Victor and Eloise represent the new face of debt in America. Together, they've worked in a series of low-wage jobs that include stints at fast-food restaurants, small factories, and hotels. Technically, they are not poor according to the government's official definition of "poverty," but the economic vulnerability of the working poor and the near-poor are increasingly similar. The couple, whom I interviewed for my recent book, live in Montgomery, Alabama, with their two children, aged 4 and 14. They own their own home, which they bought in 2000 after their second child was born.
Today, after more than a decade of working low-wage jobs, the couple's annual income has risen to about $50,000, more than double the poverty-line for a family of four. But their long years of subsistence living have left them with high-interest debt totaling $13,000. They're paying a 25 percent annual percentage rate on a $3,000 credit-card balance that paid for new tires and alignment work on their car, as well as for a new stove for their kitchen. They also have three personal installment loans totaling more than $9,000, all at interest rates of 25 percent or higher. These loans were used to help cover bills while Eloise was on maternity leave, to help pay for a used car, and to help repair the family's home air conditioner. After years of barely making a dent in the principal, the couple now pays $345 a month to a credit company that negotiated lower rates and makes payments on their behalf toward one of their credit cards and on two of their installment loans, but they still pay over $500 month, mostly in interest, in past loans that financed basic living expenses.
Victor and Eloise symbolize what many in the financial industry enthusiastically champion as the democratization of credit. Its cheerleaders remind us that two decades ago, virtually all lenders -- save, perhaps, for the local pawnbroker or loan shark -- would have snubbed Victor and Eloise. But today, thanks to technological change and deregulation, the low-income market is a bonanza for lenders.
With ever-more-sophisticated underwriting technology, lenders say they can better calculate risk and price loans accordingly. In addition, deregulation in the early 1980s and '90s all but eliminated interest rates and fee limits. The result is a tidal wave of high-cost credit targeted to low-income individuals, particularly in communities of color, at interest rates once considered usurious but now regarded as perfectly legitimate. It's a great system for everyone but the borrower.
The unleashing of exorbitantly priced credit coincided with two other important trends: the steady decline in earnings power of low-income households and the shredding of our public safety net. As already strapped low-income households found themselves falling further behind, they also found their mailboxes stuffed with rescue offers of easy and fast credit. And in low-income neighborhoods, storefronts selling fast and expensive loans are now as plentiful as McDonalds selling fast and cheap food.
Consider the payday loan. A borrower simply writes a postdated check and exchanges it for cash from the lender for a fee -- typically starting around $15 for each $100 borrowed, or about 300 percent to 440 percent APR. The premise is that in two weeks or so, the lender will cash the check, paying off the loan. However, most borrowers end up extending their loan because they don't have enough funds to cover the postdated check. In fact, according to the Center for Responsible Lending, the average payday loan is renewed eight times, costing the borrower about $800 for an initial loan of $325. The center estimates that $4.2 billion is extracted in payday-loan fees from borrowers' pockets each year.
Low-income households turn to payday loans for many of the same reasons they incur credit-card debt: unexpected expenses or drops in income. Today, about one in three low- to middle-income households have credit-card debt, with an average balance of $6,500 for those with incomes below $35,000. Most of these households aren't indebted because they have a spending problem; they're indebted because they have an income problem. According to a study conducted by D¯emos and the Center for Responsible Lending, 44 percent of low-income indebted households reported that a layoff contributed to their credit-card debt; 20 percent cited medical expenses; 50 percent cited car repairs; and 38 percent cited home repairs.
As all of us can attest, things happen that can cause a financial crunch. For low-income families, however, the likelihood of such things happening is much higher, while emergency reserves are much lower. The ability of these households to save has diminished as incomes at the bottom of the wage distribution have fallen while costs for housing and health care have soared. In addition, our social safety net no longer really catches those who experience a fall: Fewer workers qualify for unemployment insurance, and wage-replacement levels have diminished. The health-care safety net in the form of Medicaid catches the most vulnerable, but it leaves many low-income individuals completely unprotected. And so, unleashed by deregulation that lifted interest-rate caps and limits on fees, major banks have underwritten and financed billions of dollars in loans and extracted billions in high interest rates and fees from low-income families with nowhere else to turn.
Borrowers need to share responsibility for their indebtedness, but government, like the lending industry, is far from innocent. Over the last three decades, policy-makers have steadily abandoned Americans in and near poverty.
Belatedly, however, the practices of the lending industry are coming under scrutiny. Since January 2007, with the meltdown in sub-prime mortgage loans and the change in Congress, the Senate and House have held multiple hearings on lending-industry practices. Chris Dodd, who chairs the Senate Banking Committee, has signaled that legislation addressing the credit-card industry may be on the way. Meanwhile, an impressive and diverse group of organizations have joined together to form Americans for Fairness in Lending (www.affil.org), whose goal is to raise awareness of abusive lending practices and to call for reregulation.
Restoring responsibility to the lending industry is just one aspect of the remedy, however. The deeper cure for debt as a safety net is to increase earnings and social benefits for the working poor, so that low-income families have the opportunity to move beyond mere subsistence living. That means raising the minimum wage, tearing down barriers to union organizing, providing universal health care, and creating more incentives in the tax code to help these families save and build wealth. Debt is not a safety net, but unless change is forthcoming, it will likely remain the only net available.
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