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Consumer debt seen rising--again

NEW YORK (MarketWatch)--The financial crisis prompted consumers to start paying down their debt, but even with the economy far from recovery, that decline in consumer debt is expected to reverse.

Consumers owed a total of $11.4 trillion in March, down from $12.7 trillion in the third quarter of 2008, according to Federal Reserve data. That figure includes credit cards, auto loans, mortgages and other types of debt. If you divide the current debt load evenly across all U.S. households, that's more than $96,000 per household.

The good news is that credit-card debt fell to $679 billion in the first quarter of 2012 versus $837 billion in the same period in 2008.

"The credit-card issuers have been tightening credit through the recession, making it more expensive and less available," said Cristian deRitis, a director at Moody's Analytics. Plus, consumers aren't borrowing as much, he said.

Still, consumers' debt level is now shrinking at a slower pace and likely will soon start to expand, deRitis said. Credit "will slowly grow through the end of this year and in the next year," he said.

The expansion of credit is positive for the economy in the short term, as consumers spend more, deRitis said, but in the long run, financial sustainability is what matters.

As consumers start tapping into credit again, some financial advisers warn that all debt--even a mortgage loan--is best avoided.

"Just because the society lives that way, it does not mean it is a good way," said Dave Ramsey, a financial counselor and author of several books on personal finance. Debt is "a poison" and there is no such thing as a good debt, he said.

Ramsey's radical philosophy: Nothing should be bought with debt. Instead, consumers should save for items they want to buy, and tame their need for instant gratification.

Ramsey has been debt-free for more than 20 years. He advises people to pay off all of their debt as soon as they can, though he says it usually makes sense to leave the mortgage payoff until last. The mortgage term should not exceed 15 years, and payments should not exceed one quarter of household income, he said.

"The problem with debt is that it increases risk for the people that are involved and it drains their most precious wealth-building tool, which is their income," he said.

Other advisers are less hostile toward debt, but agree that abusing debt is a bad idea.

"Credit cards are the worst kind of debt, because of the high cost," said Charles Buck, a certified financial planner in Woodbury, Minn. Credit-card rates can go as high as 33% if a cardholder doesn't pay on time. Rates rose last year, especially for consumers with low credit scores or no credit history.

Read related story: Credit-card interest rates move higher.

In general, debt is not a good thing, Buck said, but some kinds of debt may make sense. For instance, if buying a house means paying less or the same as renting a similar property, then buying may make sense. Financing the purchase of a first car can be justified, but second and third cars should be purchased in cash, he said.

What about student loans? Total student debt outstanding spiked to $904 billion in the first quarter of 2012 compared with $506 billion in the first quarter of 2007, according to Federal Reserve data. It became the largest form of consumer debt outside of mortgages.

"If you pay for an education, you have to be in a position to pay back what it cost you," Buck said. Even high-ranking universities may leave graduates with few job prospects. For those considering college, Buck noted that a big part of the cost comes from room and board on campus. He said students might consider living with their parents while attending a local community college for freshman year, and then transferring to a university.

Ramsey proposes more austere measures in tackling student debt. He suggests students spend more time working and less time playing. If they spent the same amount of time on the job that they spend watching television and engaging in social activities, he said, they would be able to put themselves through state school without the help of loans.

Many financial advisers say a rule of thumb is that your debt should not exceed about 33% to 38% of income. That includes your mortgage, car loan and consumer credit. Buck suggests to his clients that they not exceed 25% and plan to pay off their debt in total by the time they retire.

"Aside from auto loans and your mortgages, assuming a fixed-rate mortgage, the interest rates on most debt is variable," said Jay Hutchins, a financial adviser with the Wealth Conservatory in Lebanon, N.H. He said that people don't think about variable interest rates as a risk factor, but rates can spike to double digits from current lows. The stability of future income should be taken into a consideration when taking on debt, especially in the current economy with a high level of unemployment.

"We all are going to take emotional and other noneconomic considerations into play when we make decisions about taking on a debt," Hutchins said. As long as your balance sheet can tolerate a specific amount of debt without sending you into bankruptcy, then emotional factors may guide you. For example, a person might justify the cost of a face-lift by considering the benefit of how he would feel looking in the mirror after the medical procedure is done.

Still, Ramsey cautioned consumers against letting their "wants" dictate their financial decisions.

"One definition of maturity is the ability to delay pleasure," Ramsey said. "Adults devise a plan and follow it, and children do what feels good. We've got some 52-year-old children walking around."