Unlike normal recession patterns, consumer spending actually increased last year in the midst of the recession, according to the U.S. Bureau of Economic Analysis–rising 6 percent in the fourth quarter of last year. That’s great for the economy overall, as consumer spending accounted for more than two thirds of the gross domestic product in 2001. But it’s not so good for the consumers who are spending beyond their means and racking up high-interest credit card debt. Experts say household debt is now at a record high relative to disposable income. Can the trend be reversed? NEWSWEEK’s Jennifer Barrett spoke with Ivan Hand, president and CEO of Money Management International, the nation’s largest nonprofit credit-counseling agency, on the challenge of teaching Americans to rein in their debt and live within their means.
NEWSWEEK: In 2001, bankruptcy rates jumped, an estimated 2 million Americans lost their jobs, consumers confidence levels dropped and, according to Money Management International, the average household carried a credit card balance of $8,562. How much worse can it get?
Ivan Hand: Clearly, the situation can and will get worse if we as a society fail to recognize the importance of financial literacy. Every consumer should have a basic understanding of the fundamentals of money management in order to have the ability to make sound financial decisions. A decade of prosperity combined with a general lack of financial education is creating a generation that lacks the ability to determine the difference between a need and a want. In January of 2002, the Commerce Department reported that the personal savings rate was only 1.8 percent. Savings is key to the growth of our economy.
In order for the situation to improve, consumers must understand that credit is a privilege, not a right. In order for consumers to climb out from under mountainous debt loads, a paradigm shift must occur. Adjusting spending habits, creating a financial master plan and diligence in living within their means will help not only the American consumer create a more secure financial future, but will also help the economy regain its former momentum. Education on sound financial principles must begin to permeate all aspects of American life. Governmental reform, private sector involvement and community-based programs are all needed to shift America’s mindset to one that focuses on long-term stability versus short-term gratification.
Has the profile of the “typical” consumer seeking help changed in the past few years? Are the consumers who seek your help now in worse shape financially than those in previous years?
The profile really hasn’t changed. Our typical client is 39 years of age, with a family of three and an income of $27,000 per year with seven creditors and an average debt of $18,000.
With options like this available, and all the educational material out there, why the continued increase in the amount of personal bankruptcies?
First and foremost, it’s the lack of financial literacy. Americans just don’t understand the need to be committed to saving. We see situations of inadequate savings, poor money-management skills, the “living up to the Jones” mentality and easier access to credit by high-risk consumers. Secondly, there are external conditions such as 2 million job losses, dwindling consumer confidence, a weak economy and the proposed bankruptcy reform. Many people view bankruptcy as the easy or only way out of their current state of debt.
What should you do if your income drops–through a divorce or a job loss, for example? What’s the first change you should make in your budget?
There are a couple of things a consumer should do. First and foremost, make an assessment to totally and fully understand your financial situation. Secondly, setup a survival spending plan. Outline your priorities, only spending on bare necessities such as rent or mortgage, car payment, insurance, groceries, utilities and gasoline. Trimming luxuries such as cable TV, cell phones and dinners out can help make ends meet. Consider selling assets to keep afloat. Third, contact each of your creditors and advise them of your situation. We recommend that you ask to speak to a representative in their “hardship” department. Maintain communication every two weeks with your creditors and advise them of a reasonable timeline in which you think your financial situation will recover. Fourth, stop charging and overextending yourself. Using credit will only exacerbate the situation. Remember, you cannot borrow yourself out of debt.
When it comes to your debt-to-income ratio, how high is too high?
Maintaining a safe debt-to-income ratio is an integral part of your financial stability. Mortgage companies prefer to see consumers with a financial income to debt ratio of less than 36 percent. As a rule of thumb, our counselors have always advised consumers that if they are spending more than 20 percent of their income on debt, excluding the mortgage payment, that should be interpreted as a red flag.
What sort of budgeting tips would you give to help consumers make it through tough times like these?
Realistic tips for an uncertain economy include: developing a functional and realistic spending plan; making saving a habit; establishing an emergency saving account, and maintaining a balance of three to six months net income. Also, you should limit the number of credit cards you carry (usually one debit card and one credit card), pay off existing credit card balances as quickly as possible, live slightly below your means and maximize the benefits of retirement plans.
What is the biggest mistake that consumers make when it comes to budgeting? What is your first recommendation to consumers who have a high debt load?
A big mistake that most consumers make when it comes to budgeting is mentioning the word “budgeting.” Most consumers correlate budgeting to dieting and most of us do not enjoy dieting. Another mistake is establishing an unrealistically low spending plan, overspending, and then getting frustrated and never looking at it again. Consumers should focus on developing and using a realistic spending plan by tracking all of their spending for 30 days. Then identify the plan’s three basic components: fixed costs, variable costs and periodic costs. Armed with this information, adjustments can be made to eliminate unnecessary spending.
My first recommendation to consumers who have a high debt load is to contact all your creditors and attempt to negotiate lower interest rates. Secondly, these consumers should modify their spending plans and eliminate unnecessary expenses such as cable/DSL, cell phones, entertainment expenses and consider brown-bag lunches. Additionally, if the consumer is receiving a large income tax refund each year, he or she should consider adjusting their withholdings and use more of their current income to pay off high-interest-rate debt throughout the year. If, after you have worked through all your options and you are still not where you need to be financially, consumers should consider contacting a professional certified counselor for help. But make sure that whomever you contact is an accredited nonprofit credit-counseling organization.
At what point is bankruptcy the best option?
The decision to file for bankruptcy is an extremely personal one. Bankruptcy should always be your absolute last resort. A professional credit counselor can provide you with a comprehensive analysis of your income and expenses and can help you develop an action plan that, in most cases, can help you avoid filing for personal bankruptcy.
What advice would you give to consumers during good times to prepare for downturns? (i.e. How much savings should you set aside for a rainy day?)
During our good times, consumers should focus on saving a minimum of 10 percent of their gross monthly income. This money should be placed in an interest-bearing account, with limited access. A good rule of thumb is to have approximately three to six months of net monthly income saved for a rainy day.
What is the hardest change for consumers to make?
The biggest hurdle to cross is realizing that credit is not an extension of income. Living within your means can require a major lifestyle change. Credit, when used wisely, is a useful money-management tool, but learning when and how to use it requires dedication and diligence. However, most consumers who have successfully made the change to debt-free living say that living with one credit card and using a spending plan has created a sense of freedom that they have never known before. All the stress and negativity of living from paycheck to paycheck has vanished.
Any other advice you would give to consumers trying to manage their debt?
Consumers who are trying to manage their debt should remember to create obtainable goals. For example, our recommendation is to pay off the credit card with the highest interest rate first. However, consumers will achieve a psychological boost when they pay off a small-balance credit card first. So, if there is a credit card with a relatively low balance, pay it off immediately, if possible. If not, begin working on the high-interest debt. Consumers should also make this process a family matter. Discuss your plans openly with all members of your family. Everyone usually wants to lend a hand in helping achieve a family goal. And reward yourself–within reason–once you’ve done it!
