CONSUMER DEBT IS ON YOUR MIND. WHY?
While we have been paying a lot of attention to the good economic news in recent months – low unemployment, the continued bull market, lower taxes – we have also seen consumer debt growing at a rapid clip. According to a recent report by Lending Tree, the total tab for consumer debt in the US is on track to reach a record $4 trillion by the end of this year.
The report, which analyzed data from the Federal Reserve on non-mortgage debts found that Americans owe more than 26 percent of their annual income to this debt, up from 22 percent in 2010 and higher than the levels we saw during the mid-2000s when credit was easily available. This rise in borrowing could put some American families on the path to financial trouble.
WHY IS DEBT SUCH A BAD THING?
Debt in and of itself is not a bad thing. Debt can be a tool that we use to accomplish goals buying a house. There are two important distinctions to make. First, the type of debt matters. Money owed on a mortgage is much better than money owed on a high interest credit card. Second, the ratio of debt or credit to income is key. Non-mortgage debt that exceeds 20% of your take-home pay is generally a cause for concern.
WHAT TYPES OF CONSUMER DEBT ARE YOU MOST CONCERNED ABOUT AT THE MOMENT?
Auto lending trends show signs of future trouble, Tom. First, car buyers are borrowing larger amounts of money for longer periods. Last month the average monthly car payment hit a record high and the average length of an auto loan stretched to 69 months – nearly six years! This is one of the drivers of a higher ratio of non-mortgage debt to income levels the LendingTree report found.
On top of this, the subprime auto loans continue to be a problem for many Americans. While we have seen a reduction in lending to subprime borrowers, defaults on subprime auto loans at the highest rate since 1996, even exceeding that during the financial crisis according to a Bloomberg report. The delinquency rate for subprime auto loans more than 60 days past due reached 5.8%, according to Fitch’s data for March, its most recent data available.
Credit card debt is also something we need to watch. As lenders have made access to credit easier as the economy has recovered, we have seen credit card debt grow. The year-over-year loan growth rate for credit cards in Q1 of 2018 reached 6.7 percent, higher than the 5.3 percent for auto loans and 3.6 percent for residential mortgages.
Along with the rise in credit card debt, we have seen the number of late payments rise in the past few years. Because interest rates are on the rise, that means that borrowing will cost you more money and if you fall behind on your payments it will be harder to get caught up.
These two types of debt could cause consumers real pain if current trends continue.
WHAT STEPS SHOULD WE TAKE TO AVOID GETTING IN HOT WATER?
The easiest way to avoid problematic debt is to create a budget and stick with it. The most important part is to know where each dollar goes, because then you can prioritize spending and manage your expenses. If you already have debt that you want to tackle, start by taking a comprehensive look at all of your finances, and tally up your debts.
Next, rank them in order from the highest interest rate to the lowest. Once you have done that, put the most toward your highest interest-rate debt, since that debt is costing you the most in interest. If you are having trouble finding extra money to pay down your debt, turn to your budget. Look for areas to cut back. If you take a short-term drop in your wants – that new car or the latest iPhone – it will pay off financially.
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