With rising rates, it's wise to reduce your debt


May 23, 1994|By JANE BRYANT QUINN | JANE BRYANT QUINN,Washington Post Writers Group

NEW YORK -- Ever since the collapse of high inflation, consumers have known that it no longer pays to go into debt. There's no pressure to buy before prices go up. And your wages might not rise enough to reduce the pressure of high monthly payments. If you're on your company's layoff list, high debt endangers the very security that you've been working toward.

But like any other addiction, a debt habit seems difficult to give up.

During past recessions, safety-minded consumers have hastened to lower their borrowings. In the double downturns of 1980-1982, for example, total mortgages and installment loans dropped to 56 percent of disposable income, from 60 percent before the unpleasantness began.

But in the last recession, consumer indebtedness merely leveled off -- and now it's charging up again.

Total mortgage and installment loans have risen to a record 78 percent of disposable income -- 79 percent if you count auto leases, which are replacing auto loans -- and people don't seem the least concerned.

It's a thumb in the eye of the experts who said the aging boomer generation was finally going to slow its spending and start to save. Savings rates continue to hover around their historical 4 percent lows.

As consumers see it, however, their debt burden is lighter even though their total debts remain the same. That's because monthly payments are lower, mostly due to the sharp slide in interest rates. At its 1990 peak, 18.5 percent of consumers' disposable income was pledged to carry their mortgage and installment debt. By early 1993 (the most recent data), that burden had dropped to 16 percent of disposable income.

That's still on the high side. The historical norm for monthly payments is around 15 percent of income. Nevertheless, the drop was enough to make everyone breathe easier.

But because the size of the debt itself didn't decline, consumer spending is vulnerable to the interest rate increases currently coursing through the system.

Your mortgage payment will stay the same if you refinanced it at a low fixed rate. But payments will rise on adjustable-rate mortgages, as well as on many home-equity loans. New car loans will cost more (although higher rates haven't bitten yet).

Rates will also be rising on variable-rate credit cards -- which tend to be those that currently charge up to 16 percent on unpaid balances.

The rate increases, engineered by the Federal Reserve, are meant to slow the 7 percent growth rate experienced by the economy late last year -- a rate greatly encouraged by the boom in consumer debt. That pace was a prelude to inflation. In this year's first quarter, by contrast, growth ran at around 3 percent, which the Fed thinks can be noninflationary.

Interest-rate moves like these were called "fine tuning" back in the days when people thought that economists knew what they were doing.

In the lives of consumers, higher rates are expected to moderate home sales and nick the new-car bubble. But will they really? Kurt Karl of the WEFA Group in Bala Cynwyd, Pa., thinks consumer spending won't slow by much. Jobs and incomes are on the rise, he says, and there's already room in the average budget for additional monthly payments.

But Laurence Lindsey, a member of the Federal Reserve Board, sees troubling trends beneath the surface. Neither the affluent nor the elderly carry much debt, Lindsey points out. Adjusting for this, he finds that the average household is spending 23 percent of its disposable income on monthly debt payments -- well above the historical norm.

Americans of all ages are saving less. So you can't blame low savings and high debt entirely on the baby boom generation. More likely, these trends result from the flattening of real incomes that has been under way since the early 1970s. In order to raise their standard of living, Americans still have to spend almost everything they earn. And they continue to borrow from the future.

Holders of adjustable-rate mortgages might see sharp jumps in their payments this summer (mortgages pegged to Treasuries typically adjust to the rate prevailing 45 days before the loan's anniversary date). On the rest of your loans, your payment increases may be small.

Still, any increase in interest rates should remind you of the high risk in high levels of debt. The best thing you can do for yourself today is to lower your debt and not take on more.

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