How Do Clients Manage To Get into Serious Debt?

Big numbers can get scary. As of 2Q24, Americans owe $1.142 trillion dollars in credit card debt. (1) As an FYI, New Jersey residents top the list at $8,909, using 4Q23 numbers. The news is better if your client doesn’t live in Jersey. The nationwide average is $6,864. With the average credit card interest rate (as of 8/19/24) at 27.62%, (2) it is not surprising many people have dug themselves into a hole. How did they get there?

Let us not forget Home Equity lines of Credit (HELOC). Unlocking the equity in your home seems like a “no brainer” but clients need to remember lenders expect to be paid back. According to Lending Tree.com, there is about $380 billion in outstanding home equity loan debt. The average HELOC value is $42,139. (3) The average HELOC rate is 9.37%. (4)

The 1980 song “Once in a Lifetime” by the Talking Heads asked several questions “And you may find yourself…” which was eventually followed by “Well, you may ask yourself “How did I get here?” (5)

If the average American household has $104,215 of debt (3) how did they get to the point of owing so much?

Financing your lifestyle on cash flow. Are you a fan of “The Gilded Age” series on HBO? Back in the 1880s, very wealthy people used money as raw material to make more money. They bought luxury goods from surplus wealth. Today, many people buy cars and luxury good, finance them on credit and make monthly payments. If the interest rate is variable, they get into trouble as rates go up.
You are what you drive. The average price of a new car is about $48,000. (6) Auto loans account for 9.1% of household debt. (7) New car loan rates are about 6.73% (8) in 1Q24. About 80% of new car purchases involved financing. (9) Car loans are another component of overhead expenses.
Keeping up with the Jones’s. Some people do home improvements because their neighbors keep talking about it. They add an extension. They renovate their kitchen or bathrooms. Renovations are often financed through their HELOC.
Assuming the good times will last forever. People are generally more comfortable spending when they see the stock market rising and their portfolio value increasing month after month. They might borrow against their equity portfolio, creating a margin debit. They don’t realize profits are only “on paper” until they are realized.
Thinking a big score or big bonus will pay down the debt. Some hope they will make a killing in the stock market or get a large annual bonus. They run up debt, assuming it will be paid down in January when they get their bonus at work. The bonus is often based on how well the company has done that year. If the firm had a difficult time, bonuses will be smaller.
Unrealistic expectations about real estate. People have forgotten about “the Great Recession” and the problems the real estate market had in 2007-2009 when the housing bubble burst. (10) Some clients think buying real estate is a “one way bet” with no downside. They can overpay.
Making minimum payments instead of paying off credit cards. When money gets tight, people often service their short term debt instead of paying it off. If the interest rate is about 27%, this can get very expensive. The rule of 72 teaches us how long it takes for compounded interest to double the underling amount. 27% divided into 72 means the debt would double in about 2.66 years.
Taking the “trip of a lifetime” every year. Advertising encourages people to “go for it” and “treat yourself well.” The luxury and ultra luxury segments of the cruise market are a good example. You can find yourself paying $500 to $1,000 per person per night. On a ten night cruise, the cost cane be substantial.

Let us get back to the basic question. How did your client get so deeply into debt? Often it comes down to letting overhead expenses get out of control. If everything is financed and debt is carried over from month to month, it is expensive for them to maintain their lifestyle. Their debt keeps growing. Recognizing there is a problem then embracing financial planning and budgeting, are ways financial professionals can add value to the relationship.

How Do Clients Manage To Get into Serious Debt?

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How Do Clients Manage To Get into Serious Debt?

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