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How Stretched are Today’s Borrowers? Debt Service Levels in Fourth District States

Data show that states within the Fourth Federal Reserve District have lower total debt service ratios than the nation as a whole, primarily because these states have lower mortgage and bank card debt.

Both nationally and in the Fourth Federal Reserve District, which comprises Ohio, western Pennsylvania, the northern panhandle of West Virginia, and eastern Kentucky, the debt service ratio, or the DSR, has stabilized.

The financial crisis of 2008 crystallized the importance of understanding household debt burden, as unsustainable debt levels led to a spike in mortgage defaults and threatened the stability of the financial sector.

A simple measure of debt burden, the DSR is the average share of disposable income that is devoted to required minimum payments on debt obligations. In other words, the DSR is how much of one’s post-tax income is used to pay for things such as auto loans and mortgages, among others. When the DSR is high, the average family has high levels of debt payments relative to its income—a large mortgage payment in relation to the family’s monthly post-tax pay, for example—a situation which may hinder the family’s ability to pay for other things. Of course, when the average debt service level is high, many households will have even higher debt burdens, while other households will still be relatively untroubled by their debt payments.

The Federal Reserve Board of Governors publishes the DSR for the nation as a whole. This series is based on national-level data on debt balances, data which get combined with information from other sources to estimate the sum of payments. These data have proven valuable, but they cannot capture differences across states or provide much detail on what type of debt service—auto loan, bank card, home equity loan, mortgage, student loan, or other debt—is changing.

Research underway at the Federal Reserve Bank of Cleveland is helping to increase our understanding of household finance by estimating DSRs for individual states.

Newly available data in the form of the Federal Reserve Bank of New York’s Consumer Credit Panel (CCP) make it possible to observe payments directly rather than having to estimate them based on aggregate balances. The CCP is built from a random sample of credit reports from Equifax, with personal identifiers such as name and address removed to protect consumer privacy.

The Cleveland Fed creates its DSR estimates from the CCP, providing an alternate national DSR and, for the first time, state-level DSRs.

Consumer debt trends can vary greatly across states and can signal when there are unusual increases in debt. For example, during the recent housing boom from 2004 to 2007, Florida’s DSR rose from 16.6 percent to 19.8 percent, a rise of 3.2 percentage points, double the nation’s increase of 1.6 percentage points during this same time period. Having such information can help policymakers better connect trends in consumer credit to changes in a state’s economy.

Nationally, the share of incomes devoted to debt service has gone through 3 phases in the past decade:

  1. The DSR rose 1.4 percentage points from the first quarter of 2005 to the fourth quarter of 2007, the years leading up to the Great Recession.
  2. Then it fell from 17 percent at the end of 2007 to 13 percent at the end of 2012 as households deleveraged and as institutions discharged delinquent debt. The decline in DSR in these 5 years was more than twice as large as its increase from 2004 to 2007.
  3. Deleveraging tapered off in 2012, and the DSR has been relatively stable since. In the middle of 2015, it was 13.2 percent.

While the Cleveland Fed’s estimates begin in 2004, the Board’s DSR goes back to 1980. Currently, the Board’s DSR is below levels seen at any time prior to 2012. This level suggests that balance sheets of households are relatively healthy and that households are in a position to take on new debt.

The share of income devoted to required debt payments fell after the recession and remains historically low.

The national trend is similar to those of the 4 states that are at least partially in the Fourth District, Ohio, Kentucky, Pennsylvania, and West Virginia. The key difference is that 3 of the 4 saw much smaller increases in the DSR from 2004 through 2007. The exception was Pennsylvania, where the DSR rose one-third less than it did in the nation.

It’s not surprising that for most states in the Fourth District, increases prior to the recession were not as large because these states did not experience the housing boom that occurred in other parts of the country.

Though District states did not experience much increase in the DSR leading up to the recession, they did have substantial declines during the recession and in the first years of the recovery. Ohio had the largest drop, with its DSR falling 3.6 percentage points, from 16.2 percent at the end of 2007 to 12.6 percent at the end of 2012. As in the nation, the DSR in each of these 4 states has been fairly stable since the end of 2012.

Why is the DSR so important to household finances?

The DSR has implications for how much income households can spend on consumption or save for future needs. When the DSR is up, the share of income available for consumption or savings is down. When the DSR falls, income for other expenditures rises.

This is clear when you compare changes in real per capita disposable personal income, or “disposable income” for short, and the portion of this income that is not spent on debt service, real per capita available income, or what we’ll call “available income.”

Between the start of 2004 and the end of 2007, a time when the DSR was rising, on average the nation’s disposable income grew $743 per person per year while available income rose just $456, $287 less. During the recession, the DSR fell, and while disposable income fell $496 per person per year, available income fell only $190. As the DSR continued to drift down after the end of 2009, on average, available income rose $140 more per person per year than disposable income, $564 and $424, respectively. In recent years, then, the amount of money that households have available to spend on consumption has risen more than the disposable income measure would lead one to believe at first glance.

Since the end of 2009, the amount of income available after debt payments has risen faster than disposible income, suggesting that consumer spending has room to grow.

The differences in the growth of disposable and available income followed a similar pattern in the Fourth District states, though the magnitudes were smaller because Fourth District states experienced smaller changes in the DSR than did the nation.

For example, in Kentucky, disposable income fell $1 per year during the recession, but available income rose $181 per year during the same time period. In Ohio, the average annual increase in available income since 2009 was $100 more than the annual increase in disposable income, $615 and $515, respectively.

Outside the Fourth District, Florida, an example of a “housing boom state,” saw its DSR rise and fall more dramatically than the nation’s or than that of any Fourth District state, producing starker differences in disposable and available income growth. Since the end of 2009, following the mortgage crisis, the average annual increase in available income in Florida was more than double the state’s increase in disposable income.

This is one example of the kind of analysis that our new DSR measures permit.

Another benefit of using the CCP to estimate the DSR is that the DSR can be broken up into different debt types. Doing so can show whether there are particular types of debt that lead a state to have a lower DSR than the nation’s. The state-level DSR divides payments into 6 categories: auto loan, bank card, home equity loan, mortgage, student loan, and other debt.

Mortgage debt is the largest component of the DSR in all 4 District states and the nation and is the largest source of the difference between the DSRs of District states and that of the nation. Mortgage payments consume 5.5 percent of disposable income in the nation, while for District states this ratio ranges from a low of 3.6 percent in West Virginia to a high of 4.8 percent in Ohio.

This difference is a result of District states’ having relatively low home prices and a larger share of older homeowners, who are more likely to have paid off their mortgages.

The fact that District states have older populations is also a factor behind these states’ having lower bank card DSRs than the nation’s. Typically, older adults carry less bank card debt than do younger adults. In District states, bank card DSRs range from 1.7 percent in West Virginia to 2.2 percent in Pennsylvania, compared to 2.6 percent in the nation. The nation’s auto loan and bank card DSRs are similar to each other, but in District states, auto loan DSRs are larger than bank card DSRs. In fact, the auto loan DSR overall has been rising as car sales have gradually rebounded from recession levels, though auto loan debt service levels are still below pre-recession levels. West Virginia leads the pack, with 3.3 percent of its disposable income devoted to auto payments.

The mortgage and bank card debt service ratios are notably lower in Fourth District states than in the nation as a whole.

Student loan debt is the fourth largest component of the nation’s total DSR. The student loan DSRs of Ohio and Pennsylvania are about a third larger than the nation’s 1.3 percent, with both at 1.7 percent. Those of Kentucky, 1.4 percent, and West Virginia, 1.3 percent, are comparable to the national level.

Home equity loans are the smallest DSR component in the nation and in all 4 District states, with DSRs ranging from a low of 0.4 percent for the nation to a high of 0.7 percent for Pennsylvania.

The other debt category includes a variety of uncommon debt sources, such as loans from retail stores. The other DSR is 1.5 percent in both West Virginia and Kentucky, a number which is notably higher than it is in the nation, at 1.0 percent.

The primary reason that the states in the Fourth District have lower total DSRs than the nation does is that they have lower mortgage and bank card debt burdens. Since the recession ended, the DSRs of the states in our region have fallen along the same trend as the national DSR. Because households in the region are devoting less of their income to covering debt payments than in the past, they may be in a good position to increase consumption spending.

*This article reports on the authors’ calculations from the FRBNY Consumer Credit Panel/Equifax and the Bureau of Economic Analysis.

Sum and substance: States in the Fourth Federal Reserve District have relatively low debt service ratios, especially for mortgage and bank card debt, leaving District households with more income for other purposes.

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For more information on the current state of the economy in Fourth District cities, read our regional publication Metro Mix.

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