Wednesday, March 8, 2006

Let's start with a shocking revelation: If you borrow money, it eventually has to be repaid.

We all know this, of course. Yet the data suggest many Americans are trying their hardest to ignore this inconvenient fact.

But they can't ignore it forever. Forget the 1990s technology-stock bubble. Forget the recent real-estate mania. To my mind, today's debt bubble will prove far more damaging. It's going to derail many baby boomers' retirement plans -- and it's already hurting the generation that follows.

Facing facts. Make no mistake: The statistics are ugly. As a nation, our borrowing is growing as fast as our wealth, we are loading up our kids with college debt, and we are continuing our spendthrift ways into retirement.

Take the recent real-estate boom. This windfall could have salved the financial wounds left by the 2000-2002 stock-market crash. But instead, many homeowners have turned around and immediately spent their real-estate gains.

Federal Reserve data show that the value of household real estate climbed 71 percent over the past five years. But mortgage debt grew even faster, up 75 percent, as folks cashed out part of their home's value when they refinanced or took out second mortgages.

At the same time, car loans and credit-card balances are also rising. Outstanding consumer debt is up 27 percent over the past five years, well ahead of the 13 percent cumulative inflation rate.

Maybe, however, we shouldn't be too scornful: At least these folks are actually buying their cars, even if it is with borrowed money. According to Edmunds.com, an automobile-research Web site, over 18 percent of the new cars acquired in February were leased, which means these families will make hefty monthly payments -- but they won't have an asset to show for it.

Meanwhile, parents are increasingly leaving their kids to pick up the tab for college. Over the 10 years through the 2004-2005 academic year, annual borrowing through student and parent loans jumped 194 percent.

That's far ahead of the 66 percent increase in the total cost of four-year private colleges or the 72 percent rise at public colleges, according to the College Board, the association of schools and colleges.

"Where the average debt levels are really increasing are for children of more-affluent families," says Sandy Baum, a senior policy analyst at the College Board and an economics professor at Skidmore College. "Children of affluent families are now almost as likely to borrow as children of less-affluent families."

Even retirees are getting in on the act. Among households headed by someone age 75 or older, 40 percent had some sort of debt in 2004, up from 29 percent three years earlier.

The sums involved aren't small. The Federal Reserve's 2004 Survey of Consumer Finances -- which was just released -- found that 19 percent of these older Americans had a mortgage on their primary residence, with $31,000 typically owed.

All this seems like a betrayal of family financial values. In many cases, our parents sent us into the adult world with little or no college debt and they strove mightily to bequeath us their house and often more. Yet our kids are starting their working lives deeply in debt and, when they settle our estate, it looks like they will be settling with our creditors.

Testing yourself. Arguably, with interest rates so low, it's logical for folks to borrow more. And, arguably, the picture isn't as bleak as I suggest.

For instance, despite soaring debt levels, the typical family's inflation-adjusted net worth grew 1.5 percent between 2001 and 2004, according to the Federal Reserve's new Survey of Consumer Finances. Moreover, if you analyze different age groups, today's wealth as a multiple of income is pretty much unchanged from two decades ago.

"It looks like we're doing as well as we've always done," says Alicia Munnell, director of the Center for Retirement Research at Boston College. "But in fact, the world has changed. And it's for four big, real obvious reasons."

First, life expectancy is rising, which means seniors are facing longer, and hence more expensive, retirements. Second, health-care costs continue to escalate, including for retirees covered by Medicare. Third, real interest rates are much lower than they were two decades ago, and that means we are looking at lower investment returns.

Finally, and maybe most important, traditional company pensions are disappearing. Among workers with an employer's retirement plan, 38 percent were covered by a traditional company pension in 2003, down from 81 percent in 1981. "The implication is really clear," Prof. Munnell says. "People need to have more saved than they did in the past."

How well are you doing? Take this simple test. Tote up the value of your 401(k), individual retirement accounts and other investments. To that sum, tack on any home equity you hope to free up by trading down to a smaller home at retirement.

Next, subtract all your debts, including auto loans, mortgages and credit-card balances. Got a final number? Now, assume that you will be able to withdraw 5 percent of this sum each year in retirement. In other words, if you have $300,000, you will be able to withdraw $15,000 a year.

You should get some help from Social Security, and you may also have a company pension. Still, if your prospective retirement income looks a little thin, you know what you need to do: Stop borrowing, pay down existing debts -- and start saving like crazy.

Out From Under

Struggling with debt? Here's some advice on digging out.

If you can't help with college, tell your kids early, so they can figure that into their college plans.

Even if you're deeply in debt, your top priority should be fully funding your 401(k) -- especially if there's an employer match.

If you refinance or buy a new home after age 45, consider a 15- or 20-year mortgage, so you pay off the loan by retirement.

Previous columns

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