RCF Special Report – Why (Most) Everyone is Wrong about Consumer Debt Levels

Peter Bernstein, Chief Economist, pbernstein@rcfecon.com, 312-431-1540 x1515

The New York Federal Reserve’s 2022Q4 Household Credit and Debt report showed that total household debt reached a record $16.9 trillion with credit card debt hitting $1 trillion for the first time.  The typical media narrative is that consumers are drowning in debt, unable to pay their bills without excessive borrowing.

But that narrative is wrong.  While household debt is at a record high so is household disposable (after-tax) income.  The better measure is household debt to income ratio.  In 2022Q4, it was 89%.  That might seem high but the average debt to income ratio for households over the past 20 years is 95% and it was as high as 116% at the start of the Great Recession. The same applies to credit card debt. In 2022Q4, total household credit card debt was 5.2% of household disposable income; the 20-year average ratio is 6.1% and the ratio before the pandemic was 5.6%. 

The second flaw in the typical debt narrative is that it fails to note that debt-to-income ratios fell to unusually low levels during the pandemic as household incomes were supported by federal stimulus payments. These payments allowed households to pay down debt or acquire less new debt than they normally would.  So yes, credit card debt is increasing but it is only returning to levels that existed prior to the pandemic. 

There is legitimate concern that higher interest rates make debt more expensive to carry.  But again, the data do not support the notion that households are excessively burdened with debt interest payments. Data from the Federal Reserve show that household debt service payments, most of which is for home mortgages, was no higher in 2022Q4 than it was before the pandemic, and far lower than it was before the financial collapse and the Great Recession.

Has the recent increase in debt levels and interest rates pushed more households into debt delinquency?  The answer is no.  The NY Fed report showed that only 2.5% of household debt payments are delinquent (30 more days late) and just 1.0% are considered severely derogatory.  And guess what, those are the lowest percentages of delinquent and derogatory household debt in the past two decades!

But perhaps the biggest flaw is thinking of increases in household debt as a sign of financial weakness. In fact, it is generally a sign of financial strength. This is because by far the largest portion of household debt is home mortgages, about 70% of the total.  And the amount that people are willing and able to borrow for a house is a function of their financial ability to pay, not their financial stress.  Debt-to-income ratios rise during economic expansions and fall during recessions. 

No doubt some households have too much debt, but as a whole, and when compared to household income, current debt levels and debt service payments are not high by historical standards.