(Bloomberg) — After years of managing household budgets under the stress of the worst inflation in a generation, American families are increasingly being squeezed by a different kind of financial pressure: the cost of taking on debt.
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Two years after the Federal Reserve began raising interest rates to keep prices in check, default rates on credit cards and auto loans are the highest in more than a decade. For the first time ever, interest payments on these and other non-mortgage debts pose as much of a financial burden on American households as mortgage interest payments.
The numbers suggest a difficult reality for the millions of consumers who power the U.S. economy: The era of high borrowing costs — however necessary to slow price increases — has its own sting that many families will feel for years to come. especially those who have not taken cheap home loans. And the Fed, which meets next week for a policy decision, doesn’t appear ready to cut rates until later in 2024.
Because monthly debt payments take up a larger share of workers’ wages, these consumers are more exposed to potential economic contraction.
And the cost of money influences people’s perception of their own prosperity: A February paper from researchers at the IMF and Harvard University argues that the recent high cost of borrowing – which is not captured in inflation rates – is crucial to understand why consumer confidence even remains lackluster. now that inflation has subsided and companies are hiring at a healthy pace.
That theory suggests the debt burden could hamper President Joe Biden’s re-election bid, with the economy consistently registering as one of the top concerns at the ballot box.
Nikki Cimino, a 40-year-old recruiter from Denver, said she finally saved enough to buy an apartment last year, but missed the ultra-low interest rates that had made homeownership more affordable in the early days of the pandemic. . Her 5.25% interest rate pushed her monthly payments to $1,650. After a divorce in 2020, she has $4,000 in credit card debt.
“I’m making the most money I’ve ever made, and I’m still living paycheck to paycheck,” she said. “There is a huge gap between what people experience and what economists experience.”
Rely on credit
The Fed’s rate hikes make it more expensive for consumers to borrow.
Since the pandemic, households have taken on debt at a relatively rapid pace. According to calculations by economists at Wells Fargo, it took just four years for households to reach new record debt levels after paying off their loans in 2021, when interest rates were still near zero. Previously, the time between one debt peak and the next was three times as long. And that greater debt burden is often accompanied by a higher price. According to the Fed, typical fees on a credit card have risen to a record of more than 22%.
It helps that many families are relatively well positioned to pay off those debts: broad wage increases are helping workers rake in higher salaries, and higher home prices have boosted the wealth of many households. While the share of revenue going to debt service is higher than it was three years ago — when stimulus checks made it easier for people to throw money at their credit card accounts — it is still low by historical standards.
And part of the reason some Americans were able to take on a significant amount of non-mortgage debt is that they took out home loans at ultra-low interest rates, leaving room on their balance sheets for other types of loans. The effective interest rate on US mortgage debt was only 3.8% at the end of last year.
Still, the loans and interest payments can exert significant pressure that shapes households’ spending choices.
“Many consumers are stretched to their limits: they are maxed out in debt and can barely keep their heads above water,” said Allan Schweitzer, portfolio manager at credit-focused investment firm Beach Point Capital Management. “They can do something, if you want, but any increase in unemployment or deterioration in the economy could lead to a significant spike in defaults.”
For Denise and Paul Nierzwicki, credit cards are the only way to make ends meet. The couple, ages 69 and 72 respectively, have about $20,000 in debt spread across multiple cards, all with interest rates above 20%.
The trouble started during the pandemic, when Denise lost her job and a business deal for a bar they owned in their hometown of Lexington, Kentucky, fell through.
They applied for Social Security, which helped, and Denise now works 50 hours a week at a restaurant. Yet they barely meet the minimum payments on their credit card debt.
The couple blames Biden for what they see as a bleak economy and plans to vote for the Republican candidate in November. Denise routinely voted for Democrats until about 2010, when she became dissatisfied with Barack Obama’s economic positions, she said. Now she supports Donald Trump for cutting taxes and for his immigration policies.
“We had more money when Trump was president,” she said, noting that her credit card debt three years ago was less than half of what it is today.
The Nierzwickis are not the only ones struggling to keep debt levels under control. Among middle-class adults with credit card payments, more than a quarter say they have been “behind” at something in the past year, according to exclusive data from the Harris Poll for Bloomberg News. Data from the New York Federal Reserve shows that credit card balances last quarter lagged at an annualized rate of 8.5%, lagging by more than 30 days.
High borrowing costs – and the way households manage them – pose a risk to the broader economy.
“As rates rose in 2023, we avoided a slowdown due to spending that was strongly tied to easy access to credit,” said Shannon Grein, an economist at Wells Fargo. “Now credit has become harder to come by and more expensive,” she said, calling the change “a significant headwind for consumption.”
Mohsin Meghji, managing partner of M3 Partners, a firm that advises struggling companies, is bracing for the fallout from this kind of consumer disengagement.
“Any tightening immediately affects the top companies,” says Meghji. For those companies – themselves heavily indebted after years of easy borrowing – “there is no easy solution,” he added.
Of course, consumers may try to refinance their debts after the Fed cuts rates. But the timeline and extent of the cuts are uncertain, and refinancing costs can sometimes outweigh the benefits.
Student debt
The return of student loan payments is adding to the financial stress of many borrowers.
Brittany Walling, a 29-year-old woman from Columbus, Ohio, has approximately $80,000 in federal student loans and $20,000 in private debt from her bachelor’s and master’s degrees. That’s on top of the $6,000 in credit card debt she racked up while unemployed for six months in 2022.
She lives paycheck to paycheck, she said, on her $50,000-a-year salary at the public health department.
“I can’t even save, I don’t have a savings account,” she said. “I just know that a lot of people are struggling and things need to change.”
For Walling, that sentiment won’t necessarily be a deciding factor at the ballot box. Although she said she was disappointed that Biden’s student debt cancellation plan was rejected by the Supreme Court, her views on abortion and transgender rights will likely keep her from voting Republican.
Still, the issue overall appears to be a headwind for Biden, as it shapes the economic prospects of people like the Nierzwickis.
“Maybe the Fed is done raising rates, but as long as rates remain unchanged, you still have a passive tightening effect flowing to consumers and being exerted on the economy,” said Grein, an economist at Wells Fargo. “That family dynamic will be a factor in this year’s election.”
Additionally, swing-state voters in a February Bloomberg News/Morning Consult poll said they trust Trump more than Biden on interest rates and personal debt.
Cimino, a condo buyer in Denver, says that despite her debt burden, she’s happy to make $65,000 a year and own a home — a situation that makes her better off than many others.
“Being middle class these days,” Cimino said, “just brings a lot of guilt.”
–With help from Alexandre Tanzi.
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