We hear stories about consumers who borrow money on credit cards, unsecured loans, and real estate secured loans to finance short-term life experiences such as vacations, rock concerts, and tickets to the “big game.” With this instant gratification of a “buy-now” “pay-later” culture there is no surprise that people are willing to trade short-term positive experiences for the unpleasant consequences and the drudgery of long-term debt repayment. They may be unaware that due to such high interest rates ranging between 12% and 18% paying back the debt, comes at an enormous cost. The principle amount of the debt and accrued interest may be required to be paid back after-tax dollars.
Let’s explore how and why America has developed into the mother of all systemic pandemic debt addiction(s). Every conversation about any debt class also raises a red flag about rising interest rates.
Household Debt as of Mid-Year 2018:
Household debt is defined as the combined debt of all people in a household. It includes consumer and mortgage debt. It also includes credit cards, personal and home equity lines of credit, secured and unsecured loans from banks and other institutions, and unpaid bills. In the first quarter of 2018, it reached $13.9 trillion, a $63 billion increase from the previous quarter. Household debt was at $12.73 trillion dollars in 2007, these numbers come from Federal Reserve Bank of New York.
Paying back the household or consumer debt, the debtor must earn enough money to pay federal, state and employer related taxes on every dollar of principal reduction and interest accrual to reduce the debt. A debtor needs to earn $2.00 to pay off $1.00 of debt after taxation. $2.00 less 30% federal tax, less 10% state tax, less 10% employee related taxes = $1.00 net. Now the $1.00 is available to pay interest accruals on debt, and perhaps a little principle. If borrowers were taught exactly how devastating this process is, they would certainly alter their decision making.
With consumer interest rates being generally adjustable the rates can range from “0” to 20%, while trying to pay off debt. Promotional 0% interest rates that need to be paid off by a certain date are always reflected in the higher price of the product. Consumers may think they are getting a bargain but may be hit with a high interest rate when they do not pay back the full amount in the given time frame.
Consumers are constantly accruing interest on the outstanding balance of their debt. As interest rates rise, credit card interest rates will also rise, with required higher monthly payments for the interest portion of the payment. For tax purposes consumer interest payments are not tax deductible. For some business-related entities, interest payments are tax deductible. Delinquency rates peaked in 2009 at nearly 7%, but in 2018 they have remained below 3%.
Residential Real Estate Debt (is included as a portion of the household debt.):
For 2018 Americans owe a total of $8.88 trillion in mortgages loans. Purchasing and financing a home is the norm. With the recent tax revision act, writing off interest has now been capped at a $750,000 home loan. Mortgage home equity debt that is not used to purchase or improve one’s personal resident is not deductible at all. These are forward looking for mortgages funded as of December 15, 2017. New limits on mortgage deductions do not apply to loans funded prior to December 15, 2017. Property taxes deduction is not capped at $10,000 per year. Call your accountant for clarification.
What this really means for future upper end housing, above the write off limits, is that the homeowner will have to pay federal and state taxes on each dollar spent on interest, principal payments, and property tax payments. The homeowner will be required to earn $2.00 income for every $1.00 spent on home-ownership.
I believe that this will have a significant long-range effect on upper end housing. One should do a hypothetical example of purchasing a 5-million-dollar home, financing 4 million at 6%, 7%, or 8% interest with payments amortized over 30 years. Purchasers may decide on much smaller McMansions. At best, owning a home is a forced saving account with equity built up overtime, and with lawyers, judgment creditors and taxing authorities watching closely. The buzzards will always circle weakest prey.
As interest rates have been allowed to rise off their artificially low levels, home financing companies are under significant stress. On a forward-looking basis lenders expect significant layoffs, downsizing, and doors closing.
Automobile Debt as of Mid-2018:
The Current outstanding debt for auto loans is $1.24 trillion, rising almost 50 billion from just 1 year ago. The percent of loans financed by subprime lending standards and rates is rising. Subprime interest rates vary between 8% and 25% per annum.
Paying back the automobile debt, the debtor must earn enough to pay federal, state and employer related taxes on every dollar of principal reduction and interest accrual to reduce the debt. A debtor must earn $2.00 to pay off $1.00 of debt after taxation.
Some auto related expenses can be deducted as a business expense for those who own or operate a business. Also, leasing an automobile allows the business person to deduct a percentage of the payment for business.
Student Loan Debt:
In November 2007, the aggregate balance in the federal direct student loan program was only $98,529,000,000. Now in 2018 the student loan debt sits at $1.5 trillion dollars. A major contributor to this debt is compounded by the difficulty for some debtors to find and keep a job once the student graduates from college. Without a steady high paying job and the income, it seems they will never be able to pay off this debt.
To pay back the student debt, the debtor must earn enough to pay federal, state and employer related taxes on every dollar of principal reduction and interest accrual to reduce the debt. Only $2500 of interest is tax deductible each year. A debtor needs to earn $2.00 to pay off $1.00 of debt after taxation.
Those obligated for student debt are constantly accruing interest on the outstanding balance of their debt. Interest rates are adjustable and will rise as rates rise reflecting higher monthly payments for the interest portion of the payment.
The current default rate for student loan debt stands at 11.3% for Public Colleges and 7.4% for Private Colleges. Since most student debt is guaranteed by the federal government, defaults become an obligation of the tax-paying public.
Commerical/Mulitfamily Outstanding Debt:
The current debt for commercial/multifamily mortgage debt outstanding is $3.21 trillion at the end of the first quarter of 2018. Of all the classifications of debt borrowing money on income producing property makes the most sense for 2 reasons. Your yield is partly determined by your operational leverage, and cash flow from tenant income makes the payments. Of course, that suggests a discussion of property types, types of tenancies, vacancies, and yield/risk considerations. Another article for another day.
Corporate Debt Loan:
The current corporate debt loan currently outstanding sit at 6.3 trillion dollars. Companies finance everything from additional investments, dividends, mergers & acquisitions, expansions, promotion, research and development, and stock buy backs. Corporations have been using borrowing an historical low interest rates as a method to boost share value.
As monetary conditions tighten, interest rates rise, debt service, retiring accrued debt will become more difficult, and in many cases will come to a screeching halt, reflecting a downward spiral and many insolvencies, including bankruptcies. Reducing debt, the companies to earn enough to pay federal and state taxes on dollar of debt reduction. Interest in general is a deductible expense for companies. For every $2.00 earned by the company they may pay federal 25% (-50), state 10% (-20), multiple excise, tariff, and regulatory taxes of 10% or more (-20), leaving $1.10 to pay for interest and principal reduction of accrued debt. Tax rates will vary.
Sovereign Debt Meaning US Public Debt:
Government debt which is also known as public debt, national debt and sovereign debt, is the debt owed by a government. The government spends more money than it takes in taxation. The government finances the difference by issuing debt. Government never considers reducing expenses and bureaucracy. In 2007 government debt totaled of $9.008 trillion dollars or 67.7% of gross domestic product (GDP). For the year 2018 the US debt sits at $21.478 trillion or 107% of GDP. By year 2021 we could be looking to have the debt be at a staggering $25 trillion dollars.
Why the big deal about consumption and debt?
The foundation of the American Enterprise is consumption and debt. We earn income to spend on those items necessary to survive, including food, shelter, medical, transportation and family. Discretionary purchases consume the income above necessities. When incomes are insufficient to satisfy our spending habits, we are encouraged to borrow and accrue debt. Once the debt exist our life paradigm shift becomes punitive. Debts are expected to be paid back in a timely schedule with a significant penalty for late payments and defaults. This is a learned habit and is encouraged by most all participants.
An Automobile purchase represents an example of the thousands of products available. A standard automobile contains about 30,000 distinctive parts. Upper end automobile can contain up to 40,000. Each part must be manufactured by a company and forwarded to a central location for assembly. From the very raw materials extracted out of the ground, from a rubber tree, plastics as a chemically created by-product of oil, each part comes from a company who is profit motivated. Each company hires staff who is paid compensation including federal, state, unemployment, and various other taxes. The company will pay sales, excise, import tariffs, property taxes, and multiple duplicitous other taxation addons. Each company expects to earn a profit, which it will pay its round of taxes. If all the participants pay taxes from the beginning to the end, the finished product price will rise 30 to 40% including the acclimation of taxes.
The auto purchaser must earn enough money to pay back all the prior chain of accrued taxation throughout the manufacturing process, plus current sales taxes, and new registration on day one. Then the proud new owner of the automobile had to earn the down payment, monthly payments, and interest payments over an extended time. The new owner will pay state, federal, unemployment compensation and various other taxes on every dollar spend on the principal price of the automobile plus all the interest charges.
Business related expense deducibility will be considered, this will encourage consumers to purchase bigger, better, faster, prettier, more expensive autos. This provides the business person only a marginally better deal. Write off during each calendar year and depreciation will give some tax relief benefit.
Who are the primary beneficiaries of our us debt addiction?
Governments taxation transfer payments are the largest beneficiary of our propensity to consume more and take on more debt. Governments will even offer some incentives to get the consumer to take on more debt. Companies encourage you to consume more and take on more debt because the profits end up in their pocket. Advertisers and media outlets make sure that you are bombarded with at least 2,000 ads per day. Hollywood, sports promoters, event promoters, religious organizations all benefit while encourage spending. Social groups, friendships, significant partners, and casual dates all encourage you to spend and consume more, with little thought about what it takes to pay back the debt. There is “social pressure” to keep up with others.
When the consumer and companies, becomes insolvent Lawyers, bankruptcy, trustees, expert witnesses, court employees, even the sheriff with gun tucked tightly on his side, while he/she watches you enter the court with your shoes off, belt off, and personal contents scanned for suspicion, all benefit by your economic demise.
Now, for the mother of all debts known as Unfunded, and Underfunded debts in the USA. These debts are hidden from public view as there is a pretense by government and the media that they do not exist. They fall into 3 primary categories, retirement pension plans, social security, and Medicare. There is also a distinction between public employee pension under-funding and the public. Estimates of the total under-funding obligations in the us are estimated to be over 200 trillion. Public employees under-funding is approximately 7 trillion. They fully expect to be made whole even though many employment retirement trusts are as much as 80% underfunded. Of, that means only 20% funded. When unrealistic and fraudulent forecasts of expected yields failed to materialize no one raised a brow. They now expect for the tax payers to bail them out and to make them whole, but not the social security recipients? They expect preferential treatment.
The systemic debit crisis in the United States, and in the world is a ticking time bomb. You can’t control it, so do not develop immediate anxiety, as long as you have you have a cold six-pack in the refrigerator. But, you can refuse to let it control you. Start by reducing credit card debt, unsecured debt, and eliminating unnecessary payments that require you to make $2.00 of earned income pay down $1.00 each dollar of debt. Break the herd mentality and become a non-conformist. You may even be considered a renegade or something worst like a deplorable.
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