A Generation of Debt, Part II: Young Adults

Physician's Money DigestApril 2006
Volume 13
Issue 4

When college graduates embark on their life as independent adults, they take on their journey the educational debt accrued as undergraduates. Ushered from commencement by their idealism, these young adults have yet to encounter the hurdles of life. Securing a job, buying a home, starting a family, and saving money—benchmarks that their parents achieved before age 30—are simply not attainable until later in life as debt takes a stronghold on young adults.

Dr. Robert Manning, professor of finance at the Rochester Institute of Technology, outlines the social and cultural constructs surrounding this next generation of debt in his report "Living with Debt."Irresponsible spending and saving, disregard for budgeting, and a difficult housing market mire young adults as they struggle to establish their lives.

Harsh Transitions

Just as when they first set foot on campus, college graduates venture into adulthood with the same disregard for traditional Puritan values, according to Dr. Manning. Young adults have not inherited the responsible spending and saving patterns of their parents that had been passed down through generations. And guess who is to blame? Well-intentioned parents gave into rising material expectations and the enhanced lifestyle activities of their children by granting their every wish. Young adults, who expect a certain lifestyle, continue with the credit-and debt-based lifestyle cultivated in college—despite increased financial obligations and responsibilities.

Today's young adults encounter unprecedented levels of educational debt, particularly at the undergraduate level. According to the National Postsecondary Student Aid Study by the National Center for Education Statistics, students now graduate with an average of $18,000 in federal loans. In fact, 25% of students borrowed more than $25,000, and 10% owe over $35,000. These numbers exclude private education loans and credit cards that are used to finance education expenses as well as lifestyle costs. Graduate and professional students, including medical students, borrow an additional $27,000 to $114,000.

As a result of ingrained consumer spending and educational debt obligations, the rainy day funds of the past have a modern replacement: credit. Young adults can now respond to an emergency financial situation with one swipe of the plastic. Growing consumer debt reflects their inability to effectively balance money.

Blind Budgeting

Revolving credit is a credit line that can fluctuate each month as needed by the debtor; credit cards are the most popular form of revolving credit used by the average consumer. Americans owe $2.62 trillion of which $826 billion is revolving credit, according to a 2005 Federal Reserve report. In 1996, consumers owed almost half of this amount in revolving credit—$462 billion. Adjusted for inflation, these 1996 dollars would be $562 billion today—an increase of 46% in revolving debt. These billions of dollars break down to $11,802 owed per individual on revolving accounts, including credit cards and auto loans, according to the Experian National Credit Score Index. Young adults aged 18 to 29 now owe an average of $8636 in revolving credit.

The growing problem with debt is evidence of a single culprit: living beyond means. With every dollar of interest accrued on loans and credit cards, young adults resist implementing a personal or household budget. In a survey conducted by Dr. Manning, only 52% of young adults have developed a monthly budget, and even fewer stick to it. Only 60% of those with a budget designate dollars for any type of savings, such as investments. This nearly nonexistent budgetary discipline is fueled by the importance of consumption and reliance on credit in young adults'life. Necessity vs lifestyle needs have become interlinked, a phenomenon David Bach has coined the Latte Factor®.

New York Times

Start Late, Finish


The author of the number-one bestseller (Broadway Books; 2005), Bach believes that it's the little purchases that you don't even think about, such as fancy coffees, fast food, magazines, and bottled water, that add up over time. He bases the Latte Factor® on the idea that this frivolous spending can be redirected into saving. If you usually spend $5 on a latte and a bagel 7 days a week, you could redirect this $150 into a monthly investment. At a 10% annual return, you could accrue $30,727 in 10 years.

As young adults ignore the small daily purchases and rely on credit, their debt grows. Changing spending habits could mean the difference between young adults living paycheck to paycheck and saving for the future. Unfortunately, the housing market only compounds their cash-flow problem.

Housing Competition

The bad news:

Forty-two percent of individuals under age 35 owned a home in 2003, according to the 2004 Joint Center for Housing Studies of Harvard University. The good news is that this number represents a 4% increase from 10 years earlier. Young adults spent 10% more on rent between 1992 and 2002. While nearly one third of all households spend 30% on rent or mortgage, 13% spend more than 50%. Contributing more of their paycheck to housing expenditures, young adults'dual task of paying rent and saving for a down payment on a first home seems daunting, particularly as home prices and the cost of living continue to outpace wages. As housing affordability becomes a lost concept, the young adults of today purchase homes with more than $14,000 in consumer debt alone.

Because of low interest rates, lenders hand out risky mortgages to finance otherwise unaffordable homes. It should come as no surprise that interest-only loans particularly appeal to young adults, according to Dr. Manning, because a borrower can purchase more house than they otherwise could afford—the mortgage version of living beyond means.

According to Bankrate.com, interest-only loans offer the lowest possible monthly payment, requiring the borrower to pay only the interest on the mortgage. Usually in 5 to 7 years, the balance is due, at which time borrowers pay a lump sum or refinance to pay off the principal, which is when the payments jump. This type of loan best benefits borrowers who have the discipline to invest the money they would have paid as equity into another vehicle to pay off the lump sum. You can see the fallacy of this concept.

What's interesting to note is that there seems to be a relation between median age of first marriage and the median value for all owner-occupied housing units, according to the 2003 US Census. It seems the most expensive states also have the highest age of first marriage, with the median age in the United States at 26.7 for men and 25.1 for women. Coincidence? Dr. Manning reports that the current debts of young adults will influence their ability to marry in the future as well as delay plans for starting a family. This trend is in contrast to mature families and empty nesters, who seemed capable of having more on much less, but have their own issues with which to contend.

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