Thursday, February 5, 2009

Consumer Debt Trends

Consumer debt in this country has been on the rise since the 1980's. And, it's no coincidence that this was the beginning of the rapid expansion of credit card use in America. Banks and credit card companies figured out ways to harness the marketing power of direct mail and other forms of mass media to begin promoting their low rate credit cards and create demand.

This era also saw the beginning of the shift of consumer spending from cash and check to credit cards. Just within the last year, according to the Federal Reserve, use of plastic for payments surpassed that of cash and check.

Debit card usage, both bank-issued debit cards and prepaid debit cards, has exploded in recent years. This growth has even eclipsed the growth rates of credit cards. This phenomenon is being driven by two factors. One is the convenience offered by debit cards over writing checks or using cash from an ATM. The other is a backlash to the fear of getting into too much credit card debt.

And, this fear is probably well justified, since a majority of Americans carry substantial credit card debt from month to month. In fact, the average American household has over $9,000 in credit card debt. In order to reduce credit card debt or to become debt free, Americans need to fundamentally change the way they view and use credit cards.

As with debit cards, most people think they are spending their own money when they pull out a credit card for a purchase. But, in reality, they are borrowing money for a short term in order to make that purchase. They should almost think of the process in terms of turning to the person behind them in line and asking to borrow the money.

Using any form of payment other than cash creates a type of psychological barrier to the actual sacrifice needed to make a purchase. This is why many financial experts recommend that people in extreme credit card debt stop using plastic altogether, or at least until they can eliminate credit card debt and become debt free.

Listed below is a graph which illustrates the overall trend in U.S. consumer debt as a percentage of disposable income over the past five years. While consumer debt has increased dramatically over the past decade, the level of debt service has decreased. This indicates that, on average, Americans are paying down less of their credit card debt since 2002 than in previous years.

Consumer debt is only projected to continue rising, unfortunately. This trend is being reflected in the U.S. savings rates, which have become negative for the first time in our nation's history.

To become debt free consumers should stop adding to credit card debt and seek to lower the cost of borrowed funds. A balance transfer to a 0% APR credit card can be a good start, but only if the free interest period is utilized to pay down the outstanding principal.

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