Debt Is On the Rise Again
Are you feeling nostalgic for 2008? Perhaps not, but we are heading toward an unpleasant milestone set in 2008 – a record amount of household debt. The New York Fed's February 2017 Quarterly Report on Household Debt and Credit reports that our collective household debt has reached $12.58 trillion. At the current rate of increase, household debt should surpass the 2008 peak of $12.68 trillion sometime this year.
It's not unreasonable to expect cumulative debt to rise over time even if interest were not considered, since the number of households in the U.S. expands every year. There were 125.82 million American households in 2016 compared to 116.78 in 2008. Even so, the overall trend line is cause for concern.
Given that runaway debt was a major driver in the Great Recession, should we be worried that another meltdown is on the way? Probably not. For answers, look beyond the cumulative debt number to the changing nature of that debt.
Don't Panic Just Yet
The New York Fed's report breaks down household debt into specific components: housing/mortgage debt, student loan debt, auto loan debt, and credit card debt. While mortgage debt is still the largest component of household debt, that debt is not rising as rapidly as other forms of debt in relative terms.
The ability to manage our debt is also greater than in 2008, when 8.5% of total household debt was considered to be either delinquent or late in payment during the third quarter of the year. Compare that to the most recent data (Q4 2016), when only 4.8% of debts fell into this category.
The Fed report cites "stronger new extensions of credit" as a significant component in the debt increase. In particular, mortgage originations reached $617 billion, the highest level attained since the early stages of the Great Recession.
The housing market has been suffering from limited supply and pent-up demand, so this aspect of debt may be a positive sign — assuming borrowers are not overextending and buying more home than they can afford. That type of unsustainable debt — combined with the failure of markets to see the credit time bomb ticking inside mortgage-backed securities (where subprime loans grew from 8% of MBS loan portfolios in 2004 to 20% in 2006) — were arguably the driving forces behind the Great Recession. Today, credit may be loosening again, but it is nowhere near the freewheeling excess of a decade ago. MoneyTips is happy to help you get free refinance quotes from top lenders.
Maybe Panic Just a Little
While a mortgage meltdown seems unlikely, student loan debt may be the source of the next dangerous bubble. It increased by $31 billion in the fourth quarter of 2016 to reach $1.31 trillion, a staggering sum that many graduates are in no position to repay. Without the support of recent graduates to buy starter homes, it will be difficult for the housing market to reach full potential – shifting the more unsustainable debt toward student loans and credit cards.
Credit card and auto loan debts were rising at faster percentages in Q4 2016, with credit card balances increasing by $32 billion to reach $779 billion and auto loan debt rising by $22 billion to $1.16 trillion.
Thus, the real question: Are people generally living beyond their means once again, or simply incurring more debt and managing it wisely? That answer will be revealed over the next several years.
Be a Value Consumer
Keep in mind that debt is not necessarily a bad thing. It's the value you receive for your household debt and how you manage it that dictates whether your debt is problematic.
The key is a long-term plan and budget, especially with respect to daily expenses that can easily be applied to a credit card without thinking about overall debt. For larger expenses, such as college and a home, you must define needs instead of wants. Look at such expenses as a pure investment. Are you spending disproportionately more for college than your eventual career is likely to generate, and are you overextending your debt to buy more home than you can afford?
Don't be afraid to go into debt, but make sure that you receive value for that debt.
Debt may be increasing, and credit may be loosening, but that doesn't mean you should incur more debt than you really need. Make sure that you keep a budget to control your purchases and stick to it, maintain an emergency fund to help limit the effect of unexpected expenses, and manage your existing debt wisely to keep your interest payments as low as possible.
Be part of the debt solution, not part of the debt problem.
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