ARCHIVES :: NOVEMBER 2002 :: COVER STORY

Forever Indebted

Consumer Borrowing Reaches
Record Levels, and Even
The Wealthy Are Struggling

By JON HILSENRATH AND MICHELLE HIGGINS
Staff Reporters of The Wall Street Journal

George Keith was living the good life. Now, he’s paying the price.  

During the boom years, he took his wife and three children to Europe and put a new pool with a spa in his backyard.

Then a year ago, he lost his job as a technology consultant. Now, he has nearly $600,000 in debt—a combination of student loans for his kids in college, mortgage loans, bank credit lines, and borrowings against his retirement plan.

Mr. Keith recently got a lower-paying job with a pharmaceutical company. Despite a combined income of $185,000, he and his wife are having to cut back to meet their payments.

Worries have been mounting for a while about auto repossessions, personal bankruptcies and mortgage foreclosures; each is at or near its highest level in decades. Now, after a mortgage-refinancing boom and a slew of 0%-financing offers, there’s evidence that debt levels are becoming an issue for people at all levels of the income spectrum. For many families like the Keiths, just making monthly payments is starting to define their lifestyles.

Debt = Income

 Overall household debt has exploded to more than 100% of disposable income (income after taxes), which is the highest percentage on record. In other words, the average household earns in one year, after taxes, about what it owes in overall long-term debt.

But wealthy families are piling on debt the fastest, largely because of increased borrowing against the value of their homes. Debt for the top-fifth of U.S. households hit 120% of disposable income in the first quarter, up from 100% in 1995, according to Federal Reserve Board calculations. The debt burden for the bottom four-fifths of households also grew, but at a more modest rate. It rose to 80% of disposable income this year, from 70% in 1995, according to the Federal Reserve.

Robert Beitman, an ophthalmologist in West Bloomfield, Mich., says hundreds of his patients have taken advantage of 0% financing for laser vision surgery since he began offering it last fall. “You would think that everybody who took this option would have a cut-off sweatshirt and a car with no muffler,” he says. “That isn’t the case. [People] leave in Mercedeses and BMWs.”

The news isn’t all bleak. Nationwide, incomes are rising and interest rates are low, meaning many households, especially the wealthiest, are able to manage their higher debt loads. In addition, the Federal Reserve released a report last month hinting that the debt binge might finally be slowing a bit. The Fed said that consumer borrowing rose at an annual rate of 2.9% in August, a sharp slowdown from the 7% rate in July.

In addition, because of low interest rates, debt payments as a percentage of disposable income are at a manageable 14%. That’s at the high end of the past 20 years, but not off the charts. “As long as interest rates remain low, this level of debt is on the whole manageable to people,” says economist David Wyss.

Even so, lenders are starting to play hardball with borrowers who are heavily in debt. Lisa Orman of Madison, Wis., has about $50,000 in debt on five different credit cards from her public-relations business. Even though she says she is rarely late with payments, she receives about four or five calls a week from credit-card companies seeking payment. “They’ve gotten more and more relentless and persistent,” she says.

At Cambridge Credit Counseling in Springfield, Mass., call volumes have doubled from a year ago, to about 40,000 per day from 20,000. Manager Chris Viale says the company is increasingly getting calls from higher-income people looking for help in managing heavy debt loads. (Related article)

Consumer credit, of course, has defined American culture for centuries. “The Pilgrims came over on an installment plan,” says Lendol Calder, an economic historian at Augustana College, adding that many took years to pay for their passage. Centuries later, in 1949, at the beginning of the long postwar economic boom, a Business Week magazine headline asked, “Is the Country Swamped With Debt?”

This time around, economists say three factors will determine whether today’s debt boom turns into a bust: interest rates, incomes and home prices.

Economists worry that interest rates could rise, making it harder for borrowers to repay adjustable-rate loans.

One Big Hit

 But the outlook for incomes is just as important. Most people don’t have debt problems because they borrow too much. Instead, they experience trouble when they suffer a hit to their income that makes it harder to make regular payments.

Now the sluggish job market is taking its toll on borrowers like Don Rodriguez. Last year, he was making six figures as a marketing consultant with Accenture. He lost his job, and now, to pay his mortgage, he is liquidating his retirement investments. To keep payments down on roughly $30,000 in credit-card debt, he is switching balances to low-rate offers every chance he gets. “We’ll deal with the consequences later,” he says.

Home prices are important because many households have been tapping into the value of their homes by taking out home-equity loans or refinancing their mortgages at lower interest rates and taking cash out in the process. Because the values of their homes are rising, they have been able to take cash out without putting a serious dent in their overall wealth.

But even with low rates, many homeowners are being squeezed by monster mortgages and heavy spending. Two-and-a-half years ago, Ana and Adam Dierkhising of San Francisco bought a $1.2 million home, and they are putting another $700,000 into expanding it. Now, their payments from the two loans total $4,500 a month. Since the work on their new home isn’t finished, the Dierkhisings are paying $4,000 a month in rent for the home they just sold. On top of all that, the family pays another $7,500 a month on a second home in Massachusetts that Ms. Dierkhising owns with her brother.