There is a worldwide generation that is marked by young, highly educated individuals who are often mired in unmanageable debt. In the United States it is called "Generation Debt," a phrase coined by author Anya Kamenetz. In Europe, it is called the "1,000 Euro Generation," a moniker credited to an internet novel published in Italy. How can young people all over the globe avoid this trap? Read on to find out.
Tutorial: How To Manage Credit And Debt
Unmanageable debt is debt that can't be serviced without significant hardship to the borrower. More technically, it refers to non-housing related debt in excess of 8% of a person's gross income. The figure often comes into play when calculating eligibility for loans, particularly housing. (For more insight, see Too Much Debt For A Mortgage?)
When it comes to housing loans, your front-end ratio, which consists of the four components of your mortgage: payment principal, interest, taxes and insurance (often collectively referred to as PITI), should not exceed 28% of your gross income. Your back-end ratio, also known as the debt-to-income ratio, should not exceed 36% of your gross income. The difference between the two is where the 8% figure comes from.
To calculate your maximum monthly debt based on these numbers, multiply your gross income by 0.36 and divide by 12. For example, if you earn $35,000 per year, your maximum monthly debt expenses should not exceed $1,050, of which not more than $816.60 should be dedicated to housing. That gives you about $233 a month to cover your car payment, school loans, credit cards and all other forms of debt. For those just starting out in the working world and earning a small salary, this really doesn't provide much room to service debts.
How Does it Happen?
There are many factors that lead to unmanageable debt. For one, there is the high cost of a college education, which CollegeBoard.org cites as $28,500 for one year at a four-year private institution and $8,244 for one year at four-year public school, during the 20011-2012 school year. Students pay the price in the hope of securing high-paying jobs. (For related reading, see Invest In Yourself With A College Education.)
Some students are lucky enough to have their parents' help or scholarships to cover the cost, but many students are not this fortunate. According the FinAid.org, two-thirds of students graduate with some debt; the average undergraduate student loan debt is nearly $23,186, while graduate students, depending on the degree, end up owing an average of between $42,898 and $118,500.
If students accumulate credit card debt or lines of credit during school to pay for rent, food, car leases and other living expenses, their total debt upon graduation can really add up. As a result, many students start their careers with a considerable debt burden.
Housing: Buy, Rent or Move Back Home?
After crunching the numbers to address the question of where to live once they graduate, many young people realize that they can't afford to pay a mortgage on top of servicing their existing debt. Others decide to buy and end up house poor, and more than a few move back in with mom and dad, ending up as boomerangs. (Why Some Kids Never Leave The Nest provides a closer look at this phenomenon.)
In addition to the costs of education and housing, a pervasive culture of consumerism encourages additional consumption, turning luxury items into necessities. Travel, cell phones and computers are among the possessions everyone seems to have. Everyone wants to live "the good life," but because not everyone can afford these items, particularly young people who are already carrying significant student debt loads, credit cards and borrowing often fill the gap. (Read Stop Keeping Up With The Joneses - They're Broke for more insight.)
Few people remember that things weren't always this way. In the not-so-distant past, people worked a lifetime to achieve their financial goals, and their goals were often modest. A house in the suburbs (not a McMansion) was a huge achievement; in 1950, that home was about 983 square feet, but by 2011 the average size had ballooned to 1,800 square feet, according to the National Association of Home Builders. Similarly, baby boomers may recall that their parents' vacations were infrequent and often involved domestic travel. Other luxury items such as high-end cars and designer clothes have also become more common; in fact, marketers frequently refer to the "under-40 luxury consumer" as a key demographic.
Today, the affordability of travel, easy access to credit and heavy marketing efforts have changed the dynamic. Young people grow up seeing the lifestyles that their parents enjoy, and they want to live that way too, but without working for decades to achieve it. The end result is often unmanageable debt.
The Bottom Line
In our fast-paced consumer culture, the truth is that slow and steady still wins the race. Simple decisions, such as not spending more than you earn and learning to delay purchases until you can pay for them in cash, go a long way toward getting your financial house in order. In most cases, the biggest challenge you face isn't financial, but the need to curb your desire to spend.
While the lure of spending can be hard to resist, take your grandmother's advice and appreciate what you have instead of complaining about the things you lack.
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