evile

Jun. 29, 2004

http://montages.blogspot.com/2004/06/prisoners-of-subprime-american-
dream_28.html

Monday, June 28, 2004
Prisoners of the Subprime American Dream, Cont'd

When the Federal Reserve raises interest rates, the gap between
poorer debtor and richer creditor classes, so far hidden under a pile
of cheap credit, will widen and become painfully visible:

By several measures, Americans are more indebted than ever. Through
the first quarter, they owed nearly $9 trillion in home mortgages,
car loans, credit card debt, home equity loans and other forms of
personal borrowing - accumulating nearly 40 percent of this total in
just four years, according to published Federal Reserve data. But
most of the debt is at fixed interest rates. Thus it will be
unaffected initially as the central bank begins its much expected
quarter-point increases in the so-called federal funds rate, now at a
46-year low of 1 percent. The federal funds rate, in turn, influences
the interest rate cost of most household and commercial debt.

Only one-fifth of the $9 trillion in total household debt, or $1.8
trillion, is borrowed at variable rates. Variable rates . . . often
track what the Fed does, which means they are likely to rise one-
quarter of a percentage point over the next few weeks. The immediate
cost for the nation's households as a result of this process could be
as much as $4.5 billion. . . .

The $4.5 billion is roughly 10 percent of the cost of the rise in oil
prices so far this year. That is not a big number yet, but each
quarter-point increase would be another step closer to matching the
oil shock, which brought gasoline prices above $2 a gallon in many
parts of the country.

While the oil shock quickly raised the gasoline and heating oil bills
of nearly every household, the burden of higher interest payments
falls most heavily in the early stages on lower- and middle-income
families. They are the biggest users of variable rate debt,
particularly on credit cards, various studies show.

Upper income families, on the other hand -- that is, families with
more than $80,000 in annual income -- are more likely to have fixed
rate debt, particularly mortgages, and to owe relatively little on
their credit cards. What variable rate debt they do have is usually
at lower interest rates than lower income people. Lower income
people, as a result, are 10 times more likely than upper income
people to be devoting 40 percent or more of their income to debt
repayment, the Economic Policy Institute reports. In addition, upper
income people are the nation's biggest savers, and a rate increase
raises the return on their interest-bearing securities.

"If you are a household with a lot of variable-rate debt and little
equity left in your home that you have not already borrowed against,
this is going to be a scary time," said Mark Zandi, who is the chief
economist at Economy.com. . . .

Another notch up in home prices would give . . . some relief; they
could float a 4 to 5 percent home equity loan against the additional
value of their home and use the loan to pay down credit card debt.
Tens of millions of Americans have used this route to lower the
interest cost of credit card debt. With homes appreciating more
slowly, there is less collateral left to support home equity loans,
and paying the outstanding balances will become more costly. They
totaled $375 billion at the end of last year. Home prices are a big
potential casualty of rising interest rates. Sales of new and
existing homes surged in May, the government reported, as people
apparently rushed to become homeowners before mortgage rates went any
higher. The average 30-year mortgage is already up a percentage point
since early spring.

But for Stephen Black, a homebuilder here, the surge in home sales is
a false signal. The customer base is already shrinking for his basic
product, a two-story house with four bedrooms and a two-car garage on
nearly a quarter-acre, a home currently priced at $215,000.

The buyers were families with $50,000 to $70,000 in annual income.
Now they are increasingly bunched at the high end. The low end is
pulling back partly because mortgages are more costly . . .

Across town, in a rundown neighborhood, the working poor are just
starting to show up in greater numbers at Tabor Community Services, a
Lancaster agency that counsels those deeply in debt, said Michael
Weaver, president of Tabor.

The "fragile low income," as Mr. Weaver calls them, do not tend to
own homes, but those who do buy them through subprime mortgage loans,
in many cases with adjustable rates. Apart from housing, nearly every
transaction for these consumers involves interest payments in one
form or another. Lacking enough income, they rent television sets,
furniture and appliances, signing agreements that can adjust upward
as interest rates rise.

Like their higher income peers, Mr. Weaver's clients often take loans
to buy car, in their case, used cars. But they are loans of shorter
duration and higher interest rates than the standard four- or five-
year new car loan, now averaging 7.4 percent. They have credit cards,
but at rates above 15 percent, which convert into much higher
penalties when monthly payments are late.

"These are people who are maxed out on debt," Mr. Weaver said, "and
their numbers are growing." (Louis Uchitelle, "Families, Deep in
Debt, Facing Pain of Growing Interest Rates," New York Times, June
28, 2004)