Business Forum

High Debt and Cash Flows Management: Understanding the Credit Divide
by James Gaius Ibe, Ph.D.

What are the differences between prime and sub-prime borrowers? How can people making relatively substantial incomes have little or no savings? What accounts for high rates of debt among some individuals in all income groups in general, and many low-income individuals, minorities, and the elderly in particular? The answers to these questions loom large and are directly related to the widening credit divide.

While the causes are varied and are open to debate, individuals in this category tend to share similar profile: Lack of adequate attention to cash flows. Indeed, it is all about cash flows. It is not how much one makes but how much one gets to keep. If outflow (consumption) is more than inflow (income), there is a negative net cash flow (debt), regardless of the size of inflow (income). Though some have suggested additional inflow (income) as a way out of debt, the additional income approach fails to address the core problem. Further, if one can not effectively manage one thousand dollars, one is unlikely to manage ten thousand dollars effectively.

People tend to use their income in four basic ways: private consumption, private savings, public consumption, and leisure. As some have already pointed out, if consumption standards are satisfied easily out of current income, there is greater tendency to save privately, support public goods, and enjoy more leisure time with family or friends. However, when lifestyle and consumption standards are up-scaled more rapidly than current income, private consumption tends to crowd out other alternative uses of income

Individuals with good credit histories are prime borrowers while those with poor credit histories are sub-prime borrowers.

Most major banks offer loan products to both classes of borrowers but under markedly different terms. In most cases, sub-prime borrowers pay substantial premiums for the higher risk they represent to the lending institutions. Additionally, they frequently become victims of predatory lending and usurious interest rates, which can run as high as 240 percent in addition to hidden charges in some instances.

Individuals in this category find themselves in a vicious circle: They have high debts and poor credit histories so they borrow under poor credit terms. And because they borrow under poor credit terms, they have higher debts and poor credit histories. Further, the sub-prime credit terms are not designed to get borrowers out of high indebtedness, indeed they tend to perpetuate high indebtedness. Pay day loans, cash advance, and title loans outfits which tend to charge outrageously high interest rates fall in this category.

Some Solutions:

Start with a budget. Live within your means. Pay attention to income as well as consumption. Know what is on your credit file. Rebuild your credit by borrowing small amounts from major banks and pay them back in a timely fashion. Renegotiate with the major creditors rather than abandon your debt. Ask them to abate the accumulated late fees and lower the interest rate. If you do fall behind and your account is sold to factors (bill collectors) negotiate with them for cents on a dollar, they probably bought your account at very deep discount from the original creditors. Avoid using pay day, cash advance or title loan outfits as sources of long term financing.

ABOUT THE AUTHOR: Dr. James Gaius Ibe is the principal of Global USA-Marketing and Management Consultants. He is also a senior Professor of Economics and Marketing at one of our local colleges.

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