Goodbye to debt: the new American status symbol and how to achieve it

Goodbye to debt: the new American status symbol and how to achieve it

Margaret Mannix

Liz Lahm hates being in debt. Three years ago, during her divorce, she owed $15,000 and was “spending like crazy–a time share, furniture–major purchases that I couldn’t afford,” she says. “I was just moving my [credit-card] balances from one bank to another.” But for the past year, Lahm has been working with a financial planner in her hometown of Lexington, Ky., to erase her debt, and she says she’ll never carry a balance on her cards again. Now, when she shops, if the money isn’t in her checking account, “I don’t buy it.”

A growing number of Americans are making the same decision. Mired in debt, struggling to pay the minimum amount due, transferring balances among credit cards to get a lower interest rate, dodging calls from creditors, consumers have tired of the treadmill. While headlines still scream about the growing number of personal bankruptcy filings, what’s easy to miss is evidence that a new attitude toward debt–enough!–is taking hold. Consumer borrowing has slowed–it rose only 4 percent last year compared with 14 percent in 1995, according to Haver Analytics, an economics consulting firm in New York. But the clearest change is in the way people view their credit cards. More holders are using their cards for convenience, paying off the balance each month and generating no interest charges. In 1992, 29 percent of cardholders were convenience users; today the share is 42 percent. In January, Wirthlin Worldwide reported that 36 percent of all users had canceled at least one card in the previous 12 months. About 20 percent of those said they did so as part of a conscious effort to charge less.

Debit cards are gaining in popularity, too. These cards allow consumers to control their spending because money is subtracted directly from their checking account. In the first half of 1997, Visa and MasterCard saw 14 percent growth in debit-card accounts; credit-card accounts were up only 1 percent.

Plastic surgery. Some consumers are targeting all their debts, from mortgages to student loans to car loans. But the main problem is high-interest credit-card debt, and that’s the one most tackle first. Gone are the impulse buys–dinners out, trips to the Bahamas, the latest video games; in are planned purchases with the money to back them up. “A lot of people are hunkering down and realizing they can’t just spend, spend, spend for the rest of their lives,” says Karin McKerahan, a financial planner in Temecula, Calif. Indeed, conspicuous consumption is giving way to a new status symbol: debt freedom.

The most compelling reason for this change in attitude is simple: “It makes no sense to buy $200 worth of groceries and then pay 18 percent on it for six months,” says Jack Reed of Longmont, Colo., who has paid off $12,000 in credit-card debt. Reed now uses cash for most purchases. “The only way to really justify those kinds of interest rates–18, 19, 20 percent–is to have something that is going to be around when you pay it off,” he says.

That’s why consumers are drawing a distinction between unsecured debt like credit cards and secured debt like mortgages. The latter is pretty much unavoidable and is deemed OK. “A home holds value,” says Thomas Stanley, coauthor of The Millionaire Next Door (Longstreet Press, 1996, $22). “You are living there and you are going to get something back out of it.” Stanley says this new legion of debt-free consumers is on the right track, and he draws a lesson from the spending habits of the people he studied for his book. “Millionaires don’t carry debt on things that depreciate,” he says.

Most debtors don’t get snowed under on purpose; many say the debt sneaked up on them. “It’s kind of delusional,” says Anna Christian, a graphic designer in New York City who is paying down $45,000 in debt with the help of a local credit counseling service. “You just feel like you have $5,000 mad money to spend because you have a $5,000 credit-card limit.”

Many debtors cling to an unrealistic view of future income, pinning their hopes on a bonus or raise. “They really believed that when they made these credit-card purchases they would be able to handle them,” says Lauren Locker, a financial planner in Totowa, N.J. “Instead, the debt grew like an insidious cancer.” Typically, a catastrophic event–the death of a spouse, divorce, the loss of a job–was the catalyst for change, provoking the debtor to seek counseling or file for bankruptcy.

Fortunately, many of today’s debt fighters aren’t waiting for disaster to strike. The need to save and invest for retirement–which is nearly impossible when you’re struggling–is prodding many. With the advent of self-directed retirement plans like the 401(k) and a questionable future for Social Security, the onus for financing retirement falls on the individual. “They are looking down the road at spending 30 to 40 years in retirement,” says Pat Jennerjohn, a financial planner in Oakland, Calif. With that realization, having the hottest electronic toy fades in importance.

Despite a vibrant economy, corporate layoffs still have some consumers worried; just last week, Intel decided to cut 3,000 jobs. “I don’t want to be stuck with a credit-card payment if something happens to my job,” says Steve Wallace of Lewisville, Texas, who recently transferred his $4,200 credit-card balance to a card with a lower interest rate to pay if off quickly and more cheaply.

The overwhelming and often unendurable stress that accompanies indebtedness is motivating many to pay off their bills. “It gives one a sense of futility, hopelessness, and despair,” says Jerrold Mundis, author of How to Get Out of Debt, Stay Out of Debt & Live Prosperously (Bantam Books, 1990, $6.99). Debt can be pervasive, subtly infiltrating every facet of life. And it doesn’t just ruin credit records; debt can destroy marriages, families, careers, and self-esteem.

Debt leaves many people distracted and vexed. “I was just miserable worrying about how to pay my bills from month to month,” says Linda Pickens of Greenville, S.C. “I would much rather have peace of mind than a new pair of shoes.” In extreme cases, stress results in depression, embezzlement, even suicide.

On the job, such feelings manifest themselves in lower productivity. About 15 percent of workers have money problems that affect the bottom line, says Prof. Thomas Garman of the Personal Finance Employee Education project at Virginia Tech. “You’re moaning and groaning at the coffee machine about too many debts and money problems,” he says. “You’re wasting time on the phone trying to get a debt-consolidation loan.”

Part of the impetus to shun debt flows from the simple-living movement–the push for an unencumbered life, with the time and resources to do what you please. Debt is its antithesis. “When you are in debt, you lose your freedom,” says Janet Luhrs, editor of Simple Living: The Journal of Voluntary Simplicity, a Seattle newsletter. “You simply can’t be free if you owe a bunch of money, because you have to work whether you like it or not.” A contributing trend is the growing Christian movement to get away from debt on religious grounds (story, Page 70).

A booming stock market provides another catalyst. Debtors who cannot afford to invest find themselves more frustrated than ever at their inability to save. Financial planner Locker says many new clients tell her that if they had put the money they have spent on credit-card debt into the market they would be rich by now. “They are probably right,” she says.

How to get out of credit-card debt is no mystery. Owning up to the problem is the first step. Forget about the amount. Are your debts causing you any level of emotional or psychological discomfort? “If they are, you probably have a ‘debting’ problem,” says Mundis, who suggests adopting the creed of abstinence that guides recovering alcoholics. “If you don’t pay that card off in full each month when that bill comes in, you ought not to use those cards,” he urges.

Beans and rice. The next step is to stop spending or get a supplemental income–or both. Greg Westley of Pompton Lakes, N.J., is a medical editor by day and moonlights as a personal trainer and bartender to delete a $30,000 debt he and his wife incurred for their wedding two years ago. They live frugally–no vacations, no dining out, no new clothes every season. With a baby on the way, Westley is extremely fearful of a debt-laden existence. “Everyone we know has mortgages over $1,500, and they eat peanut butter every day.”

Debtors also need to avoid playing roulette with the cards in their wallets. “The more cards you have, the easier it is to hide your debt,” says author Stanley, who urges debtors to stick with one card. Tracking spending patterns can also lead to obvious places to start cutting back. That’s one of the tips in Surviving Debt: A Guide for Consumers (National Consumer Law Center, $15), a gold mine on topics like how to handle collectors, which debts to pay first, and how collection lawsuits work.

Means to an end. Having an emergency fund to tap in times of crisis can also keep the plastic monster at bay. Many people are so deep in debt they are living beyond their paychecks; if the brakes give out or the furnace goes on the blink, there’s no way to pay except falling back on credit. Most recovering debtors have a simple strategy for starting to build that fund: Stay out of the mall and salt away the savings. “We don’t expose ourselves where we are constantly tempted by the latest gizmo on the shelf,” says David Heitmiller, coauthor of Getting A Life (Viking, 1997, $23.95). That’s a tough lesson to learn when seduction surrounds you and many people see the American dream as having it all. “You have to shut down that little demon in your head that says you are not good enough unless you have all this stuff,” says Jennerjohn.

As a nation of overspenders, Americans have seldom been ones to delay gratification for deeper fulfillment. Olivia Mellan, a money psychotherapist and author of Overcoming Overspending (Walker, 1995, $12.95), suggests embracing a long-term goal, like sending a son or a daughter to a prestigious school. “What would you want the money for if you weren’t wasting it away on gourmet coffee?” she asks. Moreover, doing something that satisfies you, such as volunteering or taking up a creative hobby, can help wean you from overspending.

Phil and Jean Houghton of Colorado Springs became debt free in 1995. That allowed Phil to give up a management job and go back to work in computer systems support, a step he never would have taken had he and Jean been in debt. He didn’t take a pay cut, but he didn’t get much of a raise the next year. (“It didn’t make any difference because I was doing something I enjoyed much more,” says Phil.) Now the Houghtons are finding unexpected advantages to being free of debt. Jean says she and Phil had the “power position” when bargaining with a car salesman because they were paying cash.

Meanwhile, thousands of people have wiped out their debts by filing for bankruptcy, a decision made easier when fewer people frown on it. Creditors, in fact, are concerned about bankruptcy’s lessening stigma and are pushing legislation to tighten the law. Creditors say some people who file for bankruptcy under rules that allow them to wipe the slate clean are able to repay their debts and should be required to do so.

But consumer groups disagree, and they blame card issuers for the increase in bankruptcies. “Issuers should be more discriminating and responsible in their allocation of credit,” says Stephen Brobeck, executive director of the Consumer Federation of America. He suggests that issuers deny credit to anyone whose credit-card debt is already 20 percent of his income. At the same time, Brobeck challenges consumers to rein in their spending. “We need for society to view substantial high-cost, short-term debt as foolish,” says Brobeck.

Extra credit. Creditors don’t think it’s fair to impose arbitrary limits on consumers. “Consumers deserve to have access to credit and should have choice in how they want to use it,” says Jim Chessen, chief economist at the American Bankers Association. “You don’t want to bench the entire football team because one or two players missed curfew.”

Consumer groups also admonish creditors for not being more straightforward with consumers. Carolyn Ramsey of Sumter, S.C., was stunned to learn a couple of years ago, after enrolling in a local personal-finance seminar, that she owed thousands of dollars on multiple credit cards: She simply hadn’t realized that paying the minimums wouldn’t ever get her out of debt. Ramsey, 77, works two part-time jobs to help pay off her debt.

Issuers aren’t sitting on the sidelines; after all, delinquencies and bankruptcies mean less revenue. Many are using credit scoring (right) to identify borrowers at risk before an account goes delinquent and even potential bankrupts. Employers, too, are stepping in to help. Many are setting up financial-wellness programs; some are expanding retirement education to include all facets of personal finance.

That education is key to using credit wisely. And the lesson seems to be sinking in, even among those whose retirement years are decades away. “If we don’t have the money to go out to dinner, we don’t charge it,” says 24-year-old Jason Kaufman of the lifestyle he and his fiancee, Allison Anderson, lead in Portland, Ore. “We have learned to live a step below what we would like to, knowing that the future will be better because of it.”

Snowed under? Dig yourself out

These groups provide free or low-cost help for debtors:

Credit and debt counselors. The National Foundation for Consumer Credit (800-388-2227; www.nfcc.org) oversees 1,400 local Consumer Credit Counseling Service offices, which can set up individual debt-repayment programs.

In the past few years, a number of debt-counseling firms have sprung up. To get advice on how to choose a counselor–including what you are entitled to know about the counselor’s role in assisting both you and your creditors–visit the Federal Trade Commission’s Web site at www.ftc.gov.

Cooperative Extension System educators. More than 100 state universities and nearly 3,150 counties have cooperative extension offices that offer personal-finance education. Many of the offices are rolling out the Money 2000 program, which encourages participants–through meetings, newsletters, and interactive Web sites–to increase savings and/or reduce debt by $2,000 by the end of the year 2000. To find a county extension office, consult the government listings in the phone book.

Debtors Anonymous. Modeled after Alcoholics Anonymous, this group provides a 12-step recovery program for compulsive debtors. For more information and a meeting list, write Debtors Anonymous, PO Box 400, Grand Central Station, New York, NY 10163-0400.

[Photo captions]:

On with the show

Liz Lahm, Lexington, Ky.

Lahm is tired of playing the credit-card game. Being in debt has left her yearning for the funds to expose her sons, 14-year-old Eric (left) and 12-year-old Kevin, to plays, musicals, and concerts at cultural venues like Lexington’s Opera House. “I haven’t spent much on fun things for me and my family,” she says. “It’s been a struggle.”

Waiting for baby

The Westleys, Pompton Lakes, N.J.

Greg and Eileen Westley’s dream is to save enough money for a home and their child’s college education. Their first goal: paying off their wedding bill (from 1996) at $1,100 a month. For Greg, that means working three jobs. “We don’t even use credit cards anymore unless it’s an absolute necessity,” he says. “We squeak by each month, we really do.” That means no vacations–and no meals at fancy restaurants.

Down on the farm

The Birchalls, Moorestown, N.J.

Maisha and Dan Birchall plan to pay off their student-loan and credit-card debt, bid goodbye to New Jersey, and say hello to their dream: a cooperative farm (they’re looking at Oregon or Virginia). They follow a strict budget that, according to their calculations, will let them erase their debt next fall. “We are living on about $10,000 less than I make,” says Dan.

YOUR CREDIT SCORE

The number they won’t let you see

Most consumers know about credit reports. But what can make or break a decision to grant credit is a number you’ll never see–your credit score. When you apply for credit, data from your report are typically fed into a statistical model that spits out a numerical score designed to predict your risk as a borrower. U.S. News explains this closely guarded secret.

Credit scoring was invented by Fair, Isaac & Co., of San Rafael, Calif. Fair, Isaac’s risk scores generally range from 300-950. The higher the score, the safer the borrower.

Checking your report

Credit reports are free to anyone denied credit, insurance, or a job within the past 60 days. Otherwise, they cost $8 in most states. To get a copy, contact:

Equifax (800) 685-1111; http://www.equifax.com

Experian (888) 397-3742; http://www.experian.com

Trans Union (800) 888-4213; http://www.transunion.com

Taking pre-emptive action

If your credit history is spotty, you should try to improve it before you apply for a loan, particularly a mortgage. Fannie Mae’s HomePath Hotline can refer you to a local nonprofit agency in your area that can provide counseling. Visit http://www.homepath.com or call (800) 732-6643.

Settling disputes

Accurate negative entries stay on your credit report for seven years (bankruptcy, 10 years). By law, if you tell a credit bureau in writing that an item is incorrect, it must investigate within 30 days. The Federal Trade Commission’s brochures “Fair Credit Report” and “How to Dispute Credit Report Errors” explain your rights. Visit http://www.ftc.gov or write to: Consumer Response Center, FTC, Washington, DC20580.

What counts most in your score?

1. Previous payment performance. The most predictive factor for credit risk is payment history. How severe is a delinquency? A single 30-day late payment is not as serious as a single 90-day late payment. How recent is the inquiry? A 30-day late payment last month is worse than one three years ago. How frequent are the bad payments? Missing a couple of payments within the past two months is a lot worse than a severe delinquency that occurred several years ago.

2. Outstanding debt. The more debt you carry and the higher the ratio of balances to credit limits, the more risky you are. Credit-card debt, which is unsecured and can easily increase is considered more risky than secured debt such as mortgages and car loans.

3. Age of credit history. The shorter the credit history, the higher the risk. But that can be offset by factors such as low balances and a lack of deliquencies.

4. Inquiries and new accounts. When you apply for credit, the credit grantor pulls your credit report–this is called an “inquiry”. Inquiries mean you are shopping for credit, which is viewed unfavorably. But don’t worry about inquiries for account-monitoring purposes or for prescreened solicitations, which aren’t counted. Any inquiries made by a car dealership in a 14-day period are considered one inquiry; with mortgages, any inquiries made within a 30-day period count as one. Recently obtained credit is viewed more negatively than long-established accounts.

5. Type of credit. A broad range of credit types can be health. It’s not good to have too many credit cards–more than five may bring the score down. But having zero credit cards can also be a minus. And use them normally; you can get points knocked off for never using your credit. People who get finance company loans are riskier than those who don’t, as finance companies are viewed as lenders of last resort.

[Sample credit reports]:

LOW RISK

This credit report is low risk. There are no delinquencies, and

revolving balances are generally low compared with available credit.

The credit history is also well established, and no new accounts

have been opened recently.

SCORE: 750

DateDateCredit Current Current History of

Date Date Credit Current Current History of

Type of loan reported opened limit balance rating delinquency

Bank credit card 3/98 4/90 $8,000 $300 Current

Car loan 3/98 12/95 $15,000 $8,000 Current

Bank credit card 3/98 2/88 $5,000 $0 Current

Bank credit card 2/98 8/92 $7,500 $100 Current

Mortgage 1/98 6/89 $90,000 $75,000 Current

Retail credit card 12/97 2/88 $1,000 $0 Current

Home equity loan 10/97 3/95 $2,500 $0 Paid

Retail credit card 9/96 5/88 $2,000 $0 Current

Inquiries

Date Source

4/98 Bank

2/98 Retail

Public record/Collection items

None

TIP

Paying your bills on time isn’t all that matters. Factors like

excessive use of credit and too many inquiries can lead to denial

of new credit. In this case, even though credit was approved, the

score would have been higher if the report listed fewer inquiries.

AVERAGE/HIGH RISK

This credit report is deemed risky for several reasons. First, the

tax lien is a serious negative factor. Second, the ration of

balances to available credit lines indicates significant risk. The

three 30-day late payments point to a potential risk, given other

factors–the recentness of the late payments and the fact that the

file is thin, which reflects a lack of experience with managing

multiple credit obligations.

SCORE: 610

Date Date Date Credit CurrentCurrentHistory of

Date Date Date Credit Current Current History of

Type of loan reported opened limit balance rating delinquency

Bank credit card 2/98 11/94 $3,000 $2,250 Current Three 30-day

late payments

in the past

year

Personal finance loan 2/98 8/97 $1,000 $800 Current

Retail credit card 12/97 5/90 $1,000 $775 Current

Inquiries

Date Source

None

Public record/Collection items

Date Public Record

4/97 Tax Lien

TIP

A lender must disclose the top four reasons why credit was denied.

In this scenario, the cutoff score 640. The person who scored 750

will be approved for credit; the person who scored 610 will be

denied. The weight given to various factors depends on what else

is in the report.

Sources: Fair, Isaac & Co.; government and financial industry

reports

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