adjustments and rising prices. I just met with a couple yesterday who bought a house that they could barely afford three years ago. Their rates will adjust this summer but they're already two months behind on their payments and into foreclosure, because they know that when their mortgage adjusts, they're going to be out. They have a first, second and third mortgage and my question is, how can a guy who makes $65,000 with a non-working wife get approved for a $2,500 monthly mortgage payment?
The other problem is the cost of oil. With gas prices going up, it costs more just to fill your gas tank. And all other prices are going up due to higher oil costs. Oil is used to make other products and for delivery of those products, so the price of those products has to increase accordingly. People are getting squeezed from both ends and they'll continue to get squeezed.
Debt really has been going up, but it hasn't spiked. There's a trillion dollars of consumer debt lying around out there. That's going to increase over time because as our society progresses, we are becoming a cashless society. And as such, of people who are using their credit cards, only 35 percent of people are paying those bills. So 65 percent are carrying balances.
Q: As people continue to float themselves using credit cards as supplemental income, what will be the aftereffects? Will we ever get to retire?
A: These folks will be in debt until probably past their retirement, which is a shame. They're adding years and years onto their repayment time. The problem is that over the last five years, people have looked at the house as a piggy bank and in doing so they've tapped out their houses, paying off their credit cards with the equity in their houses through use of equity lines and low interest mortgages and things like that. But they committed the cardinal sin of leaving those credit cards open.
Bad habits are hard to break and they charged the credit cards up again. Now they're sitting there with credit card balances, perhaps in excess of their original debt, and they have no equity left in their homes.
Q: How did we get into this trouble; where did it start?
A: Greed. Greed on the consumer side and greed on the financial institution side. Essentially the consumers wanted to buy, buy, buy instead of save, save, save and the financial institutions wanted to lend. And they would lend to riskier clients than they had in the past.
There are a lot of profit centers in the credit business. If they don't make it one way, they make it another: late fees, over limit fees, interest, all sorts of stuff. When you're charging interest rates upward of 20 percent, you can make a lot of mistakes and still make money.
Q: Are you seeing new groups of debtors in trouble?
A: We're seeing seniors in trouble a lot because they're outliving their savings and, because of Medicare cuts, it's costing them more to pick up their medication. Quite frankly it's just costing them a lot more to live these days.
Seniors get themselves into trouble for a number of reasons. One of the main reasons is that they have this notion that their children should live a better life than them because that's what happened to them. Their parents probably struggled through the Depression and they lived a better life than their parents, so they expect the same to happen for their kids. And they try to help them along even though they don't have the financial means.
The other thing is, with the low interest rates, their savings -- and I'm assuming that a good majority of their savings is in bonds that typically paid off 5 (percent), 6 (percent) or 7 percent -- may be only paying off half that amount because of the reduction in the interest rates. So they're not generating the money that they thought they would generate from their portfolios.
Q: When will the day of reckoning come, because we'll have to pay our debt sometime, won't we?
A: The only time that I could see it changing is when there is a complete modification of how debt is viewed in this country. And if the banks have their way, it's not going to be for quite a while.
They're making a tremendous amount of money. It's an intricate part of our society. Thirty years ago it was a bad thing to have debt. Now it's not a good thing, but it's an acceptable practice. And credit cards were used as a convenience tool, now they're used as a form of supplemental income.
I think that credit card companies will tighten their standards and try to wean off the riskier customers, meaning they'll get rid of the people with a few late charges here and there.
Q: They'll cut customers even though they make a lot of money on the late payment fees?
A: They make a lot of money, but you've got to balance everything out, meaning you have to realize that if a person has made a few late payments, although you're making money, if they default on a $10,000 debt, that's going to hurt. And that's going to hurt a lot more than not making a $39 late fee.
Chase started pruning off the bad stuff about six months go. That's one of the few credit card companies that I saw making a concerted effort, and that's why their stock is still relatively strong. They're looking for risk, looking for accounts that have a chance of defaulting, bringing down credit lines -- things that are hard, tough decisions.
Q: What's a safe debt-to-income ratio?
A: If your monthly minimum credit card payments are more than 10 percent of your take-home pay, you might be in trouble. And you should never pay only the minimum, because the minimum payments are just designed to put you on a treadmill of credit.
Q: What sort of smart decisions should people be making to stay out of trouble?
A: The easiest one is don't use your credit cards; live off of cash. If you can't do that, you've got to do something about it.
Q: When someone is already living paycheck-to-paycheck, how can they afford to find extra money to pay off debt?
A: They need to create a household budget.
Use a spending plan work sheet to get started.
I can look at a budget and find at least 15 percent fat that I could cut out of somebody's budget without changing their life one bit.
Do they need 250 cable channels? Do they need to eat out five times a week? Do they need a Starbucks at $4 and God-knows-how-many-cents a day? That adds up to $1,400 a year.
People have a lot of fluff in their budget. If you're in debt, you need to make some hard decisions. We all live paycheck to paycheck; the trick is what you do with that paycheck.
Q: Like you said earlier, bad habits are hard to break. Any advice on making lasting changes?
A: Continually review your finances on a monthly basis. My coin statement is: If the cash isn't in your pocket, you shouldn't be spending it.
