Youth+Cards=Debt

  To consumers 18 to 34 years old, credit limits are like pocket change. Growing up in a bull market, they seemed unaware when the economy began to sink in 2000. They charged through the dot-com bomb and the subsequent recession without changing their free-spending habits.
  Credit cards have become their vice.
  "Many Gen-X'ers and Gen-Y'ers charge at will and don't worry about the long-term consequences, while others are dealing with college debt and are buried. They need credit cards for basic monthly expenses," says Tamara Draut, lead author of "Generation Broke," a report from Demos, a New York-based think tank and advocacy group. "This is a vulnerable generation."
  But how vulnerable? Vulnerable enough that credit card issuers will cut back on lending to young adults?
  There are isolated cases, but most issuers are ratcheting up fees and interest rates to cover any increase in risk. They are betting against an economic downturn that could force large write-offs of young consumers' debt. And they are hoping to pacify critics who are calling for legal limits on credit card marketing and more generous terms for cardholders.
  The numbers are chilling. Consumers ages 18 to 24 spend one-third of their income on debt. Their credit card debt spiked 104% between 1992 and 2001, to an average of 2,985, says the Demos report. Individuals ages 25 to 34 spend one-fourth of their income on debt. The report relied on the Federal Reserve's Survey of Consumer Finances, released every three years.
  Nobody expects to see a statistical about-face when 2004's numbers are available next year. To wit: Freshmen entering college with zero debt can expect to be more than 3,000 in the red by the end of the second semester, and almost half of that total is credit card debt, reports Nellie Mae, a leading provider of student loans. On average, college students with student loans graduate with more than 20,000 in debt, 15% of which is owed to credit card companies.
  Lenders have few options for handling consumers who are poor credit risks. They can shut off the credit spigot to young consumers, but that is a certain death knell in the competitive lending game because few, if any, peers are backing off. Or they can raise rates and fees charged to consumers after weighing such measures as credit scores and debt-to-income ratios, a strategy known as risk-based pricing, says Fritz Elmendorf, vice president of communications with the Consumer Bankers Association.
  "It's a tough balancing act because lenders are criticized for making credit too available on one hand, then criticized when they try to restrict it," he says. "Pricing loans based on risk is the best way for a bank to hedge its bets."
  The Demos report argues that lenders are taking risk-based pricing too far. Draut points to 29 to 39 late fees, which she calls exorbitant.
  In testimony before the House Subcommittee on Financial Institutions and Consumer Credit last fall, Draut criticized issuers that are hiking interest rates to as high as 29% to 34% after one late payment.
  "Tripling an interest rate is pretty excessive," she says, noting that many younger Americans spend several thousand dollars yearly to try paying off high-interest debt.
  Demos wants Congress to pass a "Borrower's Security Act" requiring lenders to provide a five-day grace period on late payments before fees are assessed and to disclose how long and how much borrowers will need to pay if only minimum monthly payments are made.
  The American Bankers Association advocates risk-based pricing, says Keith Leggett, a senior economist at the bankers group. "If you sit back and say, 'Banks should not engage in risk-based pricing,' then you end up denying groups access to credit, and access to credit is an important vehicle for upward mobility in our society," he says.
  James Orcutt, vice president in Wachovia Corp.'s consumer risk management group, believes the regulatory and institutional focus on issues such as predatory lending tactics help keep the industry honest while curbing overly high rates and fees. "A greater risk is the temptation of lenders to price their way to profitability while letting their risk appetites get out of control," he says.
  Lending, by nature, is a game of chance. Many simply gamble that they have the experience and tools they need to judge "good, thin credit against what might be bad, thin credit," says David Nole, Wachovia Corp.'s chief risk officer for consumer banking. Wachovia backed away from unsecured credit card lending when the economy began to wane in 2000. Bank One Corp. purchased Wachovia's 7.5 billion consumer credit card portfolio in mid-2001, although Wachovia reacquired 1.3 billion of the portfolio two months later to resolve a kink in its merger with First Union.
  Nole declined comment on whether younger America's debt load played a role in that decision.
  It is common for Young America to carry the biggest debt load, but nowadays there is a wild card setting them apart: student loans. "Escalating tuition expenses far outstripped the rate of inflation for years and years. That's a tremendous issue," Elmendorf says.
  The average graduate pays 200 per month on college loans. Post-graduation, efforts to pay those loans while juggling such new real-world expenses as the first mortgage, a new car or the birth of a child can exacerbate a vicious cycle of putting routine expenses on a credit card to pay that monthly debt.
  To make matters worse, high debt levels preclude the debt-laden young from the sweetest lending deals. The result: They wind up in the subprime category, paying even higher rates for borrowing.
  Lenders price for risk knowing that borrowers have different price sensitivities. Those with poor credit histories usually have fewer options and, consequently, are more willing to borrow at higher rates, the Federal Deposit Insurance Corp. reports.
  For many students, rising tuition, impulse buying and a jump in credit card charges go hand-in-hand. Many use their cards with good intentions, perhaps hoping to give their parents a break. But rather than drop the daily Starbucks habit, they also will charge the morning latte and add a bagel with cream cheese.
  To discourage credit card use by students, Demos wants laws regulating credit card marketing on campuses. Several states have passed, or are now considering, such legislation.
  Many people trace their economic woes to the first day of college. "Zero-percent interest" proves to be a one-month-only benefit; free T-shirts and free music downloads do not pay bills.
  Meanwhile, as college tuition exceeded the pace of inflation through the 1990s. Federal Pell Grants covered less of the cost of a four-year public college, dropping from 77% of the cost in 1980 to 40% today, Demos found.
  Moreover, the Minnesota State Colleges and Universities system revealed in March that 25% of the more than 600 students polled at state universities are using a credit card to pay part of their tuition and fees this semester. Over the past two years, 30% more students have taken out loans to help pay for college, and their total borrowing rose by 60%, according to another study by the Minnesota higher education system.
  Yet despite the gloom-and-doom, lenders keep embracing Young America. They want to find lifelong customers early, and they gamble on their potential future earnings.
  At Chase Card Services, meanwhile, officials cite a Georgetown University Credit Research Center study that states 88% of undergraduate student credit card accounts, on average, are paid on time and in good standing. The average for all adults is 91%. The average balance on a student credit card is 552, about one-fourth the size of an older adult's and one-third the size of a non-student cardholder. Unlike the numbers from Nellie Mae, which cite 3,000 in credit card debt for the average college graduate, the Georgetown study looks at a sampling of all students, including those without student loans.
  By paring down its consumer credit card portfolio four years ago, Wachovia is not as deeply entrenched in the issue. The bank instead chose to build its secured home-equity and mortgage-loan portfolios, says Nole, the chief risk officer.
  "We just felt that as interest rates began to drop that there would be an opportunity for us to grow in the secured space-a less risky product for us to achieve growth at a time when not many were pursuing home equity growth," he says. "We purposefully moved the portfolio to higher ground."
  Getting Worse?
  Nole fears consumer debt, including that of young consumers, could worsen at least through 2006, especially if the Fed keeps raising rates as expected. A quarter-point rate increase in early May marked the eighth-consecutive such hike since mid-2004.
  Amid the troubling consumer debt data are signs of hope.
  Credit card debt actually leveled off as a share of income in the past four years, says David Wyss, head economist with Standard & Poor's, who believes the hype about consumer debt often exceeds the reality of the problem. "What counts is not what you owe, but how much you have to pay off each month. The question, as always, is what happens when interest rates go up? And, how much can people borrow additionally when they do?"
  The ABA's Leggett believes early debt problems are more a reflection of poor financial literacy than lending policies. "Students are not really taught proper money-management skills," he says. "Education is the direction we want to go."
  Likely, there are no quick fixes, only small solutions. The plastic addiction is deeply rooted among young Americans, and sharp tuition hikes and stagnant wages are conspiring to keep them hooked.
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