How Much Can You Borrow?
A nationwide tour of the outer limits suggests that if pressed, you could probably raise more than you think.
There can be no freedom or beauty about a home life that depends on borrowing and debt-HENRIK IBSEN
For many Americans the old tenets of thrift and common sense have been put aside; they are brought out occasionally, like sepia photographs of Victorian forebears, to evoke amusement or nostalgia. The modern way of personal finance, American style, is to borrow against future income easily, often and without regret. Consumer credit is a fact of today’s life, the essential lubricant of commerce and industry. Without it, few people could buy a house, and few would buy a luxury car. With it, almost anybody can dip into a cornucopia of goods and services, from TV sets and double-knit suits to round-the-world airplane tickets and college educations — even, in Ohio, bail bonds. By buying now and paying later, wisely or not, U.S. consumers ran up a staggering $137.2 billion in short- and intermediate-term debt last year alone — an average of $660 for each man, woman and child in the country.
Obviously, credit is not hard to get, as astonished European visitors are quick to observe. “Do you mean,” asked one new arrival from Britain, “that somebody wants to lend me money?” Indeed somebody does. Unless you make less than a steady $140 or so a week, or have run up bad debts in the past, the chances are overwhelming that your friendly bank, savings-and-loan association, credit union, life insurance company, auto dealer, department store, service station and finance company are eager to supply you with a personal loan, credit card or charge account.
If you had to, how much could you borrow? The answer depends on a lot of things: your credit record, income, assets, prospects and reasons for borrowing. Since particulars prove precepts, Money checked out the borrowing ability of four invented people in various parts of the U.S. While the borrowers are fictional, the lenders’ responses and the sequence of borrowings are not. We gave each of the four an income, described their circumstances and armed them with various credit weapons — national travel and entertainment cards (American Express, Diners Club, Carte Blanche), bank-issued cards (Master Charge, BankAmericard), oil-company cards and some local charge accounts. Then we explored each person’s power to borrow and get credit with a cross section of lenders in the cities chosen. How much, we asked, could this man or woman borrow from you if he were a real person? We followed two strict rules. We did not mislead the would-be lenders about the reasons for seeking credit or the borrower’s circumstances in order to increase the amount our hypothetical people could borrow, and except in the last case — that of Veronica Parker — we did not have them borrow any more than they could reasonably hope to repay eventually.
The bankers’ rule of thumb is that outside of ordinary home mortgages, a person can normally borrow no more than one-third of his annual income. That rule, it turns out, is far from absolute. Our somewhat surprising finding: if your income is moderately high, you can quite likely raise in cash an amount nearly equal to your annual earnings — and possibly a lot more.
John Merrick INCOME: $32,500 BORROWINGS: $33,621
John Merrick, 38, is the marketing manager of a small but diversified manufacturing company outside Seattle. A bachelor, he must turn over about $9,230 of his annual salary to the Internal Revenue Service. His take-home pay after taxes — what the federal government calls “disposable income” — is thus $1,940 a month, and John disposes of most of it with cool ostentation. For his high-floor apartment in town — on a clear day he can see over the shimmering expanse of Puget Sound to the snowcapped Olympic Mountains — he pays $300 a month (which cuts his uncommitted net to $1,640). His clothes are bespoke; he jets over the Pole for vacations in Scotland or Morocco; his car is a tangerine Porsche, as quick and low as a striking snake. Even so, Merrick does think of the future; through a local broker, he has built up a stock account now worth $17,500, a lot of it in new issues.
Merrick’s journey deep into debt is a product of his modish life style. When a San Francisco friend asks him to invest in an experimental film about a commune in Big Sur, Merrick is quick to accept. It is a risky, one-shot venture, but Merrick can afford to take the chance — and besides, he rather likes the new image of himself as a patron of the avant-garde. He heads for his bank to raise some money against his portfolio. The bank’s credit officer, a golfing friend, advises Merrick to take a three-year loan at 9.5% interest against 65% of his portfolio’s worth. John accepts the $11,375, agreeing to repay it in 36 equal installments, each of which will reduce his monthly discretionary income by $365, to $1,275.
Then an engineer acquaintance, laid off by Boeing and desperate for money, offers to sell Merrick his weekend A- frame house on San Juan Island for $10,000 cash. Merrick can either get a 20-year 7.5% mortgage or else hit his friendly banker for another loan. He chooses the mortgage, borrowing the $3,000 down payment on a bank credit card; that will cost him $140 a month initially. The monthly mortgage payment will be $56.40.
Possessions tend to breed other possessions. To get to the island, Merrick buys a $9,989 cabin cruiser, paying for it with a $5,000 loan against another bank credit card (the first monthly payment is $210) and financing the rest (at $166 a month) with the boat dealer. Now Merrick’s discretionary income is down to $703 a month. Undeterred, he decides to refurnish the A-frame, using his $2,000 line of credit at a Seattle department store. Merrick agrees to repay the store in 24 equal monthly installments of $98. That leaves him $605 a month for himself. The rest is earmarked to meet fixed expenses and debt repayments.
Even so, Merrick cannot resist one last fling — a two-week trip to stay (free) with a girlfriend in Hawaii. All it costs is $246 for the plane fare, and his American Express card permits him to repay in twelve monthly installments of $21.85 each. As we leave him flying toward the setting sun, Merrick has borrowed a grand total of $33,621. With about $585 a month left for food and entertainment, he may have exceeded the boundaries of prudence—and he has probably cramped his freewheeling life style. Still, if his film-making venture pays off, he can start the process anew without trouble. Meantime, deduction of all the interest he is paying will reduce his income taxes.
As Merrick found, the keys to borrowing are disposable income, collateral and an excellent credit record. The next case illustrates what happens when a man decides to cash in on all of those valuable commodities in a hurry. Though such instances are mercifully few — mainly because most people hesitate to tempt immediate ruin — they test the outer limits of personal debt.
INCOME: $38,500 BORROWINGS: $65,500
Douglas Randall, 48, is a man of substance. He is not only a vice president of a midwestern railroad headquartered in Chicago, but also a pillar of his pleasant suburban community of Winnetka, Illinois. He raises money for local charities, promotes cultural activities and serves on the board of the country club. Even his $85,000 white clapboard house, protected by thick old oak trees, looks like solid money. Except for a mortgage of $50,000, Randall tries to avoid debt, a habit he formed in his thrifty youth. He even bought both his cars for cash. His income allows him to send his two children to private colleges and to contribute occasionally to his stock account, now worth $20,000.
One day his broker phones. “Mr. Randall, you know I don’t get excited easily,” he says, “but I’ve got a stock here that looks like it’s sure to double in a couple of months. It’s a once-in-a-lifetime thing.” Some discreet research convinces Randall that the broker’s advice is sound. Randall has seen acquaintances take advantage of such opportunities and knows that they do not occur often. After some sleepless nights, he decides to plunge — for all he is worth. He calls a family conference to outline his plan. “Spend as little cash as you can,” he says. “We need all the cash we can put our hands on. For the next few weeks, the word is charge!”
He starts into debt by using his $50,000 life insurance policy. Randall borrows the full $5,000 cash-surrender value. Then he goes to his banker, telling him that he wants a loan to buy a speculative stock; he knows that banks do not readily lend money for such a purpose, but because of his standing in the community, he thinks he will succeed — and does. The credit officer figures that Randall’s post-tax income is about $29,950, or $2,500 a month, of which $500 must go to mortgage payments and property taxes, a minimum of $800 to living expenses, and $400 to college tuitions. “I’ll give you $15,000 at 6.5% on your assets, Doug, no sweat,” says the banker. “How about my stocks?” Doug asks. The banker frowns. “We usually don’t lend more than 20% of their value, but seeing that it is you, how about $7,500 at 6.5%?” In one working day, Randall has borrowed $27,500 without immediately diminishing his monthly discretionary income. Interest on the life insurance loan is due only quarterly, and the bank has given him term loans with both principal and interest to be repaid at the end of six months. Randall does not worry because if all goes well, he will be in debt for no more than a few weeks.
His next stop is a consumer finance firm to get a five-year second mortgage on his house. That takes some persuading, for Randall is already heavily in debt. But he relies on his reputation as a dependable citizen and gets $15,000 at 12%, with installments of $334 due every month. A title search will take a week, but Randall will have the money when he needs it to settle with his broker. Now Randall has raised $42,500. By writing a check on his account with a Winnetka bank, he goes to the limit of a reserve overdraft of $1,500. The next day he commits $44,000 to his broker, who gives Randall a 45% margin loan at 6.25% and reserves in his name $63,800 worth of the stock.
Borrowing dulls the edge of husbandry. -Shakespeare
Randall still has more than enough cash for the host of petty expenses that can be paid for in no other way — taxis, movies, snacks and (in most states) bottled liquor. His family is now busily charging everything else. Randall knows that he will soon be faced with gasoline bills on a Texaco card, lunch bills on his Carte Blanche card, a dentist’s bill, a doctor’s bill, a country club bill, all adding up to about $500. The family also uses bank-issued credit cards to the $1,000 limit prearranged with the bank: back-to-college clothes and a new stereo for the kids, a fall coat for Mrs. Randall, a club chair to replace the one that finally gave out. When Mrs. Randall announces that she has charged some $200 worth of food at a local grocer’s and complains that his prices average nearly 7% higher than the A.&P.’s, Randall is ready with an answer: “Honey, it’s expensive to avoid spending cash.”
The Randalls’ activities do not draw prompt queries from the credit agencies; the pertinent bills take time to be reported, and Doug Randall has built such a solid reputation that merchants trust him anyway. In total, Randall has accumulated $65,500 of debts.
A probable end to this saga would be that the stock would not soar, and Randall would take a net loss on the whole adventure. But say the stock doubles in value in six weeks. Randall sells it for $127,600, of which about $33,300 will go to the IRS. That leaves him with roughly $28,800 in cash after repaying his debts. Because he has repaid them long before they are due, Douglas Randall emerges with a better credit rating than ever. He wins in every sense.
Randall’s assets and past credit record formed a solid foundation for his pyramid of debt, and indeed his borrowing seems fairly monumental. But what happens when someone has neither sufficient collateral nor an established credit history? One answer comes in the case of Frank Ferrer, a man who can, in effect, parlay his bright future prospects into a substantial amount of debt.
INCOME: $22,500 BORROWINGS: $17,584
For an able young man who seems to have arranged his life as neatly as if it were plotted on a graph, Frank Ferrer is in grave, unexpected trouble. Only 27, he has a good job with a Manhattan-based educational publishing house. He is proud of his salary and prouder still of his solid reputation as “the man to watch” within the firm. His mother and father regard him as the family success. “A sweet wife, adorable kids, lots of family feeling,” they say. “Who could ask for more?” They contrast him to his older brother Phil, who remains a bachelor and seems a bit too flashy, too selfish.
It is Phil who sends Frank reeling into debt. He calls up one day and says, his voice quavering, that his boss in the payroll department of a large chemical company has caught him embezzling, but will not press charges against him if full restitution is made immediately. “I’ve got to have $20,000 by Wednesday,” he insists. Otherwise he will be prosecuted and probably convicted, besmirching the whole family’s name.
“How much can you raise yourself?” asks Frank.
“No more than $2,500,” replies Phil.
Frank Ferrer takes a quick inventory of his personal assets: the furniture in his rent-controlled apartment on Manhattan’s West Side, a $5,000 joint savings account with his wife, a two-year-old Volkswagen, a bank credit card with a $5,000 line of credit — not nearly enough. But he can hock his future. Ferrer asks his company for an advance, explaining his problem as “an urgent family affair that I’d prefer not to discuss.” His boss listens coolly to Ferrer’s plea. “Our policy is not to help employees go into debt,” he says, reaching for the phone. “But in your case we’ll put in a good word at our bank.”
The bank’s credit officer has seen enough frantic applicants — homosexuals being blackmailed, debtors threatened with muscle tactics — to put a discount on despair. “The important thing,” he says, “is to help you make the most of your borrowing capacity.” Then he goes on to reckon that after Ferrer has paid taxes, rent and other living expenses for his family (food, medicine, insurance and basic recreation), he has a maximum of $450 a month left over with which to carry debt.
Borrowers are nearly always ill-spenders-JOHN ruskin
On the banker’s advice, Ferrer goes to his savings bank for a loan on his account at 7% a year while the account continues to draw 5% interest. Since Frank expects Phil to start repaying him soon, he accepts this cheapest form of debt. He can borrow 97% of the $5,000 for only $8.20 a month, net, and can postpone repayment of the principal for a while if he keeps up his interest payments. On the strength of Ferrer’s company’s endorsement, the banker he has consulted will “go beyond reasonableness,” as he puts it, and lend another $7,500 at 11.5% for three years. That works out to monthly repayments of $247. Ferrer’s regular commercial bank will lend him $5,000 more against his Master Charge card at 12%. Though Ferrer will have to repay the loan, the card’s “revolving-credit” feature allows him to keep his debt at the full $5,000 limit almost indefinitely merely by withdrawing any repayments the day after he makes them; for the purposes of his planning, he will only have to meet the interest charge of $50 a month. Counting all three loans, Ferrer’s discretionary income has shrunk from $450 a month to $144.80. But he has raised $17,350.
“Don’t borrow a cent more,” says the banker. “If you have any unforeseen expenses — say, a major sickness — you’re going to have one hell of a time.” He pauses, then adds: “And don’t come back here next week expecting help. You won’t get any, regardless of your reasons.”
Still, Ferrer needs another $150. Having exhausted his credit elsewhere and even mined his expectations of a successful future, he buys an unorthodox kind of negotiable paper. At an airline ticket office, he uses his travel and entertainment card to buy an economy round-trip ticket to Denver ($234) with the flight number and dates left open. He sells it to another customer for $150. The deal will cost him about $21 a month for a year.
“You’d better get a good raise soon,” his wife tells him when she hears what Ferrer has done. “Right,” he answers. “And you’d better not let anybody get sick.”
Though Frank Ferrer plunged further into debt than he should have, in the world of serious debtors he is a piker. The big leaguers are those who can borrow against a business venture. They get credit that is not available to ordinary salaried citizens. Certainly, most people will not switch professions just to enhance their ability to borrow. But business-borrowing opportunities often do appear before Americans of moderate means, and when that happens it can cause marked changes in their life style.
INCOME: $20,000 BORROWINGS: $45,051
When Veronica Parker was divorced five years ago, she was, at the age of 42, attractive, poised, elegant. She proved energetic, too, refusing to make do on her alimony of $10,000 a year plus $2,000 from a small family trust fund. Rather, she went to work as a receptionist at a big Atlanta architecture firm and now earns an additional $8,000 a year. Her friends admire her gumption — and her superb collection of Early American furniture.
Her assets also impress her brother. He wants to open an antiques and decorating business dealing only in quality goods. To build up an inventory, he needs more cash than he can raise by himself and turns to Veronica for help. She becomes a backer, which gives her certain advantages that she had never even thought of before.
Most important is her ability to borrow. Previously she had considered personal debt as slightly odious — a final refuge for the crass and opportunistic — and had avoided her bank’s credit officer. On visits to the bank, Mrs. Parker had seen his face as he dealt with suppliants. Sometimes he was all smiles, sometimes as stern as a block of granite. Today he smiles as he listens to her describe her wish to borrow for the new business.
The alimony does not count highly in his eyes. “What if your husband stops paying?” he asks, posing a question that plagues divorced women everywhere when they look for credit. But her steady salary and her trust fund are a different matter. Because of them, Mrs. Parker has no trouble borrowing $5,000 for three years at 8%. Since the money is going into a business venture that takes time to get into the black, the bank is willing to postpone amortization for six months, when she will have to work out a schedule of monthly repayments. Present cost of her loan: $32.88 a month.
While $5,000 helps to secure a lease for the shop, it does not go far in buying authentic antiques. Mrs. Parker visits the officer who administers her trust. Can she borrow against assets that she has not yet received? “Sure,” says the officer, “if the trust agreement says you can.” It does, and she borrows $20,000 at 8%, repayable when the trust’s term expires in 1980. That costs her $133.33 a month in interest, so she now has $25,000 at a monthly cost of $166.21— a figure that hardly strains her $793 monthly income once taxes, rent and basic living expenses have been met.
Mrs. Parker knows that her brother needs even more help. Having raised all the money she could against her personal assets, she goes to her architect boss for advice. “I’ll take you to my banker,” he says, and on the strength of his endorsement, she gets an installment loan of $10,000 for three years at 11.08%. The monthly interest and amortization payments of $327.70 cut her remaining discretionary income to $299.09.
She already feels the strain of raising $35,000, and she will suffer financial agonies when she has to start repaying the first $5,000 loan. But she prefers to look at the bright side and counts on the shop’s operating at a profit from the start. In fact, she begins to spend the future profits to spruce up her image with her brother’s rich clients. The business will depend on the carriage trade, she reasons, so naturally everybody associated with it should give off an aura of genteel prosperity.
Trips to Atlanta specialty shops for classy new clothes result in $1,100 in bills. Of this, $400 can wait; some shops do not charge extra for deferred payment. But the other stores will charge 1.5% a month on her outstanding balance. She trades in her old Chevrolet on a Jaguar XJ6, which costs her another $8,100 at 14.55% interest over 36 months, financed by the dealer. But a tentative bid to get a nice house is stopped cold. The mortgage banker frankly tells her that she is already overextended.
Never spend your money before you have it. -thomas jefferson
She learns from her brother that business expenses are tax deductible, so she decides to use her vacation to search for antiques in England. Her Diners Club card pays for the plane tickets ($459) and for her hotels and car rental ($392). What her brother did not tell her, unfortunately, is that bills cannot be paid with tax deductions. Mrs. Parker has become what one Atlanta banker terms “a walking bankrupt.”
Her debt-carrying ability has been completely consumed. When she has to start repaying the first bank loan after six months, she cannot. She is summoned by the credit officer at her bank. On his desk lies the evidence of her expenditures and loans. His expression is as unyielding as granite.
With the bank’s help, Mrs. Parker can probably work out a reasonable repayment schedule and so avoid being hounded by her creditors. Meantime, her line of credit will end. If her brother’s business fails, she will of course be in deeper trouble. As a last recourse, she could get relief under Chapter 13 of the Bankruptcy Act, which in effect provides for federally supervised debt consolidation. She would have about three years to pay off her debts in full through a court. During that time, creditors generally would be allowed neither to press her for money nor to charge interest. In one recent twelve-month period, some 31,000 Americans sought the protection of Chapter 13; such people are known in the credit business as “honest bankrupts.”
In an atmosphere of easy credit, it is predictable, and probably inevitable, that a small proportion of borrowers will wind up as bankrupts, honest or otherwise. Borrowing is expensive, and careless — or desperate — borrowing can be prohibitive. Unless you are a member of a credit union, the best place to get a loan is usually a commercial bank. Current interest rates for personal loans average between 13% and 15% annually, though the banks also get from 12% to 18%, depending on state law, for unsecured debts charged against their own credit cards and against “overdraft,” or “cash reserve,” accounts. Finance companies can exact a good deal more. Partly because theirs is a risky business — they specialize in lending to people with poor credit ratings, who probably should not be borrowing at all — their interest rates run from 10% in Arkansas to 41.7% in Mississippi.
Our four hypothetical cases illustrate some of the other vagaries and variations of the lending business. Bankers differ over what percentage of a stock portfolio they will lend on; for John Merrick in Seattle it was 65%, for Doug Randall in Chicago it was only half that. Bankers do not necessarily come up with the cheapest answers for their customers: Frank Ferrer could have saved a bit by emptying out his savings account rather than taking a loan equal to 97% of what he had on deposit.
Lenders know that when a borrower defaults on his debt, there is not very much that they can do about it. At best, they can persuade him to consolidate his debts by taking one big loan to pay off all his nagging creditors. While that sounds sensible, the debtor nonetheless sometimes risks finding himself paying a higher rate of interest for the consolidation loan than some of his various creditors had been charging. In some states the lender may be allowed to charge an extra fee, and he may well do so because the debtor who is forced to come to him for a consolidation loan has already shown himself to be unreliable. Another recourse for lenders, generally after months of pleas, threats and angry calls, is to sell the unpaid debt to a collection agency that will harass the borrower and perhaps finally take him to court.
Mend your clothes and you may hold out this year. -george Herbert
Abandoning debt can get a man into civil lawsuits, but it is not a criminal act. (Maine still has a law that allows jailing of debtors, but it is no longer enforced.) Consequently, a man who flees to a foreign country cannot be extradited to face his bills. But he can’t come home again either, unless he is willing to risk having his creditors take him to court to collect what he owes them.
Because their weapons against the determined deadbeat are ultimately so flimsy, lenders screen most requests for credit more carefully than applicants may realize. “If a man asked for a loan and told us that he did not have any other loans outstanding,” says a Manhattan banker bravely, “we would know within ten minutes whether he was lying.” The head of a bank credit-card operation explains: “When an individual requests a credit-card or personal loan, he must fill out a form. The information then goes to a central credit agency like TRW Credit Data, which has computer files on about 20 million people. If the individual already has a lot of debt or what we consider to be too many credit cards, his application will probably be turned down. If he begins to overextend himself, the agency will alert inquiring merchants so they do not respect his request for credit.
Still, credit remains very much a borrower’s market, at least in the sense that a dedicated debtor can almost always find someone to provide one more loan. An official of American Express, whose cardholders last year defaulted on less than half of 1% of their bills, concedes unemotionally: “Everybody has heard horror stories about people who go on credit binges. Some of them are true.” At American Express and elsewhere, lenders have learned to live with—and adjust their rates for—two related, unpleasant certainties: monitoring systems are not foolproof, and there are plenty of fools around who are ready to borrow too much in too many ways.