Written by Liz Weston
March 28, 2011 in Credit
Consumers Need to Limit Debt Because Creditors Won’t Do It For You Adapted from The 10 Commandments of Money by Liz Weston Compared to previous generations, we have a lot more debt—and a lot more trouble paying that debt. By every measure, from household debt…
Consumers Need to Limit Debt Because Creditors Won’t Do It For You
Adapted from The 10 Commandments of Money by Liz Weston
Compared to previous generations, we have a lot more debt
—and a lot more trouble paying that debt. By every measure, from household debt loads to bankruptcy rates
, debt is a much bigger problem than in the past.
You might be tempted to conclude that earlier generations were better able to handle temptation or had higher moral standards about repaying the debt they accumulated.
But the reality is that until recently, people had far fewer opportunities to get into serious debt than those in previous generations.
Credit card issuers were emboldened by two developments:
The FICO credit scoring system
, which allowed lenders to better predict the risk that a borrower would default—and to change their interest rates and terms based on those risks.
Loan securitization, where issuers began packaging up debt into securities that could be sold, shifting the risk of losses from the issuing bank to investors.
As a result, credit card issuers began offering cards to more and more people, including those with more troubled credit histories.
A similar loosening of standards occurred with other forms of debt including auto loans
, where negative equity lending became prevalent, and home loans. Instead of the thirty-year, fixed-rate loan that was standard until the 1980s, borrowers could choose adjustable-rate loans, hybrid loans (fixed for a few years before becoming variable), interest-only loans and loans with variable payments that sometimes didn’t cover all the interest
owed, let alone touch the principal (often called “option ARMs” or “pick-a-pay” mortgages).
Lenders’ excesses came back to haunt them, of course. Defaults and foreclosures started to climb. Insurance contracts and investment derivatives based on these faulty loans caused Wall Street firms to suffer massive losses, requiring bailouts, takeovers and bankruptcy filings.
Our economy edged away from the brink, and lenders trimmed their sails considerably. Lenders’ caution is likely to persist—at least until the next boom.
But even now, it’s still easy to get in over your head, particularly if you have good credit. Negative-equity auto loans are still abundant. Credit card issuers continue to brawl over prime customers, and you can qualify for multiple credit cards with limits that exceed your annual income. You can buy a home with as little as 3.5 percent down with no requirement that you have any other savings once the deal closes.
So the moral of this story is that we as individuals need to put our own limits on how much we borrow. Unlike previous generations, we can’t count on lenders to set those limits for us.
Liz Weston is the most-read personal finance columnist on the Internet, according to Nielsen//NetRatings. She’s an award-winning, nationally-syndicated personal finance columnist who can make the most complex money topics understandable to the average reader.
The New York Times called her latest book, “The 10 Commandments of Money: Survive and Thrive in the New Economy,” a “wonderful basic personal finance book…[with] enough counterintuitive ideas to keep even people who know a bit about personal finance reading further.” Her earlier book, “Your Credit Score: Your Money and What’s at Stake; How to Improve the 3-Digit Number that Shapes Your Financial Future,” is a national best-seller and was recently published in a third edition.
Liz’s columns run twice a week on MSN Money while her question-and-answer column “Money Talk” appears in newspapers throughout the country, including the Los Angeles Times, the Palm Beach Post, the Portland Oregonian, Stars & Stripes and others.
She also writes a money column, “My Two Cents,” for AARP the Magazine, the largest-circulation magazine in the world with 22 million subscribers.
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