By: Roshawn Watson
Forcibly Curtailing Our Debt
In an effort to mitigate losses, lenders are concertedly diminishing consumers’ abilities to borrow (lowering credit limits and imposing stricter credit worthiness criteria). After banks began coming under fire for reckless lending practices and suffering tremendous losses, banks issuing credit cards have finally began to more responsibly evaluate consumers ability to pay back loans. Other lenders have also done the same. Accordingly, mortgages and student loans are becoming increasingly more difficult to obtain.
Flawed Thinking Is How We Got Here
The increased media coverage on the U.S. economy has caused many people to ask "how did we get to this point?" Although its convenient to lay the entire blame for the current state of the US economy at the feet of irresponsible and greedy lenders, the truth is there is shared blame for the current credit crunch.
At some point, we have all had flawed thinking when it comes to money. I remember my own idiotic views about “smart” credit card spending years ago. Fortunately, someone called me on my blatant ignorance before I could do too much damage although it did take me months to clean up the mess I created.
Like me, millions of Americans simply thought about money incorrectly. We we borrowed our way into financial bondage because somehow we got it in our heads that we were suppose to have things we couldn't yet afford. “After all, we worked hard and have earned it!” Consequently, as of 2007, our debt-to-income ratio was recently at an all time high of 19% (Smart Money, September 2007).
We have used debt to subsidized lifestyles that we could not afford for so long our whole "money psychology" is flawed. Instead of evaluating total costs, we are willingly conditioned to only consider whether we can afford "small" payments.
Cash or Credit?
Available credit has distorted the psychology of consumers to the point where individuals are willing to pay significantly more for items laterin order to delay the pain of payment. For example, it is a fact that even consumers who pay their credit card balances in full each month (often referred to as deadbeats) will often end up paying more than their cash-paying counterparts. According to Dun and Bradstreet, consumers spend 12-18% more when making credit card purchases compared with those who pay in cash. Even a 5% cash back bonus can't compete with the "discount" of paying cash.
Not only can one often get better deals by paying cash, one also will limit purchases if he knows it is coming out of his bank account today.
The "pain of paying" cash serves as an effective deterrent against overspending.In his book, Predictably Irrational, Dan Ariely argues that credit puts a buffer between the "ecstasy of consumption and the agony of payment." Thus, as credit becomes more difficult to obtain, more people feel the pain of spending and therefore limit their purchases. In effect, there is a shift back to evaluating the true costs rather than the monthly payments. That's because if the money has to come out of your account now, you think about the costs now. It is no wonder why consumers are feeling the sting like never before as credit becomes more difficult to obtain and awareness of the credit crunch increases.
Big Implications For The Economy And Individual Consumers
Perhaps one of the more prominent examples of how tighter criteria affect consumers at large is the current housing crunch. In 2007, forty-five percent of first-time homeowners put no money down and the median first-time home buyer financed a whopping 98% of the purchase. However, as no money down mortgages became scarce, home prices began dropping faster than during the great depression. The shift was so dramatic that it crippled mortgage giants Fannie Mae and Freddie Mac and any other lending company with business models based on our flawed spending habits. In order to bailout these lenders and prevent yet another blow to an already hemorrhaging US housing market and economy, the Treasury recently seized control of the companies.
Blessing In Disguise?
Overall, more responsible lending practices are good things. Although a voluntary change in consumer spending habits would be more meaningful for individual growth (i.e. this is similar to hiding alcohol from an alcoholic instead of sending him or her to rehab), restricting how much damage we can do is not only sound but should have been done years ago. Our increased awareness of the total costs will hopefully breed better financial decisions in the future by at least somewhat limiting the financial damage that we can do.
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Credit Cards Tighten Credit Worthiness Criteria
Home Prices Dropping Faster Than During The Great Depression
Overdue Consumer Debt Skyrocketing
The Credit Crunch Means Bad News For Student Loans
