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Clients’ Growing Debt Loads Are Worrying CPAs

Clients’ Growing Debt Loads Are Worrying CPAs By SHELLY GARCIA Senior Reporter To many, the red hot residential real estate market is a sign that the local economy remains strong despite the nation’s growing economic woes. But to many CPAs, it looks like a recipe for disaster. From their vantage point of income and deductions, assets and liabilities, these accountants see mounting evidence that consumers are becoming far too heavily leveraged for their own good, and even modest changes in either their own finances or the economy could push many over the edge to insolvency. “With interest rates dropping, people have been able to take on more debt with the same payments,” said Mitchell Freedman, a CPA and financial advisor who owns MF Accountancy Corp. in Sherman Oaks. “A lot of people are finding they can’t handle the debt load.” Nationally, bankruptcy filings have reached their highest levels in history, soaring to 400,686 in the quarter ended June 30, according to the American Bankruptcy Institute, although local filings have actually decreased. In the Central District of California, which includes Los Angeles County, bankruptcy filings in the first half of the year totaled 42,844, down from 46,496 in the second half of 2001. But CPAs say that the numbers of filings do not tell the whole story. Bankruptcies may lag the economy by six months or more, and so far, the economy in Southern California has held up far better than it has in other parts of the country. The problems, these accountants say, will come later as the economy starts to improve and interest rates begin to rise. “Now you’re looking at people acting as if low interest rates will last forever,” said Gary Condie, a partner at Condie & Wood, a Valencia accountancy. “Some of these people are going to be caught by surprise.” Since the run-up in the stock market began in the late 1990s, consumers have been layering on debt to finance a buying binge, and when the market collapsed, they began to tap their home equity. The corresponding declines in interest rates led many to take on more debt by buying homes beyond their means, and others have used the savings from refinancing to live beyond their means. “I can tell you there are a number of people who got overextended in the hot days of the stock market,” said Condie. “They had this new sense of wealth. The stock market isn’t doing that anymore, but something else is, real estate.” When the stock market was on a roll, consumers figured they had a cushion they could fall back on if the economy turned sour, so they freely used their credit cards to shop ’till they dropped. Many might well have been caught red-handed when the stock market collapsed, except home prices had begun to escalate and interest rates began to drop at about the same time. Many consumers used home equity to pay off their credit card bills, heading off imminent financial ruin. But in so doing, they simply transferred their credit card debt over to mortgage debt. For the time being most in the local area have been able to manage the higher debt load. The Southern California economy has remained relatively healthy, and low interest rates mean many have seen little change in their monthly payments despite their rising debt load. But it may not be long before they have to pay the piper, and when the time comes, they may not have the wherewithal to do it. “If you sit down and do a budget, their income doesn’t meet their expenses,” said Laurence D. Merritt, whose Woodland Hills law office specializes in bankruptcies. “They’re living on the equity on their homes. That’s one big reason why, if interest rates pick up, I think you’ll see a lot of people going bankrupt.” Accountants worry that those homeowners who opted for short-term fixed-rate mortgages to take advantage of extremely low interest rates will face dramatically higher floating rates when the loans convert five or 10 years from now. “What happens if interest rates go to 12 percent?” Condie said. “Some of these people will be priced out of their homes.” Even those with fixed mortgage loans are often one paycheck away from being able to make their payments. If a spouse loses a job, or the family incurs an unforeseen expense, the house of cards could come tumbling down, accountants say. And everyone faces the prospect of declining home prices if interest rates escalate. “If mortgage rates went back to where they were (a few years ago), home prices will come tumbling down, and then you will see bankruptcies,” said Condie. Many accountants are genuinely angered by a state of affairs they think has escalated in part because of government’s role in bringing down interest rates and exacerbated by auto companies touting zero percent interest. “Mortgages are being financed at lower rates, but it’s still a debt,” said Carl Hagen, partner at Hagen & Hagen, which specializes in bankruptcies. “And now auto companies are giving them zero interest and it’s still a debt.” But most concede there is very little they can do until it is too late. “When do you go to the doctor?” asked Condie. “Most people only go to the doctor when they don’t feel well. That’s true of doctors, dentists, attorneys and accountants.” Those who take advantage of financial planning services offered by some CPAs are more likely to be disciplined about their spending in good times as well as bad. But many clients don’t seek the assistance of their accountants until it’s too late. “More often than not, you learn about it after the fact,” said Condie

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