America Breaks the Debt Record
According to the New York Fed's recent Quarterly Report on Household Debt and Credit, America has more debt than ever before. Do you? Should you be concerned in either case?
The report shows that American household debt reached $12.73 trillion in the first quarter of 2017. That tops the previous peak of $12.68 trillion in the third quarter of 2008, before the effects of the Great Recession reversed a long-standing trend of rising debt (and not in a good way).
Is this milestone good or bad for America in general and for you in particular? Let's drill into the details for the answer.
A More Stable Debt Picture
Our collective household debt may have surpassed pre-recession levels, but the nature of that debt has changed from the 2000s. In 2008, household debt was almost equal to household income. Today, household debt represents approximately 80% of income. We may have more debt, but the nation is in better shape to absorb it.
The debt mix has also changed noticeably since 2008. The Fed report divides household debt into six categories: mortgages (including home equity loans), home equity revolving debt (HELOCs), student loans, auto loans, credit cards, and other (consumer finance/retail loans). At 71.4% of all household debt in Q1 2017, housing debt (mortgages, home equity loans, and HELOCs) far outstrip the other four categories – as you would expect given the number of American homeowners and the average price of a home.
At the 2008 debt peak, housing costs were nearly 79% of all household debt. Too many Americans were saddled with unmanageable debt and few refinancing options when the recession hit and home values collapsed. Today's tightened lending environment has dropped housing risk significantly.
Currently outstanding subprime loans (Equifax scores lower than 620) are below $18 billion, compared to a 2007 peak of almost $115 billion. Mortgage delinquencies are at 1.7%, compared to a near 8% peak in 2010.
In essence, the category holding most of the household debt ($8.63 trillion for mortgages) is in relatively stable shape – a good sign overall for America's economy.
Auto and Student Loan Troubles
If housing is playing a lesser role, what is driving the debt increase? It's not credit cards. Collective credit card debt has dropped from $839 billion at the end of 2007 to $764 billion in Q1 2017. American consumers, burned from the recession, are wary of taking on excessive debt and are managing their credit wisely.
Two sources of debt are driving concern, however: auto loans and student loans. Auto loans, now at $1.17 trillion, are tracking the path of the pre-recession housing market regarding subprime loans. The share of subprime auto loans that are deep subprime (FICO scores below 550) rose to 32.5% in 2016. In 2010, deep subprime loans were only 5.1% of the outstanding total.
While delinquency rates are flat at 3.8%, an auto loan bubble may arguably be forming – but it's not large enough to take down the economy as the housing crisis did.
Student loan debt forms the more disturbing trend. It has skyrocketed from almost $500 billion in 2007 to $1.34 trillion today to become the second largest category of household debt. A disturbing 11% of student loan debt is either delinquent by more than 90 days or considered in default. Student loan debt is hard to discharge via bankruptcy – therefore, a generation may be affected for much of their life by student loan burdens, unable to afford homes and spend at the same levels as their parents.
Good for the Nation, Bad for Some
Given that debt often corresponds to increased consumer spending, which accounts for 70% of the economy, collective household debt is not necessarily bad. It must be considered in terms of value and risk.
Mortgage loans provide value in home equity, assuming the debt is manageable. Student loans should provide a lifetime payback in an increased salary, but the rise in college costs relative to salaries has skewed this premise. Auto loans and credit card purchases should be looked at through a similar prism of value.
America's household debt is arguably out of risk/reward balance in two areas, with student loans potentially more dangerous and persistent than auto loans. Neither market is large enough to cause an economic meltdown by itself, but some individual consumers will suffer – and with student loans, the effects may cause an extensive and slow drag on the economy.
Realistically, a healthy American economy should generate increased household debt – because we regularly generate more households via population increase. As long as debt is issued with adequate risk management by both lenders and borrowers, and is not outpacing America's collective income, debt increase can be a positive sign.
Debt increases are of greater concern at the individual level. Assess the risk involved in any debt that you incur. Is it worth the reward? For example, are you buying more home than you can afford, or will your planned college expenses be proportionate to your expected post-collegiate salary? Combine a return on investment viewpoint with a solid budget, and your debt will be manageable even when America's is not under control.
If you have already incurred too much debt, especially student loan debt, investigate your refinancing options and potential forms of relief – but at the end of the day, the key is responsible budgeting. Limit expenses, increase income however possible, and use the surplus to pay down debt. It's fine to look for assistance, but don't hold out for shortcuts.
If you want to reduce your interest payments and lower your debt, try the free Debt Optimizer by MoneyTips.