Money & Happiness - The Growing Income-Expense Gap

Laura Rowley

Consumer prices fell half a percent in September, the Labor Department reported Wednesday. But leaving out food, and the significant drop in energy costs, the so-called "core rate" of inflation rose 0.2 percent.

That's the third consecutive monthly rise for core inflation, which is running at its fastest rate in 10 years. Costs for housing, medical care, and clothing all showed a significant jump.

The Credit Bubble

With the cost of housing, health care, and other necessities rising, Americans are relying more and more on debt to cover basic expenses.

In the second quarter of this year, consumers spent a record $14.40 of every $100 they took home after taxes to cover required principal and interest payments on mortgage and consumer debt, according to the Federal Reserve. The figure rises to $18.06 of every $100 of take-home pay if you include automobile lease payments, homeowners insurance, property tax payments, and rental payments on tenant-occupied property.

And there is more troubling evidence of our credit-driven lifestyle: Some 2.33 percent of mortgages were delinquent at the end of the third quarter, the highest level since 2003, according to Equifax and Moody's

The worrisome part of that figure? Most of the delinquencies were not related to job loss -- the usual suspect when people fall behind on their payments. The vast majority were related to what calls "mortgage equity withdrawal," which gauges how much cash homeowners have extracted from their dwellings through refinancing, home-equity loans, or selling and keeping some of the profits.

No Shelter from High Utility Costs

More and more, shelter is straining our budgets: 35 percent of homeowners with a mortgage were paying 30 percent or more of their gross incomes for housing -- up 26.6 percent in 2000, according to a recent Census Bureau report.

This is due largely to soaring home values; the median rose by 32 percent between 2000 and 2005, the report found. (In markets such as Los Angeles and New York, prices rocketed 110.2 percent and 79.1 percent, respectively.)

Meanwhile, that strain will likely grow for homeowners with adjustable-rate mortgages. This year, interest rates are expected to reset on an estimated $400 billion worth of adjustable loans, and $1 trillion worth in 2007, according to the research firm Loan Performance.

Utilities are also on the rise, according to a New York Times report. A decade after electricity was deregulated, a competitive market has not emerged, and state controls put in place to protect consumers will expire shortly. The Federal Energy Regulatory Commission warned Congress that "customers may experience rate shock."

Another growing pocket of debt is installment borrowing -- typically, loans for autos and college expenses. According to the Federal Reserve, 46 percent of families had such debt, and the median amount owed on such loans grew by 11.7 percent between 2001 and 2004.

Unhealthy Credit Habits

And then there are spiraling health-care costs. Between 2000 and 2005, workers' health insurance premiums rose 84 percent, while their wages increased 20 percent and inflation climbed to 18 percent, according to a Kaiser Foundation study.

As costs have soared, so have the number of Americans under age 65 with no health insurance: about 46 million in 2005, up from 40 million in 2000, the Census Bureau reports.

Another New York Times article recently focused on the growth in medical tourism -- uninsured patients going abroad to get medical and dental treatment for 20 to 80 percent less than in the United States, including travel costs. I just paid $800 to cap a molar, so Costa Rica is looking more enticing.

How did I pay for my tooth? With a credit card, which I'll pay off in full at the end of the month. Unfortunately, that's not the norm: Nearly two-thirds of consumers carry a balance and pay finance charges each month -- a level that hasn't been seen since the 1990s, according to the Wall Street Journal. The average debt per cardholder is about $5,000, and interest rates on cards have been rising, according to the trade publication Nilson Report.

This expense creep, combined with higher payments to debt service, can make it impossible to squirrel away money for the future. Wages have stagnated for most workers -- the Census Bureau reported that median household income rose just 1.1 percent in 2005 -- the first rise since 1999. Consumer debt is growing three times faster than net wealth accumulation, according to Robert Manning, author of Credit Card Nation: The Consequences of America's Addiction to Credit.

What to Do?

Here are some suggestions for heading off credit-related disaster:

  • Stem the bleeding by tracking exactly where your cash is going

    I've toyed with budgeting software in the past, but found it too time-consuming. This year, I subscribed to an online program called Mvelopes Personal to help analyze our spending; I've found it to be a faster, simpler method than other software.

  • Minimize installment debt

    Don't take out a 72-month auto loan on a brand-spanking-new car; opt for a certified pre-owned vehicle at half the price and pay it off over 48 months or less. (Or better yet, pay cash. When our '95 minivan finally died this summer, we replaced it with a well-maintained '96.)

  • Pay off your credit cards in full

    Make a list of your creditors, the amount owed, and the annual percentage rate on each card -- ranking them from greatest to smallest APR. Direct extra cash toward the highest-rate card until it's paid off. Then shift the amount you were funneling toward the first card to the next on the list, working your way down.

  • Make retirement savings a priority by joining your employer-sponsored plan or opening an individual retirement account

    You can open an IRA with just $100 at financial services firm TIAA-CREF, as long as you invest at least that amount every month.

  • Do a realistic ballpark estimate of what college will cost for your child

    For help, visit Savingfor or the College Saving Palns Network. At minimum, take the amount you plan to spend on a child's birthday party and gifts and holiday presents, cut it in half, and put that in a 529 plan each year. Ask grandparents to do the same.

Most important, spend consciously. Start by changing just one financial habit this month. For example, when fuel prices fell sharply in September, many consumers took what they saved at the pump and blew it at the mall -- boosting retail sales to their strongest showing since January.

Don't follow the pack. Do some quick calculations on how often you fill up the tank, and figure out how much you're saving on gas from its summer peak. Then dedicate that amount to cut credit card debt or boost emergency savings. The path out of of the credit trap, and the road to genuine wealth, starts with one step.

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