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Households Ease Up on Adding New Debt

A key question for the continued economic recovery is whether household deleveraging is over. If households are beginning to add debt to their balance sheets, it may be a sign that consumers’ confidence has returned and consumption might be increasing.

In response to the financial crisis in 2007, households cut back sharply on their borrowing, particularly in mortgages and bank cards. Lenders were also part of the deleveraging process by tightening up on credit standards and charging off bad loans. After peaking in 2008:Q3 at $12.7 trillion, household debt declined for 17 out of the next 19 quarters. In the last three quarters, it has increased and is currently at $11.7 trillion. Given that debt levels and interest rates are so low, this additional debt is not particularly burdensome, and it could support consumption growth.

Figure 1: Total Balance of Accounts is Rising: Deleveraging is Over

By most accounts, household deleveraging appears to be over. Auto and student loans have been strong throughout the recovery, and mortgage lending is beginning to turn the corner. However, after calculating the same data in inflation-adjusted terms (1999 dollars), the weakness in consumer credit looks more striking. For example, in nominal terms, mortgage balances are up to their 2007 level and increasing. In real terms, the balances are still flat at their 2005 level. Also, while the recent growth in auto loan balances looks strong in nominal terms, the balances are still below their pre-crisis peak in real terms.

Figure 2: Total Balance of Accounts is Rising: Deleveraging is Over

The recent growth in mortgage balances also seems to be abating. Mortgage debt will continue to increase as long as purchase originations are greater than amortizations; however, purchases declined sharply in early 2014. Compared to January and February 2013, purchase originations for mortgages declined 15.1 percent and 15.3 percent, respectively, and they have been declining year-over-year since August 2013.

Figure 3: Purchasing Originations are Slowing Down

Not all households are adding debt at the same pace. Those with strong credit scores seem to be benefiting most from the low borrowing costs. A “strong” score corresponds to an Equifax Risk Score above 720. Nearly half of the population is in that range, which we call the “super prime” category. At the other extreme of the risk scale are the “deep subprime” borrowers, whose Equifax Risk Scores are below 600.

Figure 4: Borrower Categories and Equifax Risk Scores

In general, individuals with higher credit scores are also the most frequent users of credit. Currently, an average super prime borrower has five open credit accounts, but a deep subprime borrower has fewer than four, which is still a significant improvement relative to the post-crisis lows.

Figure 5: Average Number of Accounts

Yet the deep subprime borrowers apply for credit most frequently, an indicator of the frequent denials they face and their pent-up credit demand. During the crisis, they cut back on their credit applications significantly, which may be interpreted as a sign of their discouragement at the credit market conditions at the time. Since 2010, however, they are once again getting their toes wet in the credit markets, although they are still not as eager to seek loans as they used to be. Their credit application numbers are36 percent less than the prerecession high.

In the mortgage market, prime and super prime borrowers were responsible for most of the purchase and refinance activity. Subprime and deep subprime creditors no longer contribute a significant part of mortgage originations.

Figure 6: Deep Subprime Eager to Borrow
Figure 7: Purchase Origination Slowdown Affecting All Borrowers
Figure 8: The Refinance Boom Benefited Prime Borrowers

The auto loan boom, on the other hand, has not left anyone out. Although super prime borrowers have been borrowing most aggressively, the auto loan balances of the deep subprime individuals have also been showing signs of life.

Figure 9: Borrowers and the Auto Loan Boom

These credit measures suggest that the consumer credit market is still weak outside select sectors and for borrowers at the riskier end of the credit spectrum.

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