Debt Is On The Rise, Increasing Risks For Many Households

Households are sinking deeper into debt. Some of this debt creates especially large financial risks for households. They still need to repay that debt, even if they lose a job or encounter a health emergency, among other unforeseen events. As the pandemic rages on and gains speed again, the chances of such emergencies go up, too. They can also face sharply higher interest rates on their outstanding debt and the Federal Reserve is poised to gradually increase interest rates. The combination of multiple financial risks rising at the same time could be toxic for many households.

Household debt keeps on going up. It grew by a non-inflation amount of $305.1 billion in the third quarter of 2021. Those three months capped the 10^th quarter in a row, during which household debt has grown. Debt stood at 98.8% of after-tax income by September 2021. This is especially remarkable since after-tax income shot up quickly throughout much of the pandemic due to stimulus checks and other government assistance. The pandemic did not put a stop to Americans’ borrowing, even amid faster income growth.

Mortgages make up the bulk of the new debt. As a share of after-tax credit, mortgages, including home equity lines of credit, stood at 63.2% in September 2021, quickly approaching the levels recorded before the pandemic. Mortgages not only grew faster than after-tax income, but also faster than real estate values during the second and third quarter of 2021. These were the first two quarters of such home equity cashouts since the third quarter of 2007. Many households may have wanted to take advantage of low-interest rates, while they still lasted. Home equity cashouts could end again, once the Federal Reserve slows its purchases of mortgage-backed securities going into 2022.  

Credit card debt has also risen faster than after-tax incomes in the summer of 2021. It exceeded $1 trillion again in September 2021 and amounted to 5.5% of after-tax income, up from a low of 4.9% in March 2021. It is still well below the 6.6% of after-tax income recorded at the end of 2019, just before the pandemic got underway.

Other consumer debt, mainly car and student loans, have bounced back even faster. Households owed $3.3 trillion in such debt by September 2021. This equaled 18.4% of after-tax income, up from 16.5% in March 2021 and also quickly approaching the record high of 18.9% recorded at the end of 2019 (see figure below).

Many households do not have the necessary savings or the possibility to borrow against their house to finance a car purchase or their education. People of color, for example, are more likely than White households to owe such debt as a result. Yet, these loans carry higher interest rates than mortgages. Car loans for a new car, financed over four years, for example, amounted to 5.1% in the third quarter of 2021, while mortgage interest rates stood at 3.0% at the end of September. Debt is particularly burdensome for households that already lack wealth from prior generations and face greater obstacles to building more wealth. 

Household indebtedness does not stop with these formal forms of debt. The pandemic has shone a spotlight on the financial interdependence between households with low debt and few options to access affordable debt in an emergency. They often borrow from each other. Data from the U.S. Census Bureau’s Household Pulse Survey show that 17.5% of African-Americans, 14.2% of people of multiple or Other races and 14.0% of Latinx people borrowed from friends or family members to pay for current expenses in September 2021. In comparison, only 6.7% of White people and 6.7% of Asian-Americans relied on informal financial support then. Again, debt is more widespread, where wealth is less prevalent and that debt is often costly and risky.

Debt is a ubiquitous and frequently necessary form of financing for many households. It comes with unique financial risks, such as the risk of losing a major source of income due to unemployment while still needing to repay that debt or of sharply higher interest rates. These risks and costs of debt are unevenly distributed. And, debt has increased in all forms during the pandemic, leaving many households, especially households of color and lower-income ones in a financially precarious situation.