Charge It, Santa Baby

Shoppers won't snub Santa this year. Confidence is rising, real incomes continue to increase and retail sales last month were better than the industry expected. OK, mall life is still a little sluggish. But consumers who've kept their jobs are starting to think that maybe they've dodged the bullet. The average family is not--repeat, not--drowning in debt. Infact, if you're earning $50,000 and up, your finances (other than your stocks) are probably in pretty good shape.

I'm not playing Pollyanna here. Some of us are indeed in debt hell, especially the working poor and people 65 and up (a new story I'll get to in a minute). Unemployment devastates workers who can't find new jobs at their previous pay. We've seen record bankruptcies over the past two years, and rising mortgage defaults.

But these have also been golden years for restructuring costly consumer loans. That "debt burden" you read about isn't as serious as it looks.

First, about restructuring. We've been living through the biggest and longest home-refinancing boom ever. You can now get a fixed-rate mortgage for as little as 5.5 percent to 6 percent, which slashes your monthly payments and makes it a cinch to reduce your mortgage term.

Homeowners with enough equity are going further than that. Some two thirds of the refinancings today are "cash-outs," says Diane Swonk, chief economist of Bank One in Chicago. You're borrowing at least 5 percent more against the value of your house. Some of that extra money goes for fun and games, but you're using the rest to pay off high-interest credit-card and home-equity loans. A couple of years ago, cash-out borrowers used only 30 percent of the proceeds to restructure debt, Swonk says. Now they're applying more than half of it to straightening out their bills.

In general, it's a bad idea to treat your house as an ATM--but not if your spending is under control and you're using the money to lower your monthly costs. You're gambling that home values will continue to rise, rebuilding your net worth as you sleep. That's a good bet long term, although in the short term, prices could fall.

Cashing out all of your home equity is just plain nuts. To protect yourself, don't borrow more than 75 percent. What's left is your piggy bank, to tap if your life turns sour and you have to sell. The older you grow, the more home equity you should keep--say, enough to downsize when you retire and buy a condo for cash.

Sourpusses warn that heavy home borrowers will suffer when rates rise. But how dumb do they think you are? Some 80 percent of mortgages are made at fixed rates today, so you're locking your payments in.

As for the "burden" of total debt, there are two ways to measure. One compares after-tax income with the payments (principal and interest) that consumers make each month. By this count, debt service currently requires 14 percent of income, up a little since 2000, but less than the 14.3 percent we paid in the peak year, 1986. We're carrying more mortgage debt than we did back then, but less consumer debt (auto, credit-card and bank loans). Nothing to get alarmed about, at least not now.

It's the other measure that sets moralists atwitter--after-tax income compared with total consumer debt outstanding. Ten years ago, consumer debt equaled 16 percent of income. Now it's 22 percent, the highest ever. Should I faint?

Well, no. This famous debt-to-income ratio may be a bogeyman--an idea I owe to Jason Benderly of Benderly Economics in Vail, Colo. Turns out that, as incomes, new credit and repayments increase over the years, this ratio automatically rises--even with no change in consumer behavior. It's just a function of the math (don't ask). Debt levels are exactly where they "should" be--and will go higher--due entirely to the effects of income growth. We're not over borrowing, nor are we as straitened as the pundits think.

Then who are the people driving the defaults and bankruptcies up? First come the working poor and near poor, who've received an unprecedented amount of consumer and mortgage credit over recent years. Access to loans improves the lives of modest earners as a group. But they hit a dollar wall faster than other people do.

Second come people 65 and up. Their average consumer debt climbed by 141 percent between 1989 and 1998, says Robert Manning, author of "Credit Card Nation." That compares with a 66 percent increase for families overall. Older people are pressed on many fronts today--health costs, stock-market losses and minuscule earnings on savings. Some seniors go broke, Manning says, after helping their kids or grandchildren with education, health care and support.

Third come ordinary families who suffer an unexpected blow. "Few people appreciate the increasing riskiness associated with the middle-class life," says Harvard Law School professor Elizabeth Warren--inadequate health insurance, mid-50s job loss and aging parents needing help.

So it's not debt itself that's tripping most defaults, it's the punches of ordinary life. For the unpunched, borrowing is under control, with Christmas looking good.