Why the Rise in Personal Debt Could Be the Future Downfall of Housing
Americans are resilient. When it comes to personal finances, people have become more interested in empowering their own survival. Through the gathering of information and resources available, we can get a better handle on our assets and liabilities. Until an unforeseen circumstance happens: a pandemic, an illness, a job loss, a broken relationship. These are the precursors to experiencing a rise in debt.
Not All Debt Is Bad
The very word debt can get a bad rap. If you cringe just at the sound of the word, it’s likely there is a traumatic experience attached to it. (Think 2008 or 2009 and the housing crisis and economic downturn.)
If you or your parents owned property at that time, loss was part of that lifetime. As a result, economists will look back to that as a gage to measure the health of consumer finance today. In my humble opinion, housing in Arizona is not positioned for the same historic drama as before.
Lender requirements for mortgage loans are more stringent
New construction communities don’t allow for quick-turn investor purchases
Perception of ‘home’ is a priority
Ultimately, the presence of debt comes from a choice that can be traced to an initial human behavior. And while no one in their right mind chooses to initiate a reckless rise in personal debt, life happens.
Once we can get a better understanding of debt, how it can work for us and to our detriment, individual livelihood and the future can be better harnessed.
Human Behavior Bears Concern
According to Dylan Dunst of Freedom Financial, a debt consolidation company, “It’s important to think about what purchases are really necessary right now and what can be put off until later.”
Dunst has seen the company’s client base escalate greatly in recent years as consumers continue to make purchases of goods and services simply because they can instead of what’s truly affordable.
How could they afford the purchase but not the management of the debt?
The Culture of Click-to-Own
I’m pulling out the dinosaur files for this anecdote: remember when managing our personal budget was based on our hard copy checking account ledger? For those that have no idea what I’m talking about, it’s about the size of two personal checks placed next to one another, top to bottom. Consumers would take the ledger with their checkbook wherever they went to make purchases before ATM cards were popular.
The benefits of using a checkbook were many but perhaps the most redeeming was that it forced individuals to have an ongoing accounting of their liquid assets as long as they notated their purchases on the ledger in real time. This eliminated purchase surprises and “Oh I forgot about that” when the bank statement would come in the snail mail or an insufficient funds letter and accompanying penalty for the negligence.
As of October 2020, U.S. consumer debt stood at $4.2 trillion—that’s a load of stress.
Today, people have no patience and want to consume in the moment without consequence. While that may be an easy-to-succumb-to desire, the debt is the long-term reality you’re stuck with unless you have the means to pay it off quickly.
If you have a disdain for personal debt, make sure you’re looking at it correctly.
Revolving Debt
Credit cards comprise most of our revolving debt. It continues to revolve (i.e. grow) until the debt is paid off. Interest rates associated with revolving debt can increase consumer risk and indebtedness the longer a credit card balance remains.
Non-Revolving Debt
Auto loans and student loans are non-revolving debt which increased after the pandemic. Many dealerships were offering special incentives, such as no payments for 90 days or 0 percent financing for purchases during 2020. People who remained employed were able to capitalize on the opportunity, even though work-from-home guidelines were in place. (Here’s that click-to-own culture I was talking about.)
Another reason that non-revolving debt saw an uptick in 2020 could be due to the federal government pausing student loan payments and would-be accrued interest and penalties from March 2020 thru February 2021. This provided relief to more than 42 million people with student loans, though relief is temporary.
· What will happen after February?
· Each consumer with student loan debt amid federal relief potentially had purchasing or refinancing a home delayed
How long can Americans count on hope and prayer as the caveat to financial stability before the economic foundation is shaken and tumbles? If the past is an indicator, unpredictable is all we can rely on.
Mortgage Debt Is Not Considered Consumer Debt
In the Q3 of 2020, U.S. national mortgage debt increased by 5.6 percent, the same amount as household debt. This aligns with our historically low interest rates and the overwhelming increase in home purchases and refinances. Housing and consumer debt, according to the Federal Reserve, have grown at their most rapid pace since the Great Recession.
In addition Millennials, who side-stepped home ownership for years, have leaped into the foray with a vengeance while adding stock holdings to their portfolios.
For the unsuspecting or naïve, the pandemic economic climate is like Disneyland for adults. But like all theme parks meant to induce fun and feel-good hormones, the element of fantasy hangs heavy. Fantasy cannot be sustained.
How You Use Debt Tells the Story to A Lender
Contrary to the philosophy of renowned broadcaster Dave Ramsey, debt can actually assist you in strengthening your creditworthiness. With respect to housing, debt is how a mortgage bank assesses your ability to be responsible with a home loan, as well as the overall risk in providing you the loan.
A lender will look at your credit history; how long you have had credit lines, and the timeliness in payments. Debt is the oil in the finance machine that keeps your money and the economy moving.
When consumers continue to move money in and out of commerce, online and onsite, the financial foundation maintains a healthy ebb and flow. But when there is a hiccup in the process, the cycle stops.
Negative perceptions about the economy: housing, GDP (Gross Domestic Product), the stock market and more, can fuel a downturn. Although each of us can be a participant in the flow of assets, belief in its workability and benefits to the greater whole is essential.
Think of it this way, when there is heavy trading in the stock market, there remains fluidity, a give and take—movement. When there is a sell off without a corresponding buy in soon after, that’s when the red flags are raised. It is our response to stagnation that can lead to a quick recovery or a long-term fallout.
There Are Options with Rise in Personal Debt
If you already own a residential property, and purchased before 2020, you likely have gained equity due to lack of inventory and the rise in home values. For the employed (includes self-employed), a refinance with a moderate cash out may be the answer. This allows you to take some of the equity out of your house and use it to pay off the personal debt that isn’t serving you. Although your loan amount will increase, the lower interest rate helps to offset the potential for a higher payment.
Simply Do the Math
With credit card debt, the interest you owe is likely 14 to 25 percent on your balanced owed. If your mortgage interest after a refinance/cash out is 3 percent, it’s a no-brainer. The cost to borrow more on your home loan is far less than what the credit cards are costing you. However, make sure you adjust frivolous spending habits to avoid repeating behaviors that fuel more consumer debt.
Dave Ramsey Enthusiasts Often Miss Real Estate Opportunity
It’s an admirable approach to financial freedom, a concept shared often by Dave Ramsey and his followers. There are tenets of successful financial strategies that reminisce “buying low and selling high”. Such is applicable in the stock market, housing and other investment applications.
Again, thoughtful and modest participation is key to taking advantage of the right timing when it appears.
Some staunch Ramsey enthusiasts often find themselves following his self-prescribed steps to the letter and quite literally, leaving them blinded to obvious opportunities around them. Here is an example.
The Cost of Renting and Paying Off Debt in 2020
Let me introduce you to Lydia and Jeff, two buyers looking forward to building a life together and starting a family.
Lydia and Jeff are both:
Employed (W-2)
Paying down personal debt
Lydia has $30,000 in student loans
Jeff has $8500 in credit card debt
Eager to pay off all their consumer debt
Committed to buying their first home, AFTER they pay off all their debt
Their story may not be unlike yours. While I can appreciate their quest to realize financial freedom by removing debt, their goal is wrought with cutting their nose off to spite their face, so to speak. Here’s why.
For the two years prior to the pandemic, Lydia and Jeff have been scrimping and saving to chip away at their personal debt. They have not put money away for a rainy-day fund, nor invested in anything that will grow their money over time.
While they have been diligently removing debt and paying rent to someone else, their friends Amy and Mark purchased a home. Home ownership allowed them to benefit from tax write offs to include property taxes and mortgage interest paid. In addition, Amy and Mark experienced home value increases of 20 percent since they purchased just two years earlier. They were then able to refinance and pull cash out to pay off Mark’s remaining student loan, while keeping their home and remaining equity.
In comparison, Lydia and Jeff are still paying off their debt, paying someone else’s mortgage (rent) and have nothing to call their own for growth assets.
How long will low interest rates remain…as long as it takes Lydia and Jeff to pay off their debt? And when they do decide to buy a home, will they have enough in liquid reserve assets to satisfy a lender? Remember, the future always starts now.
Paying off debt is admirable but what story does it tell if they can’t show an ability to have debt and actively manage it? Remember, it’s important to show debt payment but also how you participate in the cycle of credit (acquiring debt-paying debt-acquiring debt-paying debt, etc.)
Balance of Risk vs. Reward
I may have moments of strong intuition about people and circumstances. This doesn’t filter into my forecasting the financial agility of America, my economic power or yours.
What I can say is that no matter your situation when it comes to money and your ability to grow it, it’s all about weighing your risks and the potential for reward.
If you’re just starting out on this kind of venture, pick a financial goal—one within reach in the near term.
Be cautious, be active and make sure you don’t risk more than you can afford to lose.