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Credit Card, Household Debt May Be the Next Bubble to Burst: How to Protect Yourself

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Despite talk of an economic recovery, it's time to get off the debt treadmill.

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This is supposed to be good news: The American consumer made a comeback in a big way in April, as demonstrated by figures that show a steep and fairly abrupt spike in the use of revolving credit, mostly credit cards.
 
Federal Reserve figures for April showed a 10.2% surge in borrowing for purchases, after years of declines or modest increases beginning in 2009 with the housing crisis. There's also a dramatic increase in use of the cash-advance option available on credit cards or from checking accounts.
 
Increased consumer spending is the only sure way to create an economic boom, so the news was widely applauded as a sign that the American consumer had regained confidence and was willing to spend freely again.
 
But there's a very good chance that this is not going to end well, for us as individuals or for the economy as a whole. There are several reasons for the surge in credit card use, and none are pretty to look at.
 
First, there is the fact of flat or declining family income for most wage-earning Americans, from the working poor through the affluent upper reaches of the middle class. As Peter Atwater, an expert in the credit industry, wrote here recently, "revolving credit has now become non-discretionary, the only way to close the gap between stagnant incomes and rising food and gas prices."

Second, there's the inevitability, for many American families, of large outstanding bills that are not tied to credit card spending. College loans for younger parents and for their children. Car loans, to get both parents to work and home again. Emergency loans, because they can't possibly save enough to meet an unexpected event.
 
But there's a third factor that is going to keep all but the richest on the treadmill, and that is the upward surge in interest rates for unsecured consumer credit. At a time when banks are borrowing money at near-zero-percent interest, they are lending it to consumers at an average annual percentage rate of 15.61%, according to Bank Rate Monitor.
 
Even that figure is deceptively low. The average interest rate for customers with "fair" credit hit 21% in April, up 2.12 percent from just one year earlier, according to the industry group CardHub. People with "good" credit paid an average 17.35%, and people with "excellent" credit paid 12.86%.
 
Cash advances are even worse as they come with an upfront fee, now an average $12.31 -- an increase of 10% in one year.
 
If you're familiar with the credit card industry's definition of "excellent," you know that the best way to get that top rating is to take on a lot of debt and pay it back slowly. Pay the minimum due, let the interest pile up, keep spending at a steady pace.

As a financial game plan, this is great for the banks, and lousy for their customers. The only way out of the trap is to strive to fail the excellence test, as defined by the lenders. Suggested steps:

  • Spend less
  • Pay cash
  • Postpone big purchases until you can afford them
  • Pay more than the minimum due until your credit card balance is gone
This may seem too simplistic for sophisticated consumers, but maybe most of us aren't as slick as we thought, or at least we aren't as slick as the people who are persuading us to buy more and more stuff.
 
In an article for The Guardian, economist Dimitri Papadimitriou argues that American household debt could become the next balloon to burst. He believes that 90% of Americans -- that is, almost everyone but the very richest -- are steadily acquiring more debt than they can handle.
 
Barring policy changes, his doomsday scenario occurs around 2017.
 
Stay on Top of Household Debt

There is no easy financial game plan for us, as consumers, but there are a few effective ways to free yourself over time from the treadmill of consumer debt.
 
  • Stay informed. Your credit card statement includes a required Minimum Payment Warning that tells you how long it will take you to pay off your present balance, and how much it will cost you in interest, if you pay only the minimum each month. It also indicates how much you would save if you paid a bit more each month. This information can be highly motivating. You may even be motivated to tap into savings, cash in some stocks, do whatever it takes to get the debt under control.
  • Take advantage of those bank teaser offers to switch your debt to another bank with a low introductory rate, but make sure to pay off the balance or switch banks again before the higher rate kicks in. Introductory rates last for about 10 months. They are offered because most people fail to switch in time. Also watch out for fees for transferring to the new card issuer.
  • Be wary of any offers to help you out of debt, by mail, by phone, or online. There are scams on top of scams out there. You think payday loans are a scam? There are identity theft operations that get their leads from people who search online for payday loans, or for debt relief.
If you're in too deep for these steps to be plausible, check the Federal Trade Commission's consumer site for trustworthy information on coping with unmanageable debt.
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