America is known for being the largest debtor nation in the history of the world, but consumers are slowly finding a way to deleverage.
Consumers across the country are in less debt than they were earlier this year. According to the Federal Reserve’s latest Household Debt and Credit Report, total outstanding household debt declined $78 billion to $11.15 trillion in the second quarter. That is the lowest level since 2006 and 12 percent below the peak of $12.68 trillion in the third quarter of 2008. A large part of the decline was due to housing-related debt, but Americans are increasing their liabilities in other areas.
“Although overall debt declined in the second quarter, households did increase non-housing debt, led by rising auto loan balances,” said Andrew Haughwout, vice president and research economist at the New York Fed. “Furthermore, households improved their overall delinquency rates for the seventh straight quarter, an encouraging sign going forward.” While total mortgage debt decreased, total auto loan balances rose $20 billion from the previous quarter, representing the ninth consecutive quarterly increase and the biggest jump in seven years. In fact, auto loan debt has climbed $108 billion over the past nine quarters to recapture $800 billion for the first time since 2008.
Consumers also raised their credit card balances by $8 billion to $668 billion in the second quarter. The number of credit inquiries within six months — an indicator of consumer credit demand — was mostly flat. The amount of bills 90 or more days late edged lower to 10 percent.
Additionally, outstanding student loan balances increased to $994 billion as of the end of June — up $8 billion from the end of March. Separate reports already place this amount above $1 trillion. On the positive, the delinquency rate on student loans improved from 11.2 percent to 10.9 percent.
The report confirms the sentiment on Wall Street as auto and credit card stocks have outperformed the market this year. Shares of General Motors (NYSE:GM) and Ford (NYSE:F) have surged 21 percent and 27 percent year-to-date, respectively. Shares of MasterCard (NYSE:MA) and American Express (NYSE:AXP) have gained 26 percent and 30 percent this year, respectively.
Last week, ABC’s “The Lookout” aired my follow-up report about Diana Mey, the woman we first profiled in 2012 who won a $10 million judgment against a debt collection company. Like the original story, it garnered thousands of page views, zooming to the top of ABC’s most viewed list.
I mention this not to pat myself on the back, but because I think the viral nature of the story is a story itself. Clearly, people out there are struggling with debt collectors. In fact, debt collectors remain the No. 1 subject of consumer complaints to the Federal Trade Commission. And not just any collectors. The subset of debt collectors that really riles people up are called “debt buyers.”
Once a bank, credit card company or other lender gives up trying to collect a debt itself, it often sells the account to a debt buyer for a tiny fraction of the amount owed. That debt buyer either tries to collect it or re-sells it to yet another debt buyer — or both. Consequently, consumers are often hounded by the original creditor, that creditor’s hired-gun collectors, the first debt buyer and a string of subsequent ones.
And when a debt buyer purchases a debt, what exactly do they get? Not a fat file full of detailed information about the account. Not at all. They get an electronic file with the bare-bones details: maybe name, account number, amount, date. Using that vague information, they try to collect.
Because their information is incomplete, debt buyers often go after people for debts they’ve already paid. Or they go after the wrong people altogether. God forbid your name is “John Smith” and you live in a densely populated zip code! Consumer complaints about mistaken debtor identity have skyrocketed, according to the FTC.
Worse yet, some citizens have disputed a debt with one company and gotten the matter resolved, only to find that the company sold their debt yet again and didn’t pass along the paperwork showing it wasn’t their debt. So the entire process begins again.
That’s why Consumers Union, the policy arm of Consumer Reports, says reforms are needed to protect consumers:
Require proper documentation. Consumers Union says debt collectors should have to show they are collecting from the right person, for the right amount and on a debt they have a right to collect.
Create “sell by dates.” After seven years, bad debts can no longer be reported on consumers’ credit reports. The group says similarly it should be illegal to try to collect a debt after that same time period. Currently, debt collectors can attempt to collect a debt indefinitely, even if it no longer affects your credit rating.
Require more documentation for lawsuits. Debt buyers often sue consumers to recover debts, a timely, expensive problem if the debt isn’t even yours or you’ve already paid it. That’s why Consumer’s Union wants debt buyers to have to provide information about the debt to the court in order to prove that it’s a legitimate case.
Make courts notify defendants. Debt collectors are notorious for what’s called “gutter service,” where instead of serving a consumer with a lawsuit, they throw the summons “in the gutter.” When the consumer fails to show up in court, the collector automatically wins. Consumers Union says courts need to notify consumers of collection lawsuits themselves to prevent this from happening.
So what should you do if you’re contacted about a debt you don’t owe? Pay it? NO. Ignore it? No again. Here’s a better battle plan:
Write a letter. Send it to the debt collector stating that you do not believe the debt is yours and demanding proof. Send it certified so you have a paper trail. Here are several sample letters created by the Consumer Financial Protection Bureau that get the wording right for you.
Check your credit report. If you are wrongfully pursued by a debt buyer, you should get a copy of your credit report to find out whether the debt buyer has reported the debt to the credit reporting agencies. To obtain your free credit report, go to the FREE website mandated by Congress: www.annualcreditreport.com.
Answer lawsuits. If a debt buyer goes so far as to sue you over a debt you don’t owe, don’t ignore the lawsuit. Instead, be sure to file an answer with the court. You may be able to do this yourself if you can’t afford an attorney. Alternatively, contact the National Association of Consumer Advocates, a group made up of consumers lawyers, for help finding a low- or no-cost attorney.
Two-thirds, that’s right, two-thirds of students graduating from American colleges and universities are graduating with some level of debt. How much? According to The Institute for College Access and Success (TICAS) Project on Student Debt, the average borrower will graduate $26,600 in the red. While we’ve all heard the screaming headlines of graduates with crippling debt of $100,000 or more, this is the case for only about 1% of graduates. That said, one in 10 graduates accumulate more than $40,000.
It’s a negative sum game for both student-borrowers and the economy. According to the Consumer Financial Protection Bureau, student loan debt has reached a new milestone, crossing the $1.2 trillion mark — $1 trillion of that in federal student loan debt.
This pushes student loan debts to dizzying new heights, as they now account for the second highest form of consumer debt behind mortgages. With the federal debt at $16.7 trillion, student loan debts measure at 6% of the overall national debt. This is no small figure, and national debt carries many consequences including slowing economic growth (translating into fewer jobs being created) and rising interest rates. Capital will not be as easy to access.
The majority of student loans are backed by the U.S. government through banks like Sallie Mae, or since 2010, by the Department of Education. Translation: the creditor in this scenario is the U.S. tax payer, who if students default on these loans will be subject to carry the burden of these loans.
Federal Loans are Safer than Private
Lauren Asher, president of TICAS, a nonpartisan policy group, says that government loans are the safest type of loans to take while financing education. “Federal student loans are the best way to borrow if you have to in order to get through.” She identifies a lack of information as a major problem in the debt game as she identifies growing private loan debt as a major problem. “Half of those taking out private loans have not maxed out on federal loans.”
Why the preference for federal loans with federal debt being such a hot topic? “Federal loans are subject to income based payback, fixed interest rates, and take nine months to default on, making them a much safer loan for students to take,” Asher explains. Conversely, private loans have done away with late fees, and in the fine print have redefined the right to claim default on the loan after missing a single payment. Default is a one way ticket to bad credit. “Any ding in credit rating can affect [a borrower] more now than ever, even employment,” says Asher.
Asher argues, however, that higher education “is still the best investment in your future.” The college degree is getting more and more weight as political leaders are calling for upwards of 60% national higher education attainment by 2025. “The demand for higher education is increasing. When the economy is down, more people demand higher education to give an edge in the job market, but have less money to finance it,” explains Asher.
Debt and Community Colleges
If you are under the impression that only four-year schools are subject to debt, think again. Of those students completing an associate’s degree from a community college in 2008, 38% graduated with debt. In the for-profit sector of two-year degrees, over 90% have debt. The average debt load at a public two-year institution is $7,000.
One community college, Henry Ford Community College in Dearborn, Mich., is offering a one-time student debt amnesty program that will allow students who owed a balance prior to or including the winter 2012 semester to afford to return to the college. The program “offers the opportunity for students to pay 50% of what is owed on their account to settle their debt with the College.” Will this become a norm within the two-year degree space as more and more debt is accumulated?
The Cost of Debt
Of this $1.2 trillion in student debt, about $1 trillion is in federal student loans. This figure does not tell the full story, however, as the $1.2 trillion does not include funds students must divert away from retirement savings, parent borrowing, or credit card debt. Asher explains that federal loans are “income based repayment with a standard repayment plan of 10 years. The more you borrow, the more it increases the cost of college and the cost will depend on the type of loan and how you pay it back as well as how much you take.”
President Obama is expected to sign the bipartisan Senate bill to tie federal student loan interest rates to the market this week. On one side, this will reverse the interest rate hike that went into effect on July 1, lowering the current rates for undergraduate students from 6.8 to 3.8%. As the market climbs, however, these rates will climb until they reach a cap of 8.25%. By TICAS calculation, this may cost families $715 million more over the next 10 years.
What does 3.8% interest translate to for students? If we go back to that average figure of $26,600, compounding for interest year over year using the 10-year-payback plan that is the standard, the total cost of your $26,600 loan is about $38,600. Break that down by monthly payments and you are looking at about $320 per month going toward student loan payments. “Debt costs you time in savings, pushes back when and whether you can buy a home, start a family, open a small business or access capital,” says Asher. Not to mention the opportunity cost of the education itself at almost $40,000.
Dealing with the Problem
What can we do? With more and more emphasis being placed on college education for all, raising costs of an already expensive degree, and underemployment of college graduates running rampant, student loan debt is a problem that will cripple economic possibilities and success to come. In its recent report, Aligning the Means and the Ends: How to Improve Federal Student Aid and Increase College Access and Success, TICAS is calling for simplification and better access to information regarding student loan debt, including information on consolidating debt, and increasing students’ information to both school’s default and graduation rates.
One of the problems of debt forgiveness is that it sets a precedent that similar loans in the future will also be forgiven. Although the loans are allocated toward education, money is fungible and will have the net impact of increasing the spending ability of students in other areas of their lives. As the expectation of repayment obligation falls, borrowers may enter into a situation where they take on higher levels of debt and take more risks. This will lead to a weakened ability to repay, creating a vicious cycle that hurts the financial sector and the credit ratings of the borrowers.
I have seen firsthand the effects of this phenomenon that economists call moral hazard. One friend explained to me in my sophomore year that because his student loan money finally came through he was able to put the finishing touches on his beer pong table.