Drowning in Debt?
Americans' love affair with plastic may have a messy ending if interest rates rise
By Paul J. Lim
Like millions of Americans, Cathy and Scott Gabrielsen got used to a certain standard of living in
the late 1990s, when times were flush and their Internet stocks were going gangbusters.
So when times toughened as the stock market bubble burst at the start of this decade, the couple
took a risk: They chose not to cut back. "The truth is, nobody wants to sacrifice their lifestyle,"
says Cathy, 34.
Despite steep losses in their portfolio, the Gabrielsens continued to upsize during the bear
market. The couple--parents of two boys, now ages 5 and 3--bought a 4,000-square-foot house in
West Chester, Pa., near Philadelphia. That's double the size of their previous home. Then they
had to furnish all that empty space.
They also upgraded their cars--Cathy, who works part time in sales, went from a Ford Bronco to a
Volvo station wagon, while Scott, 40, a commercial real-estate broker, moved from a 5 Series
BMW to a pricier 7 Series.
Eventually, the expenses led to something else that was new: debt, including credit card
balances. "It wasn't like hundreds of thousands of dollars," says Cathy. "But when it gets to be
$10,000 or $15,000, you start to get concerned."
The Gabrielsens aren't alone in their concern. Consumers and economists alike are looking over
their shoulders at a growing American mountain of debt. Just how worried should most families
be about what they owe? At the very least, economists fear that the indebtedness of the all-
important consumer threatens U.S. economic growth, already slowed by record-high oil prices.
Household finances, like the economy, tend to run in cycles. Usually, when times are good,
families assume things will be good forever, so they spend more and save less. When times get
tough--as they did in the mid-'70s, early '80s, and early '90s--consumers tighten their belts,
saving more and borrowing less.
Belt loosening . But in the most recent downturn, starting with the bear market of 2000 and the
recession of 2001, belts didn't get tightened. In fact, they were loosened.
Household debt rose from 96 percent of personal disposable income (consumers' take-home,
spendable cash) in 2000 to 111 percent in 2003 to 113 percent at the end of 2004." Just the fact
that it's growing isn't necessarily a problem," says Scott Fullwiler, an economics professor at
Wartburg College in Waverly, Iowa. "My concern is that as a percentage of disposable income,
it's at an all-time high."
At the same time, the savings rate--that's savings (not including home equity or investment gains)
as a percentage of disposable income--has plummeted. It fell to 0.6 percent in May, down from as
high as 3.4 percent in 2001 and 7.9 percent in the early 1990s.
Americans are saving less partly because they are spending more, often because it has been so
cheap to borrow money to do so.
As the Federal Reserve Board scrambled to pump life back into the economy at the start of this
decade, interest rates tumbled to historic lows. Borrowing to buy cars, furniture, and homes
became a bargain.
But, as always, there comes a time of reckoning. Consumer debt of all sorts--from home
mortgages to credit card balances--has shot up. In 2000, average household credit card balances
stood at $7,842, according to Cardweb.com. That figure rose to $8,940 by 2002 and $9,312 last
year. "There is an explosion in household debt taking place, and it's a serious problem," says
Robert Parks, an economist and finance professor at Pace University's Lubin School of Business.
Chris Viale, chief executive of Cambridge Credit Counseling, says, "Americans are in big trouble
right now." He notes that 1 in 4 households is either behind on card payments or over the credit
limit on at least one account.
Yet other evidence, both statistical and anecdotal, suggests the picture is much more mixed.
Yes, it's true that households continue to charge up a storm on plastic. But credit card
delinquency rates are actually lower today than they were in 2000.
Thanks to still-low interest rates, it doesn't cost Americans as much to finance debt as it did in the
1990s. In 2001, for example, debt payments represented only 18.3 percent of disposable income.
Today, the percentage has barely budged, to 18.45.
Even though the savings rate is down, the total dollar amount of savings in deposit accounts has
actually grown more than 50 percent to $4.4 trillion since 1999.
Rising assets. That, plus the increased value of real-estate holdings, helps explain why
household net worth is thriving as debt is growing. According to the Fed, the net worth of
households and nonprofit organizations grew 8.2 percent over the past year and more than 15
percent since 1999, before the bear market in stocks launched an assault on assets.
"I'm not too concerned about the increase in household debt," says James Sullivan, an
economics professor at the University of Notre Dame. "Now, if we saw net worth falling, too, then
that would be a different story."
The fact is, many families are building income and assets at the same time that they're dealing
Take the Gabrielsens. While continuing to spend, they've also kept maxing out contributions to
Scott's employer-sponsored retirement plan. And they're putting money away for their children's
To help pay down debt, Cathy, once a stay-at-home mom, recently started selling health- and
skin-care products. The job is already adding roughly $4,000 a month to the family's income.
Meanwhile, the couple has invested in a small business, a restaurant and bar in nearby
Conshohocken, Pa. The equity in both the business and their home means the Gabrielsens are
worth more now than ever--they just have more liabilities than ever, too.
Frederick Spann is another example of credit card debt leavened by home equity. The 41-year-
old pharmacy technician from Pontiac, Mich., has amassed roughly $30,000 in debt spread out
over eight cards. The culprits: vacations, jewelry, and especially shoes, over 600 pairs housed in
a custom-built, cedar-lined closet in the basement of Spann's home. "It's so easy to buy a pair of
$300 shoes when you have plastic," he laments.
Spann says he does not feel he has a handle on his finances. Yet he may not be in as bad
financial shape as some might think. He chose an interest-saving 15-year mortgage and has only
about $6,000 remaining on it. While Spann is hesitant to take out a home equity loan to pay off
his cards--because he says he is so close to becoming the first member of his family to own a
home outright--doing so would lower his bills.
Though Americans' debt pile may be manageable while interest rates stay low, could consumers
cope if rates rose? Some rates have been increasing since the Fed started tightening monetary
policy in June 2004. In fact, the average credit card interest rate is nearing 17 percent, up from
15.7 percent in the past year. In the hottest housing markets, adjustable-rate loans account for
over half of all new mortgages, according to Merrill Lynch. Millions could face higher monthly
housing payments as rates rise, says Bert Whitehead, president of Cambridge Connection, a
financial planning firm in Franklin, Mich.
Households have to worry about inflation, too, says Cheryl Burbano, a planner with American
Express Financial Advisors near Tampa."You're seeing key expenses rising, whether it's gasoline
prices or the cost of health insurance," she says.
Of course, for individual households, the final debt blow may come out of the blue, as it did for
Tracy Moore. As this decade began, the 37-year-old Southfield, Mich., resident had more than
$20,000 in credit card debt but was unfazed. Then, shortly after the Sept. 11, 2001, terrorist
attacks, Moore was laid off from her job as an event planner for an advertising firm. Within about
a year, her credit card debt had ballooned to $40,000, and she had no choice but to file for
"When you're forced to live without a credit card, you understand what it means to live beyond
your means," says Moore. "But I'm an intelligent person. There's no reason I shouldn't have
understood what it meant a long time ago."
Yes, credit card debt has soared. But not all signs are dire: Delinquency rates have dropped, and
Americans' net worth has grown substantially.