American consumers paid down 26% less credit card debt during the first quarter of 2011 than they did in the same period last year, according to a recent credit card debt study conducted by Card Hub – a fact which portends a significant rise in debt throughout the remainder of the year as well as the possibility of dangerous consumer overleveraging.
While one might consider any debt pay down to be a positive one, context is needed to explain why the Q1 2011 data is so concerning. During the first quarter of each year, consumers inevitably pay down a portion of their debt thanks to holiday bonuses, tax returns and a desire to rid themselves of balances remaining from holiday shopping. It’s normal.
However, so too is the rise in credit card debt that inevitably follows. After paying down roughly $43.5 billion during the first quarter of 2010, we racked up over $52.7 billion (net of charge-offs) in new debt throughout the remainder of the year, ending up with about $9.1 billion more in outstanding payments than we started. Likewise, after ridding ourselves of over $47.2 billion in debt early in 2009, we piled on more than $37.2 billion in new debt throughout the rest of the year, which wiped out nearly 80% of the Q1 decrease.
It would therefore seem rather obvious that a sizeable debt increase is in our near future. We have steadily decreased our first quarter debt pay down since it peaked in 2009 while at the same time adding more and more debt throughout the rest of the year. Should this trend continue, American consumers are expected to end the year with $20 billion more debt than they began, according to Card Hub’s study.
So, why is this happening, and what can we do to prevent it?
Well, spending is increasing as consumer confidence in the economy grows. The recession is over – the thinking seems to go – therefore spending can return to pre-recession levels. Unfortunately, this just isn’t the case. Many people’s jobs were tied, either directly or indirectly, to the housing bubble that infamously broke and helped lead to the Great Recession. Such people’s income most likely will not return to pre-recession levels so allowing spending to do so is simply a recipe for trouble.
Besides, one would think that people would be slightly more cautious about allowing their spending to once again get out of hand so quickly after a recession and in a still-tenuous economy. This, however, is indicative of the change in mindset necessary for many of us. According to the National Foundation for Credit Counseling’s 2011 Financial Literacy, 41% of Americans grade their personal finance knowledge at C or worse and 76% say they could use an expert’s advice on personal finance questions.
We all simply need to go back to the basics and actually apply what we know about spending money to our own lives. Avoid carrying a balance on your credit card, make budgets and stick to them, and – if you have debt – pay it down strategically. Apply minimum payments to the balance(s) with the lowest interest rates and the rest of your payment budget to the balance with the highest rate until it is paid down in full. Then continue this strategy until you’re debt free. This will allow you to free yourself from debt as cost-effectively as possible. After all, having nice things is nice, but being free from debt and the stress that comes with it is even better.
[Disclosure: Some of the links within this article point to CardHub.com, which is owned by the same parent company as Wallet Blog.]