What's in your purse?
Scratch that. Let me rephrase the question: Who's in your purse or wallet? Or even more to the point -- how much of what's in there is yours?
Don't know? Try this quick calculation:
Add up the following to come up with your total monthly debt obligations (do not include mortgage or rent and utilities):
- Your minimum monthly credit card payments
- Other loan obligations (e.g., car, student loan, doctor's bills)
Next, add the following to calculate your total monthly income:
- Your annual gross salary, divided by 12
- Other regular monthly income that you can count on (babysitting bucks, eBay profits, bonuses, etc.)
Now, divide your monthly debt obligations by your total monthly income. That number is a rough debt-to-income ratio -- the lending industry's oft-used measure of fiscal health. Since this brief calculation does not take into account long-term loans, like a mortgage, and savings, like retirement or your short-term stash, don't rely on this as the be-all and end-all assessment of your overall financial stability.
According to Gerri Detweiler, author of the Ultimate Credit Handbook, a debt-to-income ratio of 10% or less is considered great. And that's not a bad rule of thumb for Fools, either. If your debt-to-income ratio is hovering in the 20%-or-higher range, there could be trouble ahead. One fender bender, leaky roof, or embarrassing happy-hour catastrophe that ends in a visit to the emergency room and you could be facing a mountain of debt that could take years to eliminate.
Still, far be it for the credit card industry to poo-poo your request for a line of credit. Even if your debt-to-income ratio is 50% or more, you'll probably have little trouble qualifying for a credit card. Never mind that mortgage lenders preach that your debt level -- including mortgage and all revolving unsecured debts -- should not exceed 36% of your gross monthly income. In their eyes, that leaves just 8% of your income for non-mortgage debts.
Going for broke
A long time ago, we were a nation of cash-rich, house-poor people. Then, we became house rich and cash poor. Today, we're a nation that's credit dependent and cash broke.
That's right: Broke. Completely bust. According to a BusinessWeek report, total household debt -- including car loans, mortgage, and student loans -- topped 100% of disposable annual income last year for the first time ever. Contrast that to 20 years ago when the nation's debt stood at just two-thirds of our disposable income.
On average, we carry eight cards per person and have a balance of $8,400 in credit card debt. Twenty percent of our cards are maxed out, reports CardWeb.com, which tracks the lending industry's machinations. And just 40% of Americans pay off their accounts in full at the end of the month. The average line of credit is around $3,500. (A decade ago it was just $1,800.) The average household pays its lender $1,000 a year in finance charges.
It's not just that we're borrowing more money and paying it back more slowly; it's that we're spending money we used to consider off-limits. Home equity loans are more popular than ever as people borrow against their home to feed their spending binge. Today, average homeowners owe nearly 50% of their home's value. Twenty years ago, that figure stood at 30%. Can't you just picture the modern-day needlepoint plaque? "Home, Sweet Credit Line."
Fees, glorious fees
Despite an economy with a case of the shakes and growing card competition, last year was one of the most profitable ever for lenders. Author Robert Manning writes in Credit Card Nation that bank credit card interest and fee income tripled in the 1990s -- from a combined $28.6 billion in 1990 to nearly $80 billion in 1998.
Fees are rising and lenders are getting more creative about what they slap them on. In addition to annual fees and interest, there are fees for balance transfers, fees for paying late, fees for going over your credit limit, fees for account inactivity, foreign currency transaction fees, commissions for cash advances, fees to pay your bill by phone. The list goes on, and the fees keep going up.
There's no stopping 'em, either. According to the American Bankers Association, 26 states have no limit on what bank credit card issuers can charge for interest rates. And 27 states are free to charge whatever they can get for annual fees.
There's a tidy profit to be had, and a lot of issuers want a piece of the action, including yours truly. According to CardWeb.com, among the five major payment networks -- Visa, MasterCard, Discover, American Express, and Diners Club -- there are more than 30,000 different programs.
Today, Visa and its brethren are certainly everywhere you want them to be. And in some places they don't belong.
Your credit crunch
So what does any of this have to do with you? You use a credit card, don't you? Eighteen percent of all U.S. consumer spending is currently made with a bank credit card. Throw retail credit cards and debit cards into the mix and the figure rises to 24%. Industry watchers estimate that by 2006, about 30% of all spending will be on credit and debit cards combined.
If you're going to use credit cards -- and who isn't -- you might as well make sure the cards you've been dealt are good ones. The more you know about your creditors, their competition, and your borrowing peers, the better off you'll be.
Around Fooldom, we keep a watchful eye on the lending industry goings-on and have introduced tools for helping people deal with debt and improve their credit score. (Try our free Get Out of Debt Guide or pass it along to someone you know who is struggling.) On the extremely active Consumer Credit/Credit Cards discussion board, a generous community takes care and time to offer advice, answers, and encouragement.
Make an effort to find out what's in your purse or wallet -- how much, at what interest rate, to whom it is owed, and how it affects the rest of your financial life. It's worth it.
Dayana Yochim has been test-charging on The Motley Fool Visa card for the past three months and will report her findings in the near future. We're all about disclosure here, as you can see by our official policy.