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YOUNG AMERICANS OVERBURDENED BY CONSUMER DEBT Most young people rely on credit cards, student loans, auto loans and other forms of consumer loans to attend college, find a job, pay rent, and live independently. Loans give young adults the chance to pursue educational opportunities, begin their careers, and start families of their own. But there are also pitfalls that come with carrying debt, particularly for an age group that tends to be low-income and new to credit. Young adults are more likely to have trouble paying a debt on time and frequently must pay their debt several times over in interest and late fees. Young adults are also often the target of predatory practices by lenders. Strong consumer protection laws are critical to prevent abuse and ensure our future financial security. Adults Under Age 35 Carry More Debt Relative to their Income than Any Other Age Group Adults under age 35 have a higher debt to income ratio - meaning more of their monthly income goes toward debt - than any other age group. In 2007, young adults spent nearly 20 percent of their earnings on debt.[1] Young adults also exceed other age groups in their frequency of late credit card payments.[2] But young people in the work force are not the only ones with consumer debt. College students are increasingly likely to pile on debt as well. In 2009, 30% of students paid for tuition with their credit cards.[3] In fact, half of college students have four or more credit cards and pay monthly finance charges - payments such as interest and fees which do not reduce the underlying principal - for failure to fully pay off their credit card balance.[4] Young Adults Pay Millions in Overdraft Fees, Late Payment Fees and Other Finance Charges, Leading To A Debt Cycle Overdraft fees, late payment fees and other finance charges cost young adults billions of dollars each year.[5] Because young people are often new entrants to the work force, unemployed job seekers or students, few of them have significant experience with managing their finances and are prone to overlook hidden costs. Young adults are generally low or middle- income and can struggle to stay on top of their credit card and student loan balances, let alone pay additional charges in interest, penalties and fees. Strong consumer protections would go a long way toward preventing finance companies from taking advantage of young people. Many young adults also turn to payday loans in times of need, loans that rarely work out well for consumers. The loans use extremely high fees and interest rates to trap customers in a harmful pattern of borrowing that keeps them coming back to pay off debt from the prior loan. Over one-third of payday loan consumers are 34 years old or younger and the median borrower earns $31,000 a year.[6] During these difficult economic times, college students are also turning to payday lenders. One study found that 5% of University of Arizona freshman took out payday loans in 2008, which was twice the percentage in 2007.[7] Regulators will soon have an opportunity to protect young people from harmful lending, and should take special care to protect against these abusive practices. Once young adults fall into financial trouble, they have a hard time climbing out. In fact, long-term consumer debt can damage a young person’s credit report and score for years to come, leading to other problems. P eople with low credit scores often struggle to borrow money to purchase a house, buy a car, or start a business. They also pay more to borrow - meaning higher interest rates and more fees. They may face discrimination from prospective employers, who are increasingly using credit scores to screen job applicants. Landlords often look at the credit scores of tenant applicants. For all these reasons, having a negative credit report and a low credit score makes it more difficult for young adults to seize economic opportunities, pay off their debts, and establish financial security and stability. In other words, high debt can be yet another hurdle for young adults as they try to pursue an education, build their careers and start families. Strong Regulation is Needed to Protect Young Consumers The federal government has made some progress toward protecting young Americans and all Americans from the worst practices of the lending industry through the recent passage of both F inancial R eform and C redit C ard R eform. As a result of new federal rules issued in August 2010, banks can no longer automatically enroll customers in overdraft protection. In other words, banks can’t approve a debit card transaction which overdraws a customer’s account, and then charge that customer $35 or more as an overdraft fee, unless the customer chooses to enroll in overdraft “protection.” These and other safeguards found in the Credit Card Act of 2009, will better protect young adults against abusive credit card fees and penalties than they have been in the past. In the Financial Reform Bill, the creation of a new Consumer Financial Protection Bureau (“CFPB”) to closely look at common financial products will provide a powerful new way to hold financial service companies accountable for deceptive practices targeted at young consumers. However, despite these positive reforms, there is still much to be done to adequately regulate lenders and credit card companies and effectively protect consumers. Credit card contracts are long, hard to understand, and full of provisions that give the credit card company the right to impose very high interest rates, and unfair fees and penalties. With limited financial experience, young adults are ill-equipped to decipher these contracts and choose among competitors. With scant or poor credit history, young adults are particularly vulnerable to “subprime” credit card offers, which charge even higher interest rates and more extreme fees than traditional “prime” credit cards. Areas for Improvement A few specific policy changes could have a positive impact on the financial security and prosperity of young adults. First, young adults have a lot to gain from targeted financial literacy campaigns. The complexity of the credit system often confuses young consumers, leading them to make poor choices or run-up hidden fees. More training in personal financial skills would help young adults avoid the financial industry’s worst practices. Second, the newly created CFPB has the power to create rules governing credit cards, private student loans, payday loans and other consumer financial products. The CFPB must enact tough regulations to prohibit companies from continuing the deceptive lending practices that helped lead to the consumer debt crisis, undermining the financial well-being of millions of Americans. The new agency must also force credit card companies to clarify and simplify contracts so that consumers understand the interest rates and fees associated with the cards they purchase. The credit card companies, banks and other lenders are skilled at discovering new fees and new penalties ; the CFPB needs to stay ahead of the lenders and pro-actively target emerging abuses before they become the industry standard. All these practices disproportionately impact young people who have the least experience with finance. Therefore, the CFPB should create new rules with particular concern for young adults. Strong consumer protections will help young adults to avoid predatory practices, to get the credit they need, and to start to build a secure future for themselves and their families. [1] Author’s interpretation of data from the Federal Reserve Board, “Economic and Research Data,” accessed September 1, 2010, http://www.federalreserve.gov/econresdata/default.htm. [3] Sallie Mae, “How Undergraduate Students Use Credit Cards: Sallie Mae’s National Study of Usage Rates and Trends,” (2009). [5] Leslie Parrish and Peter Smith, “Billion Dollar Deal: Banks swipe fees as young adults swipe debit cards, colleges play along,” Center for Responsible Lending (2007).
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