Some GOOD News About Personal Debt?

By Dr. Steve Sjuggerud, President, Investment U
Monday, April 14, 2003: Issue #230

Are we all idiots, hopelessly drowning in debt? Do we stupidly take on more and more debt, even though we know that every penny we borrow must be paid back?

Most financial “experts” will tell you yes that any way you slice it, we’re in hock up to our eyeballs “American households alone have $6+ trillion in home mortgages, and another $1.7 trillion in other debts, the most in history” they’ll argue.

I’m not so sure it’s that easy. So let’s take a look at the truth about debt in America – including just how those debt figures are calculated and we’ll uncover the single biggest factor influencing our debt level over the past two decades.

Old Debt Habits Die Hard…

I went looking for the latest household debt statistics on the Federal Reserve’s statistics website (http://www.federalreserve.gov/releases/housedebt/).

I was amazed at what I found our debt HABITS really haven’t changed in the 23 years since the government started paying attention to this.

What the Fed tracks here is the household debt-service burden – the “ratio of household debt payments to disposable income.”

In short, it’s a way of comparing your growth in debts to your growth in income. And the key here is that it compares debt PAYMENTS, not absolute level of debt, to your income.

As it turns out, our debt payments-to-income ratio has been remarkably steady. 23 years ago, the ratio was 13% and change. Today it is 13% and change. And the average over the last 23 years has been 13% and change. How can this be? How can our debt burden be the same, when we’ve taken on more debt?

You probably already know what I’m going to say – it’s due to the massive fall in interest rates. While we owe more, it costs us less to service those debts.

When the “experts” tell you about the “$6+ trillion in mortgages and an additional $1.7 trillion in debts,” those numbers sound huge. But they are not in any perspective.

The market value of homes owned by U.S. households is currently about $12 trillion. If we say there are 100 million households in the U.S. (to keep the math easy), that’s a home worth $120,000, a mortgage of $60,000 and additional debts (say cars and credits cards) of $17,000.

Another Way To Look At Debt

Another way to determine whether our collective “debt habits” have really changed is to look at precisely WHY we’re borrowing money. One of my favorite ways to do this is to look at the Federal Reserve’s “Survey of Consumer Finances” (also at www.federalreserve.gov).

I once again found that our borrowing habits haven’t changed much at all. Consider these percentages of where Americans use debts:

In 1995:
70.3% – Home purchase
7.6% – Vehicles
5.7% – Goods and services

In the current survey:
70.7% – Home purchase
7.8% – Vehicles
5.7% – Goods and services

I think it’s uncanny how similar the makeup of our debts are today versus 1995, before the stock market boom (and bust) and before the real estate mini-boom today. Don’t you?

I don’t think these numbers are accidents. I think we’ve all determined that that 13%+ debt-service burden figure must be about right. Above that level, we have a harder time sleeping at night, and we cut back. Below that, we’re playing it safe and giving ourselves some headroom to take on more debts, if and when it feels right.

An Unbiased Look At The Numbers Shows… We’re Not Debt Idiots!

So what conclusions can we draw from these numbers? Well, first of all I don’t think we’re debt idiots. Actually there are even fewer debt idiots today than there were in 1998 In 1998 12.8% of all households had debt-service burden ratios above 40% (remember, that’s required loan payments divided by disposable personal income). But only 11% of households were in that “danger zone” as of the most recent survey. And in 1998, 8.1% of families were 60 days past due on at least one debt payment. In the most recent survey only 7.0% were 60 days past due on at least one debt payment.

I’m not trying to say that there isn’t a lot of debt out there. There is. And I’m not trying to say that a lot of debt isn’t harmful. (In Japan, where interest rates are near zero, the debt service ratios can be small, but the mountain of debt outstanding is extraordinary.) And I’m not trying to say “You’ll be fine.” Because if house prices were to come tumbling down (which I’m not predicting) – or your income were to fall significantly – you could get into trouble.

No, my only point is that while the sheer amount of debt is higher, our ability to service it is not much different than it has been for many years. And for this, we can thank the extraordinary fall in interest rates over the last two decades.

Good investing,

Steve

Today’s Investment U Crib Sheet

In spite of what you might hear from the mainstream, I really don’t think we’re debt idiots, mindlessly taking on new debt. I think we’ve acted rationally in response to lower rates. The danger is a Japan-like situation, with big debts and deflating asset values. People there have $300,000 mortgages on places now worth $100,000 – not a good place to be.
How do the debt figures from the Federal Reserve compare to your situation? Even with the lower rates we’ve enjoyed of late, it’s a good idea to be mindful of your own personal debt level. For more details on personal debt, please visit the Investment U E-Letter archives and check out IUEL #202 – Where to Put $10,000 Now.
Finally today, I want to tell you about a dynamic-and highly interactive-two-day course that Dr. Van K. Tharp and I plan to hold this June. It’s called Stock Market Mastery 101 and it will be held June 7-8, 2003 in Cary, North Carolina. During this unique event, Dr. Tharp and I will reveal 15 key “secrets” that you need to know to make consistent profits in the stock market. This information is not available anywhere else that I know of it’s truly a comprehensive presentation revealing exactly how the “market wizards” make money year in and year out. I hope you’ll join Dr. Tharp and me for this one-of-a-kind event. For more information please click here or call the Stock Market Mastery Headquarters at 800.385.4486 or 919.852.3994.

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