A new way to dig a deeper debt hole

MARY REICHARD, HOST: It’s Thursday, the 5th of December, 2019. Glad to have you along for today’s edition of The World and Everything in It. Good morning, I’m Mary Reichard.

NICK EICHER, HOST: And I’m Nick Eicher. Despite virtual full employment and an 11-year economic expansion, household debt in the United States has hit a record high: nearly $14 trillion. Let’s break it down. 

Two-thirds of it is mortgage debt, so it’s connected to a tangible asset. Not that we don’t worry about it, but let’s back that out. 

So that leaves us with $4.5 trillion in car loans, student loans, credit card debt, revolving home-equity accounts, and a final 3 percent for “other.” We’ll get to that in a minute.

When you consider we have about 125 million households, that $4.5 trillion averages to $35,000 per household.

REICHARD: Credit agency Experian recently reported that personal-loan indebtedness reached $305 billion as of the second quarter of 2019. 

It’s in that “other” category Nick just mentioned, and it’s a smaller fraction of the debt pie, but it is the fastest-growing. The size of these loans is increasing too, with the average amounting to more than $16,000.

Joining us now to explain what’s driving this trend is WORLD Radio correspondent Katie Gaultney. Good morning!

KATIE GAULTNEY, REPORTER: Good morning.

REICHARD: So, Katie, sounds like if I want to get everyone extra lavish Christmas presents this season, all I have to do is take out a personal loan! Right?

GAULTNEY: Well, that’s probably the way a lot of people are approaching this holiday shopping season! Christmas spending is forecasted to increase by more than 5 percent this year, after all. Maybe you can be the bulk of that increase, Mary!

REICHARD: Well before I run to the bank for all that paperwork, maybe it’d  be useful to remind us what a personal loan actually is?

GAULTNEY: Well, in the past, personal loans were a last resort for people trying to escape debt—paying off credit cards, for example. But over the last several years, financial technology firms, or fintechs, have popped up left and right. These are largely online or app-based financial businesses that are able to “cut out the middleman,” more or less. These fintech operations have made a big push to offer consumers easy-to-qualify-for personal loans. And many of those loans are unsecured. “Unsecured,” meaning that there’s nothing tangible for the lender to take back if the borrower defaults. So it’s a greater risk on the part of the lender, but there’s potentially a higher yield, too. And personal loans have a lower APR—that’s annual percentage rate, or interest—than most credit cards. Personal loans will incur about 10 percent interest, on average, while most credit cards are in the neighborhood of 20 percent. So that appeals to a lot of people.

REICHARD: But surely there’s a catch…

GAULTNEY: There’s always a catch! It’s going to take a very specific type of consumer for these personal loans to make good financial sense. I spoke with Ethan Pope, a certified financial planner in Christian ministry. Here’s his take:

POPE: Many people have come to me saying, “I want to consolidate my credit card debt and high interest rate to a new loan, lower interest and counting, spread out the payment. And here’s what I’ve seen. My experience shows me over the past 30 years unless they have solved the spending problem, and unless they’ve proven to me in a sense that they are living on a budget for at least 12 months, and this problem has been solved, it is not a good move to make.

Pope put it this way: Assume that you have $10,000 racked up across four credit cards with an average interest rate of 20 percent. Now, here you have this opportunity to consolidate your credit card debt into one new loan with a lower interest rate of 10 percent. Sounds like a great plan, right? It’s a good plan only if those two conditions Pope mentioned are met: The consumer is no longer overspending and has proved that he can live within his means for at least a year.

REICHARD: OK, so stop overspending and live within your means for a year. And if those two conditions are not met?

GAULTNEY: Pope said his experience shows that the consumer will have double the amount of debt within 12 to 36 months of trying to consolidate if he or she hasn’t stopped the overspending habit. So before long, you’ll have your $10,000 personal loan incurring interest, plus $10,000 of new consumer credit card debt at 20 percent interest because you’re still spending above your means.

POPE: Hey, debt is debt and it must be repaid. And does this stop the cycle transferring credit card debt to personal loans? The answer’s no. Uh, simply paying off one debt, credit card debt, with another debt. Personal loan debt does not solve the problem. In fact, most of the time it doubles the problem.

Bottom line, it’s a cycle, and it won’t stop until consumers truly stop overspending. And with easy access to new debt, that doesn’t look likely.

REICHARD: Katie, we joked but of course I’m not going to run out and get a personal loan. But still, this is something I should care about, isn’t it? 

GAULTNEY: Yeah. Ray Dalio is a billionaire investor and leads one of the world’s largest hedge funds. He’s among those who have been sounding the alarm about debt levels, but I like what he says about questions like that: “He who lives by the crystal ball will eat shattered glass.” Sounds a lot like Proverbs 27:1, “Don’t boast about tomorrow, for you don’t know what the day may bring.”

Here’s the thing, Mary: It works until it doesn’t. As people default on loans, available credit will decrease, which leads to economic decline. It’s all part of the boom and bust cycle, but no doubt this is an unprecedented level of debt. The Bible doesn’t prohibit taking on debt, but it gives plenty of warnings on the dangers of debt. Essentially, we are borrowing from our future to consume more today, which may make us less resilient in the event of an economic slowdown. I think we’d all be wise to heed another verse in Proverbs 27; verse 12: “The prudent sees danger and hides himself, but the simple go on and suffer for it.”

REICHARD: Wise words from Proverbs, indeed. Katie Gaultney, thanks for this report.

GAULTNEY: You’re welcome, Mary.

(Photo/Creative Commons, Flickr)

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