After years of managing family budgets under the stress of the worst inflation in a generation, U.S. families are increasingly under pressure from a different kind of financial squeeze: the cost of carrying debt.
Two years after the Federal Reserve began raising interest rates to tame prices, default rates on credit cards and auto loans are the highest in more than a decade. For the first time in history, paying interest on these and other non-mortgage debts represents as large a financial burden on U.S. households as paying interest on mortgages.
The data suggests a difficult reality for the millions of consumers who are the engine of the US economy: the era of high borrowing costs – however necessary to slow rising prices – has an effect that many families may feel in their years to come, especially those who have not locked in low-cost home loans. And the Fed, which meets next week to make a policy decision, does not appear ready to cut rates until the end of 2024.
As monthly debt payments take up a larger share of workers’ paychecks, these consumers are more exposed to potential economic contractions.
And the cost of money affects people’s perception of their own prosperity: A February paper by the International Monetary Fund and researchers at Harvard University posits that the recent high cost of money – which is not captured in inflation data – is key to understanding why consumer sentiment remains sluggish even as inflation has eased and businesses are hiring at a brisk pace.
This theory suggests that the debt burden could be a drag on President Joe Biden’s re-election bid, with the economy consistently registered as a top concern at the polls.
Nikki Cimino, a 40-year-old recruiter living in Denver, said she finally saved enough to buy a condo last year but missed the ultra-low interest rates that had made homeownership more affordable in the early days of the pandemic. Lei’s interest rate of 5.25% pushed her monthly payments to $1,650. After her divorce in 2020, she took on $4,000 in credit card debt.
“I’m making the most money I’ve ever made, and I’m still living paycheck to paycheck,” he said. “There’s this huge disconnect between what people are experiencing and what economists are experiencing.”
Rely on credit
Fed rate hikes, by definition, make it more expensive for consumers to borrow.
Since the pandemic, households have fallen into debt at a relatively rapid pace. According to calculations by Wells Fargo economists, it only took four years for households to set a new record level of debt after repaying loans in 2021, when interest rates were still near zero. Before then, the time between one debt peak and the next was three times longer. And this increased debt often comes with a higher price tag. According to the Fed, the typical charge-off on a credit card has reached a record high of more than 22%.
It helps that many families are relatively well positioned to service that debt: Large wage increases mean workers get bigger paychecks, and higher home prices have bolstered many families’ net worth. While the share of income going toward debt service is higher than it was three years ago — when stimulus checks made it easier for people to spend money on their credit card accounts — it is still low by historical standards.
And part of the reason some Americans were able to take on a substantial load of non-mortgage debt is because they had locked down home loans at ultra-low rates, leaving room on their balance sheets for other types of loans. At the end of last year, the effective interest rate on U.S. mortgage debt was just 3.8%.
However, loans and interest payments can be a significant strain that influences households’ spending choices.
“Many consumers are stretched thin, with debt at their limit and barely keeping their heads above water,” said Allan Schweitzer, portfolio manager at credit-focused investment firm Beach Point Capital Management. “They could row, if you want, but any increase in unemployment or worsening of the economy could lead to a pretty 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 problems began during the pandemic, when Denise lost her job and a 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 in a restaurant. Yet, they can barely scrape together the minimum payments on their credit card debt.
The couple blame Biden for what they see as a bleak economy and plan to vote for the Republican candidate in November. Denise regularly voted for Democrats until about 2010, when she became dissatisfied with Barack Obama’s economic positions, she said. She now supports Donald Trump because he lowered taxes and for his immigration policies.
“We had more money when Trump was president,” he said, noting that three years ago his credit card debt was less than half what it is today.
The Nierzwicks aren’t the only ones struggling to maintain their debt. According to exclusive data from the Harris Poll for Bloomberg News, among middle-class adults who pay by credit card, more than a quarter say they have fallen “behind” at some point in the past year. Data from the New York Federal Reserve shows that credit card balances fell into default – more than 30 days late – at an annual rate of 8.5% in the latest quarter.
High borrowing costs – and how households manage them – pose some risks to the broader economy.
“By raising rates in 2023, we avoided a slowdown due to spending that was heavily tied to easy access to credit,” said Shannon Grein, an economist at Wells Fargo. “Now, credit has become harder to obtain and more expensive,” she said, calling the change “a significant barrier to consumption.”
Mohsin Meghji, managing partner of M3 Partners, a consultancy for troubled companies, is preparing for the consequences of this type of consumer retreat.
“Any tightening immediately affects companies’ profits,” Meghji said. For those companies – heavily in debt after years of easy loans – “there is no simple solution,” she added.
Of course, consumers can try to refinance their debt after the Fed lowers rates. But the timing and size of the cuts are uncertain, and refinancing fees can sometimes outweigh the benefits.
The burden of student debt
Returning student loan payments adds to the financial stress of many borrowers.
Brittany Walling, a 29-year-old from Columbus, Ohio, has about $80,000 in federal student loans and $20,000 in private debt from her undergraduate and graduate degrees. Added to that is $6,000 in credit card debt, which she accrued when she was unemployed for a six-month period in 2022.
He lives paycheck to paycheck, he said, with his $50,000-a-year salary working for the public health department.
“I can’t even save, I don’t have a savings account,” he said. “I just know a lot of people are struggling and things need to change.”
For Walling, this sentiment won’t necessarily be a deciding factor at the polls. Although she said she was disappointed that Biden’s student debt relief plan was struck down by the Supreme Court, her views on abortion and transgender rights will likely keep her from voting Republican.
However, the issue overall seems like a stumbling block 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 stay the same, you’re still going to have a passive tightening effect that trickles down to consumers and plays out in the economy,” said Grein, the Wells Fargo economist. “These family dynamics will be a determining factor in this year’s elections.”
Additionally, in a February Bloomberg News/Morning Consult poll, voters in swing states said they trusted Trump more than Biden on interest rates and personal debt.
Cimino, the Denver condo buyer, says that despite her debt load, she feels fortunate to earn $65,000 a year and own a home, a situation that leaves her better off than many.
“Being bourgeois these days,” Cimino said, “just means carrying around a lot of guilt.”