Recent data showed that US consumer debt hit an all-time high, surpassing levels from the Great Financial Crisis. It’s not surprising as there are more people in the country today versus then and inflation matters. The good news? Consumers have also shored up their personal balance sheets – they are paying much less interest on their debt versus the mid-2000s.
So like many pieces from the financial news, the headline does not tell the whole, or even accurate, story. Let’s first take a gander at the balance sheet of the American consumer. 24% of our assets come from homes, 21% are in pensions, 42% are of financial assets, 8% in checking accounts, and 5% tangible assets. For liabilities, 66% are mortgages, 10% student debt, 7% car loans, 7% credit card debt, and 11% other.
The good news: While we have more debt than ever, Americans are in better shape than year’s past.
A key measure of the health of the American consumer is the ‘household debt service ratio’. This statistic peaked in Q4 2017 at 13.2%. Today it ranges between 9-11%, and that is 40+ year lows – so things are not so bad even though we collectively have more debt than ever. Certainly, low rates on our mortgages helps.
In Michigan, personal finances have improved markedly since 2007-2009. The unemployment rate has come down from 13.7% to under 4% in 2019, a two-decade low. While Michigan has the 11th highest bankruptcy rate, credit card debt per capita is the third lowest nationally. The average credit score is slightly better than other states too.
Now, what exactly is ‘consumer debt’? Mortgages, car loans, credit card balances, student debt are the primary pieces that makeup consumer debt. Not all debt is bad. Debt allows us to buy homes, drive to work, send our kids to college and meet unexpected financial emergencies. We just have to be diligent and responsible about how we use it.
How do you properly manage debt? Be intentional with your goals and your plan to pay it off. Too many folks buy too much house, purchase the new fancy SUV and whip out their credit card for every day-to-day purchase. Be careful! Let’s focus on the big items.
Your house – just because you are pre-qualified to buy a gigantic house, don’t go for it. Buy a house that you like – not just the biggest, most expensive place on the block. Your house is your most significant single investment and will represent your biggest liability. It is important to keep that monthly payment in check to ensure you are in a sound financial position to meet life’s other financial responsibilities. And of course, you want to have some cash flow to save for your long-term goals.
Your car – seriously consider buying a 2-3-year-old used vehicle instead of a new one. Let someone else pay the huge depreciation that comes with driving that new SUV off the dealership parking lot. If you already have an expensive car, that’s ok. Just plan on driving it for a long-time to get the most value from it. Many Americans get tempted into buying a new car every few years to keep up with the Joneses.
Student debt – this is a growing piece of debt for the American consumer. It’s not so bad though. Data suggests those who take out student debt also go on to earn bigger salaries. So they have time and cash flow to pay it off. Teach your kids to be prudent with financial choices, but don’t just skimp for the very cheapest education. It is an investment. But like everything, an informed and an intentional investor will be better off. A tip is to find ways to keep your student loan interest rate as low as possible and look into options to have the loan forgiven.
Credit card debt – this is the usual ‘no-no’ from the financial gurus. Credit cards are fine – it is how we use them that can get us in trouble. Have a purpose for each purchase. If you know you struggle with spending, studies show that using physical cash instead of plastic helps you spend less. If you already have high-interest rate credit card debt, call your credit card company and see if they can lower your rate – often they will work with you! Develop a plan to pay it off, perhaps start with the highest interest rate card and go from there.
Here’s the point
- While we have more debt than ever, Americans are in better shape than year’s past.
- Managing your biggest areas of expenditure is critical to avoid taking on too much consumer debt – your house, car, education, and credit cards.
- Be thoughtful and intentional with each purchase. Avoid the compulsion to keep up with how our peers are doing. Free up cash flow to build your financial future and fund your goals.
Action items
- With interest rates so low, it could be a good time to lock-in a lower rate on your house
- Drive your car a little longer to get the most value; perhaps buy an efficient 2-3-year-old vehicle next time
- Look for an in-state school for your kids. Teach them about being a responsible consumer.
- Bonus: be healthy – a good diet and regular exercise habits can keep your health care expenses lower throughout your life.
Featured Image: Photo by Stockvault