Friday, January 26, 2007

The Debt Crisis of the 21st Century

Debt has become a major issue in the beginning of the 21st century. Today it is the year 2007 and only the past 5 years have I begun noticing that debt is becoming more and more problematic. Bankruptcies filing has been all time high, debt amounts continue to grow every year, and home foreclosures are increasing. Ever year, since 2002 bankruptcy filings continue to break a new record. In 2005, 1.8 million people filed for bankruptcy, setting a new record. I don't know how many people filed for 2006. I wonder how can this happen? America is suppose to be the most educated country in the world, and yet many of us make bad decisions or don't know how to say "no" to these so-called professionals who are trying to sell you something.

1) The Mortgage Industry

When the prices of home plumeted after 2001, many Americans started buying homes. The problem was that many people don't know the different types of mortgages out there and I bet most homeowners today really don't know what kind of mortage they have right now. They think its a fix rate mortgage, but if a mortgage specialist look at it, it may be something else. Do you have fix rate mortgage or adjustable rate mortgage or maybe its an interest-only mortgage? You don't know since they all look the same until you get your next statement that shows a larger mortgage payment than usual. When your mortgage payments start to increase, most people can't afford to pay it. According to, adjustable rate mortgages accounts for 11% of all total outstanding mortgage debt (Sept 6 2006). Over the next 5 years, about one million people could lose their homes through foreclosures. Take a look at this, if you are paying $1500/month on a mortgage and then next month your mortgage payment jumped to $1700/month, will you be able to pay for it? What if it increases again to $1900/month? Most people can't afford an increase in mortgage payment. The best way out is maybe to refinance into a fix-rate mortgage. Refinancing is a difficult task for the lender and you may or may not qualify to refinance with them. Plus, there will be fees involved to refinance. Some lenders include the fee within the loan so that you don't have to pay it upfront. So, if you are going to buy a home, buy a home that you can realistically afford and always get a fix-rate mortgage. That way you can manage your finance better without the need to guess what is your next mortgage payment is going to be.

*UPDATE 2-12-2007* According to Realtytrac Inc, foreclosures has increased by 25% in January 2007 over January 2006. Total number of homes that were foreclosed in January 2007 was 130,511.
*UPDATE 3-13-2007* According to CBS Market Watch, in the 4th quarter of 2006, delinquency rates (people falling behind their mortgage payments) increased from 4.67% to 4.97%. Foreclosure rates (people who are force to close their homes) increased from 3.86% to 4.53%.
*UPDATE 4-29-2008* According to Associate Press, number of US homes facing foreclosure jumped 112% in first quarter over 2007. Nationwide, 649,917 homes received at least one foreclosure-related filing in the first three months of the year, up 112 percent from 306,722 during the same period last year, RealtyTrac said.
*March 15, 2010: CBS "60 Minutes" Author Michael Lewis on Wall St's Delusion

2) Credit cards

The first time I got my credit card was at age 18 and it was a joint account with my brother. I rarely used the credit card except when I needed to buy books and supplies for college. My brother paid for it all and I thank him for that. I knew that if you use a credit card, you have to pay it back. Since I didn't have a job, I didn't use it for anything other than for college expenses. But most people are not like me, and so they spend as much as they can or they max it out. Then when they over did it, they see a huge balance on their credit card and so they opt to pay only the minimum, which is usually less than $50. I believe that credit cards brings the "greed" out of people. We are spending freaks. I'm not going to lie. I like to spend too, but I am able to control myself. If I was out of control, I would be buying plasma tvs, the biggest and loudest speakers there is, and the most powerful computers and consoles to play my video games. So, I think credit card is more of a pyschological problem than a financial problem.

Recently, my state started banking awareness week that teach young adults about money such as budgeting, checking and savings accounts, and being responsible on the use of credit cards. Today, the average balance on credit cards nationwide is around $22,000 and it continues to grow.

3) The Solution

If you are like many other Americans, you probably have debt too. Whether its mortgages, student loans, car loans, or credit cards, there are several ways in which you can pay it off. One option is to create a budget worksheet. That way you an evaluate where all your money is going to and which area you can cut or limit your spending on.

A second option is to consolidate all your debt into one payment. Instead of paying to multiple parties, you now pay one bill to one lender. In most cases, your monthly payment is usually lower. What you should do next is use the savings and add it to your principal. For example, lets say you have a mortgage payment of $900/month and credit card payments of around $500/month. You have about 28 years left on your debt payment. That's $1400/month. When you consolidate them, lets assume your new monthly payment will be $1100/month. You saved $300/month, but now you are in debt for another 30 years. Most banks will stop here and let you figure out what to do with the savings. I only know one company that shows you how to get smart with your money and get out of debt sooner. Note: When you consolidate or refinance, interest rate does not matter. Its the rate at which you pay that matters. The larger the loan and the longer it takes you to pay, the more it cost you to pay.

Third option is to start living below your income. That means, don't spend too much. Whatever income you make, save 10-15% of it. By the time you retire, you will be better off than the rest of the country.

Fourth option is to seek professional help if you are unable to control your spending. Spending above your income means that you are not saving anything for your future. If you want to live a happy life when you retire, you better control your spending habits and start saving.

Fifth option is to pay more than minimum amount. That way you are paying off the principal faster.

Sixth option is to utilize some or all the options above and just do it. Don't wait tommorow, or next week, or next month, when then turn to years and years and years and then you forgot about it.

Seventh option is educate yourself of the products and do research about the company. Read all fine prints before signing any documents.