The widespread availability of easy credits lead to an explosion of consumer spending. As a consequence, people spent more than what they can reasonably afford to pay. Most people now carry a big balance on their credit cards with no hope of paying them off. Most cardholders carry balances of US$7,500 to US$8,000 on the average and still want their credit limits increased. Mr. James Montier who is an expert on behavioral finance says people will still continue to buy using credit cards even though they have no way of repaying them in the near future. It seems credit cards are intoxicating consumers the way wine does on a person. This has some experts extremely worried. The consumer demand that comes from using credit cards is two-thirds of the U.S. economy and is significantly large in most countries. Card issuers do not want blame for the surge in consumer or personal debt; rather they say it is the lookout of the consumers or the cardholders. Most cardholders are financially illiterate or simply do not care enough to be financially educated on personal finance. It seems banks are intoxicated also into lending!
Most of the present problems of personal finance stem primarily from overspending and a large part of that overspending comes from the extensive use of credit cards for almost all purchases. There are also other problems facing the personal finance industry such as the sub-prime mortgage crisis and predatory lending practices. These pale in comparison with the anticipated implosion in credit cards when cardholders reach paying capacity limits and default in large numbers. But most banks will try to see a way out of this mess since profits from personal financing form a big chunk of the overall profits. The bigger part of the consumer debt problem lies in the U.S. where Americans took credit cards as a way of life. They used cards to aspire to a higher and more comfortable lifestyle than what they can reasonably afford.
There are about 1.3 billion credit cards outstanding in the U.S. alone with the average American family having 6 to 8 cards. Other nations are much more deliberate and circumspect in their use of consumer debt. Europeans, with the exception of the English, are averse to using credit and even look at it like some social stigma. Asians are also a bit cautious in using their credits except for business and investment purposes. Their aversion to credit extends only when consumption is concerned. Asians are inveterate savers but South Koreans are an exception with regards to using their credit cards.
- Overspending
A problem such as overspending can begin very innocently enough. You want to buy something now rather than save up for it and buy it in the future by paying in cash. This can happen innocuously like a drug that was administered and soon becomes addictive. A small purchase here and another purchase there cannot possibly harm your finances. But this mentality is soon ingrained and like any habit gets harder to expunge once a pattern is set. People are now addicted to credit cards.
According to economists, U.S. consumer spending accounts for fully two-thirds of the U.S. domestic economy. Consumer debt has reached alarming staggering levels of more than US$2 trillion (auto loans and credit cards) but if you include mortgage loans and other types of debt it will reach an astounding US$10 trillion. This amount is more than the economic output of most countries combined. Americans are in the habit of using credit cards that they continue to use them to get cash even during economic downturns. There are many warning signs now that debt levels have become unmanageable for some families and most individuals.
Perpetually spending more than what is earned leads to increased risk of bankruptcy. The U.S. has recently tightened its bankruptcy laws and it is now much harder to wipe out credit card debt. Americans who overspent or who can no longer afford monthly payments on their cards can avail of personal bankruptcy laws which are more lenient than in other countries but that will not hold true anymore once new laws are passed. Germany has one of the strictest bankruptcy laws anywhere while France frowns on personal credits as a social aberration. People there opt to save instead. The foremost concern of most Americans nowadays is not to reduce fat or lose weight but to reduce and pay off their credit card debts. Relatedly they also want more job security since a main cause of bankruptcy is job loss rather than overspending. Job loss can be caused by anything such as a messy divorce, a prolonged illness or even outsourcing. This site offers a good discussion on the dangers facing an economy over-leveraged on consumption that is largely credit-card based; the next site offers a counseling service to compulsive debtors:
http://www.wsws.org/articles/2004/jan2004/debt-j15.shtml
http://www.debtorsanonymous.org
- Foreclosures
The worst case that can happen to any family is a home foreclosure due to inability to meet mortgage payments. The home mortgage market is very large and is linked to a lot of other down stream industries such as construction, temporary labor, materials such as cement and lumber, and the banking industry. A significant rise in home foreclosures has been noted due to the credit crunch caused by the sub-prime lending market. This market had been overlooked before for its risks but banks lent aggressively to this sector. Many of these homeowners were not really qualified for these housing loans but were extended mortgages because of greedy brokers. Industry jargon call these people as NINJA – no income, no jobs and assets. Housing markets such as in the U.S. and U.K. are facing declining values. Housing starts have declined as well. In the U.S. the most severely hit states are California, Florida, Arizona and Nevada. The housing boom started in those states. An overall view:
http://www.pbs.org/wgbh/pages/frontline/shows/credit/etc/synopsis.html
- Repossessions
Like home foreclosures, the auto loan industry is also facing a record number of repossessions. Most lenders now are getting strict with their payment standards. Whereas before a six-months’ grace period was given, most lenders now repossess your car if you fail to pay even for three consecutive months. The reason is to avoid further deterioration of the units before they eventually get them back and re-sell them as good second hand units. Repossessions are not limited to cars or autos alone. Any consumer durable product that was purchased using personal finance can be repossessed if payments are not updated. These items can include such household items as TV, refrigerators, air-conditioners, washing machines, or DVD players.
For those who are overextended, it is a choice of which debt to pay first: home mortgage? the car payment? or the TV? The car financing sub-sector have only themselves to blame since they aggressively marketed their loans even to those not qualified for credit in the first place. To stimulate ever greater numbers of borrowers they used as “teasers” in their advertisements “zero-interest” plans. The aggressive marketing eventually got back to them with high repossession rates.
- Predatory Lending (Usury)
Loan sharks prey on people who are financially ignorant. These are also the people who do not bother to read the fine print and do not use their credit in a responsible manner. But predatory lending refers to so many practices which are illegal or outlawed. Among these are charging very high interest rates and not disclosing all the relevant information a borrower needs to know before signing off. It can be said that credit cards are no different from loan sharks in these regard. Maybe the only difference is the absence of the threat of violence and blackmail.
Majority of customers of loan sharks are low-salaried government employees, factory workers, and office clerks. Products offered by these loan sharks were also overly complicated to make orderly repayment almost impossible so borrowers ended up paying the interest portion only for long periods. These loans made debtors perpetually in debt so that interest payments became annuities. Many critics call payday loans as loan sharking in a different garb. They want it outlawed altogether. Period. Please see this article:
http://www.bankrate.com/brm/news/chk/19980217.asp
- Subprime Loans
These are the loans which are extended to borrowers with low credit scores based on credit history maintained by credit rating agencies. In a simple sense, these are “marginal” borrowers, people who are more likely to default on their payments. The current credit crunch in the U.S. now is due to “sub-prime loans” in the housing industry. As the American housing industry is very big, most banks, credit unions and other financial institutions sometimes do not lend directly to housing borrowers. What they do is employ the service of mortgage brokers. These are agents who help housing borrowers fill up all the necessary documentary requirements. In the process of helping out, brokers often do not properly examine borrowers. What they did was aggressively market housing loans since they earn fees or commissions based on number of successful referrals. Proper credit evaluation went out of the window in the scramble to earn fees and solicited loan accounts from people who are not qualified.
http://www.bankrate.com/brm/green/mtg/basics2-4a.asp?caret=8
Personal Bankruptcy
The sudden explosion in the size of consumer debt has brought along with it the threat of personal bankruptcy. This situation happens when individuals take on too much debt, loses an income source such as a job loss, suffers incapacitation due to illness or injury and also to other emergencies in life that require huge amounts of money. This is a situation that many individuals and even families face today as they keep on borrowing either from personal loans or through the use of their credit cards. Their consumer debts continue to pile up month by month until they reach a point where payments become delayed and then finally defaulting on them. Some countries allow bankruptcies to be filed only by business corporations. However, the U.S. has laws on personal bankruptcies that allow a debtor to wipe off most of his or her debts. But it is always better to stave off filing for personal bankruptcy as it affects negatively your ability to borrow again in the future.
The sheer size of consumer debts has fostered the growth of a new cottage industry in most countries – the “home industry” of credit counseling and debt consolidation. There are many “fly-by-night” small businesses that claim to let you get debt-free using their tested methods. What they offer for a certain price is just actually a no-nonsense approach and financial advice to spending your money. A lot of us do not yet realize that money “leaks” out everyday on items and expenses that are completely unnecessary. These are usually the small amounts which we do not notice yet sum up to something over time. A few standard steps are common to all the “advice” they offer:
- -Know the cause why you got into debt overload in the first place.
- -Identify areas where there are “money leaks”.
- -Prioritize which debt/s to pay off first (the most onerous!).
- -Increase payment using freed-up cash to other debts (snowball).
- -After debt pay-off, focus on future goal of wealth building.
Stay debt-free for the rest of your life!