Rising household debt in the US – Is it a red flag?

• Brief history of Household Debt in the US
• Current profile and outlook of Household Debt in the US

Macro-economic data variables in the US continue to portray weakness in different segments of the economy, with economic data continue to be subdued in manufacturing and services along with other variables such as inflation, business confidence amongst others also depicting negativism. Forecasts and predictions are indicating that the world’s largest economy might move into recession in the 2020, however, economists and major financial and economic agencies remain divided whether the country has moved into the red zone or still has a chance to avoid any major hard landing. The only major driving factor which is still supporting the economy has been the consumption trend. Nevertheless, within the consumers segment, one of the critical factors that weighed the economy negatively during the last major recessionary phase in 2008-2010 is the level of Household Debt in the US. This factor is once again moving into the heated zone with the total US household debt rising to USD 13.95 trillion in the Q3 2019; this amount is around USD 1.28 trillion higher than the largest value of household debt during the great recession of 2008 (in nominal terms). In the current blog, we look into the major factors which drove the household debt value higher over the past few years and whether it is raising any red signals as of now.

The household debt in the US was USD 12.68 trillion in Q3 2008. It begun to reduce post that since banks and lending institutions made the qualifying standards tougher for borrowers following the financial and economic issues in the country. It continued to decline until 2013, when the qualifying standards were relaxed again. The household debt increased at a slower rate after 2013 but eventually surpassed its peak level of 2008 in Q1 2018 and had continued its increase till now.

The low mortgage rates and positivity in the economy have increased the quantum of mortgage debt taken by Americans during the past few years, though tougher economic conditions lately raise questions over the continued growth of the same. During the great recession of 2008, it was the mortgage debt that played a key role in changing the course of the economy. The mortgage debt formed 78.6% of the total household debt in 2008 while the other key contributors were the student debt, credit card debt and auto loans. Though mortgage debt, in terms of value, has increased significant in the last decade, strict underwriting standards after the great recession has aided the mortgage debt share as a percentage of household debt to be curtailed down to 70.4% in 2019, thus providing some comfort. The student loan debts form the second highest component of the total household debt in 2019. Student loan debts, which accounted for only 5% of the total household debt in 2008, now make up 10.7% with the actual increase standing ~USD 700 billion during the last decade. In one of our previous Blogs, we have elucidated how student loans spiked after the great recession, and although presents increasing investment in education presents a positive thought process, the dynamics of investment to return in form of high paying jobs is not well balance and indirectly puts individual finance under stress. Backed by the lower interest regime over the last decade alongside pent-up demand post the 2008 recession, auto loans volume also increased wherein, auto loans have risen by USD 350 billion since 2008. The auto loans make up 9.4% of the total household debt currently. The balance of the household debt makes up of credit card debt and others.

Notwithstanding the worries over rising household debt, it portrays a positive side as it indicates confidence in overall economic growth of the country. Positively, comfort also comes in from the fact that the overall debt profile in 2019 seems more sustainable than the debt profile of 2008, as per reports from different agencies in the US. Owing to the stricter qualifying standards for taking debt after 2008, most of the debt holders of 2019 are older and more affluent than the debt holders in 2008. Only 10% of mortgage holders have credit score below 651 in 2019. 26% of the total debt holders had credit score below 660 in 2008 whereas only 20% of the total debt holders have a credit score below 660 in 2019. The delinquency rates of the present debts are considerably lower than what were observed in the pre-recession period in 2006 and 2007. The lower delinquency rates further bolster the claim that the debt configuration of the present day is healthy. A rise in delinquency rates has historically been a precursor to weakening of economy. The defaults on loans are also in a lower and much safer range. The ratio of household debt to disposable income is much better than what it was in the pre-recession and recession period. This shows that the overall population has a better debt servicing capability at present.  Only concern lingers over the auto loans and particularly the student loans, which are largely borne by the younger generation, and are a bit more vulnerable section.

From an external perspective, the rise in household debt is currently a global phenomenon. Many developed countries in the world have recorded a rise in household debt and the US is not an exception. Switzerland and Australia respectively top the list. The US has in fact improved its position from 10^th to 11^th position in the last 2 years. The home ownership rates in many developed countries have also fallen and the US is no exception to that. The home ownership rates in the US have decreased by 4.5% in the last 10 years. Economists continue to be divided on the likelihood of a recession in 2020 with the average predictions suggesting a 41% probability; similarly, opinion on household debt as a threat is also divided. With the issues in the broader segments of the economy looking rather evident now, it is highly unlikely that the effects of the same could be completely avoided by the consumers. However, optimism stems from the aforementioned data point of a stronger debt profile of consumers, which has enhanced over the years. Overall the financiers as well as the consumers remain more prepared as compared to the last recessionary phase that could lead the US to stay clear from a fatal crash in the household debt segment as witnessed in the 2008-2010 crisis period.