Personal Debt

Personal debt in the U.S. - statistics & facts

Personal debt, a term similar to consumer debt, is used in economics to denote the outstanding debt of consumers as opposed to businesses or governments. Unlike public and corporate debt, personal debt is amassed primarily through consumption rather than investment. Households tend to incur debt through various types of lending, which are typically used for the acquisition of a home, or a car, as well as to finance studies. However, consumer lending is also used to pay for smaller purchases, such as goods that do not appreciate value and are consumable. Apart from traditional loans, buy now, pay later (BNPL) services also are a source of debt for many consumers.

Why are Americans in debt?

According to a survey conducted in 2022, two thirds of consumers in the U.S. are in debt. The main source of debt for most of them were mortgages and credit cards. Credit card debt is one of the worst types of debt due to the high interest rates, which makes it harder to pay off. In several states, the average value of credit card debt was above 6,000 U.S. dollars in 2021. However, in recent years, an alternative to credit card emerged: BNPL. Initially introduced in the e-commerce sector, BNPL allows consumers to purchase goods and services in interest-free installments.

Personal debt: good or bad?

Many economists advocate the power of personal debt to fuel economic expansion. According to that argument, the availability of cheap credit along with an increased demand for consumer goods can help to increase domestic production and economic growth. However, as the household debt ratio to GDP in the U.S. shows, Americans are already quite indebted. Individuals spent a higher share of their earnings in order to pay back their financial obligations in 2022 than a year before, as indicated by the increase in the debt payments to income ratio. If some of those households are not able to make those payments anymore, they may go bankrupt. In 2021, Alabama was the U.S. state with the highest personal bankruptcy rate.

Consumer Debt: Understanding the Pros and Cons

What Is Consumer Debt?

Consumer debt consists of personal debts that are owed as a result of purchasing goods that are used for individual or household consumption. Credit card debt, student loans, auto loans, mortgages, and payday loans are all examples of consumer debt. These stand in contrast to other debts that are used for investments in running a business or debt incurred through government operations.

KEY TAKEAWAYS

• Consumer debt consists of those loans used for personal consumption as opposed to debts incurred by businesses or through government activities.
• Consumer debt may be segmented into revolving debt, which is paid monthly and may have a variable rate; and non-revolving debt, paid as a fixed rate.
• Consumer debt is considered by economists to be a suboptimal form of financing as it often comes with high interest rates that can become difficult to pay off.
• The consumer leverage ratio (CLR) is an economic indicator that tracks the aggregate level of consumer debt in a country.

Understanding Consumer Debt

Consumer loans can be extended by a bank, the federal government, and credit unions, and are broken down into two categories: revolving debt and non-revolving debt. Revolving debt is paid down on a monthly basis, such as credit cards, whereas non-revolving debt is the loan of a lump sum up front with fixed payments over a defined term. Non-revolving credit usually includes auto loans and school loans.

Advantages and Disadvantages of Consumer Debt

Consumer debt is considered a financially suboptimal means of financing because the interest rates charged on the debt, such as credit card balances, are extremely high when compared to mortgage interest rates. Furthermore, the items purchased typically do not provide a necessary utility and do not appreciate in value, which might justify taking on that debt.

An opposite view is that consumer debt results in increased consumer spending and production, thereby growing the economy, and achieves a smoothing of consumption. For example, people borrow at earlier stages in their lives for education and housing, and then pay down that debt later in life when they are earning higher incomes.

When the debt is used for education, it can be viewed as a means to an end. The education allows for better-paying jobs in the future, which creates an upward trajectory for both the individual and the economy.

Regardless of the pros and cons, consumer debt in the United States is on the rise due to the ease of obtaining financing matched with the high level of interest rates. As of September 2020, consumer debt was $4.16 trillion, with $3.17 trillion in non-revolving debt and $988.6 billion of revolving debt.

If not managed properly, consumer debt can be financially crushing and adversely impact an individual's credit score, hindering their ability to borrow in the future.

Prioritizing Debt

The Consumer Leverage Ratio

The consumer leverage ratio (CLR) measures the amount of debt that the average American consumer holds, compared with their disposable income.

The CLR has been used as a litmus test for the health of the U.S. economy, along with other indicators, such as the stock market, inventory levels, and the unemployment rate.

On an individual level, the consumer leverage ratio is advised to be between 10% and 20% of an individual's take-home pay. Above 20% is an indicator of urgent debt problems.

Consumer Debt and Predatory Lending

Consumer debt is often associated with predatory lending, broadly defined by the FDIC as “imposing unfair and abusive loan terms on borrowers."

Predatory lending often targets groups with less access to and understanding of more traditional forms of financing. Predatory lenders can charge unreasonably high interest rates and require significant collateral in the likely event a borrower defaults.