If you go only by the news over the last few years, you might get the idea that the financial world is still melting down. Foreclosures on every block, people losing their jobs and not being able to find new ones or pay their bills. And banks are the big bad guys, right?
My credit trend reports show a different picture. You might think that consumer debt is skyrocketing, but it’s actually the opposite. Outstanding debt is contracting.
If we’re seeing all these negative financial stories in the media, why is debt contracting? I’m looking at two causes:
1) Consumers who can’t pay down their debt are giving us record default rates.
2) Consumers who have some extra cash are paying down their debts.
American consumers are acting like banks right now; they’re “cleansing the balance sheets” by being more careful about the money they spend and the debt they take on.
Banks cleanse their balance sheets by becoming more cautious about the people they lend to. The pace of lending slowed as more debts were being paid down, so the debts paid off have exceeded the new loans issued.
Since October 2008, total debt balances have contracted by $690 billion, or 6 percent. I’m seeing Americans who are more cautious with their money and preparing for the future.
It might sound funny, but I’ve come to see that debt has its own life cycle. Total debt balances peaked in October 2008-remember that month? Lehman Brothers and AIG, unemployment was rising, and the credit market was seizing up-when people started to realize that they didn’t know what was going to happen in the economy in the coming months.
The credit trends show that with the increasing negative conditions at the end of 2008, U.S. consumer debt peaked and began to decline. People stopped spending, and they stopped using bank cards.
Take a look at these figures:
Total Debt Since 2008 Broken Out by Category
- Home finance debt declined by $528 billion, or 6 percent
- Consumer finance debt declined by $162 billion, or 7 percent
Total Consumer Finance Debt Broken Out by Category
- Bank card (revolving) debt declined by $110 billion, or 13 percent
- Nonrevolving debt, primarily auto and student loans, declined by $52 billion, or 4 percent (due to auto loans; see information below on student loans)
Unfortunately, from the numbers I’m seeing, I don’t think we’ve hit the bottom of the cycle just yet. We’re still waiting to see delinquencies peak, then defaults will peak, and then we’ll start to see credit grow again. When credit loosens up, outstanding debt will start to grow again-but don’t worry. That will be a good thing for the economy!
Debt greases the wheel of the U.S. economy. Households buy homes with mortgages. Consumers purchase cars with auto loans and leases. They use their credit cards to buy furniture, clothes, electronics, and vacations.
As a side note, the only area of debt where we’re seeing growth is student loans. Student loan debt has increased by $77 billion, or 17 percent, since October 2008. Some of the debt can be attributed to a lack of savings, so more people have to take out loans to pay for school. But we can also look at it as people borrowing money to make an investment in themselves. They might be having trouble finding a job, so they’re taking the time to go back to school.
The end result of this cycle of debt is that consumers are right-sizing their finances by shedding debt. Rescaling personal debt so that it is more in line with income is a good thing, but I’ll be keeping a watch on bank card originations to see when the credit market starts loosening up again.
Stay tuned to the Equifax Personal Finance blog for the latest updates on the credit market.
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