June 28, 2004

Families, Deep in Debt, Facing Pain of Growing Interest Rates


Kalim A. Bhatti for The New York Times
With low interest rates, Joyce and Curtis Diffenderfer could manage $16,000 in credit card debt, but that may soon become more difficult.
By LOUIS UCHITELLE

LANCASTER, Pa., June 25 With the Federal Reserve about to raise interest rates for the first time in four years, Joyce Diffenderfer is beginning to wonder how she and her husband, Curtis, will deflect the growing cost of their $16,000 in credit card debt.

Not that her concern is a pressing issue yet; it is more like a fire drill in anticipation of a fire that she is still not convinced will occur. The Diffenderfers figure that a modest rate increase would initially add only $35 to their monthly card payments, which now total more than $600. Still, they have run out of ways to sidestep the cost of borrowing, and if the rates keep rising, as the Fed's leaders suggest they will, then the only alternative, Mrs. Diffenderfer said, will be to seriously cut family spending.

The Diffenderfers are among the millions of American families who rode the recent wave of low interest rates to home ownership and the rapid accumulation of debt, and now they must cope as rates begin to swing upward. The process is almost certain to begin at a meeting of the Fed's policy makers on Tuesday and Wednesday. They are widely expected to raise rates a quarter of a percentage point and follow that with similar increases periodically over the next 18 months.

"Unless there is a sizable jump in rates, let's say two percentage points within a year, I'm not going to think much about it," said Mrs. Diffenderfer, 47, who earns $14 an hour fielding customer calls at Kunzler & Company, a manufacturer of sausages and frankfurters in this southern Pennsylvania industrial city on the fringe of Amish country.

"Less than two percentage points we can handle just by not eating out as much," she said, swiveling her chair away from her computer for an interview late in the day, after the phone calls died down. Her husband, 55, is a construction worker.

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, like those that the Diffenderfers pay on their four credit cards, 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, including the initial $35 increase in the Diffenderfers' monthly credit card bill.

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.

The Diffenderfers have a combined income of nearly $70,000 a year, including the overtime he earns and the small payments she receives as assistant organist at her church. They have been married 17 years but they lived with her mother for the first 11, paying her rent. When they finally bought a house of their own in 1998, for $89,000, they had nothing saved for a down payment, and borrowed the entire amount through a 30-year mortgage. They also took out a second mortgage, for $30,000, which they invested in remodeling the home: aluminum siding, a new bathroom and a refinished living room with oak trimmed walls.

As interest rates fell, they refinanced both mortgages, locking in a 5.25 percent fixed interest rate for 30 years. Still, the remodeling continued, mainly on credit cards once the $30,000 was exhausted. Their three-bedroom house is now worth nearly $120,000, almost equal to the mortgage debt, Mrs. Diffenderfer estimates. That leaves the couple with no spare equity that can be extracted in cash through a bigger mortgage. Nor can they lower their $726-a-month mortgage payment. With mortgage rates already rising in anticipation of the Fed's increases, that once lucrative route for millions of consumers is closing.

The Diffenderfers have only their salaries to meet the rising cost of their variable rate credit card debt, although for a while Mrs. Diffenderfer managed to reduce the interest payments by switching the balances to new credit cards whenever she could get a lower rate. The interest rates on her cards now average just under 10 percent, partly through her efforts to find teaser discounts and partly because credit card companies dropped their rates several percentage points, a decline now likely to be reversed.

"There are adjustments we could make in our spending," Mrs. Diffenderfer said. "Eating out is one. We could put remodeling of our home on hold and give ourselves a breather. We contribute $125 a week to our church. We don't want to cut back on that but we would if our financial situation changed drastically. It would have to be pretty drastic."

Another notch up in home prices would give the Diffenderfers 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, Mr. Smith says, but also because in the past year the cost of building materials rose $17,000 and his company, Stephen Black Builders, has been able to pass along only $14,000 of that. Even the higher-income families have resisted paying the last $3,000. "Sales of these homes had been averaging 20 to 22 a year," Mr. Smith said, "but I think they will drop to 18 to 20."

One antidote to rising interest rates could be the recent surge in employment, and all the new income that will accompany the one million jobs created since February - but that remains to be seen. "The question really is, are the people who are leveraged with debt, are they the ones getting the jobs and income?" said Richard Berner, chief domestic economist at Morgan Stanley. Employment growth has been fairly robust in Lancaster, but even so, Mr. Smith is seeing fewer customers as they react to rising prices and interest rates.

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."


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