More Debt Does Not Necessarily Mean Bigger Debt Service Obligations

Many analysts voice concern about the weight of indebtedness on household finances. Over the past several decades, household debt has risen considerably. In 1950, household debt stocks were 24% of GDP.1 That means that the estimated value of all of the debt owed by US households was roughly one quarter the estimated value of everything produced in the economy. By 1980, it was 45%. By 2000, it was 65%. By 2014, household debt was 95% of GDP – it quadrupled in proportion to national economic production. In the aggregate, households carry bigger debts than they did sixty years ago.

One might infer that households are under greater financial pressure to service these debts. If people are getting bigger mortgages, carrying more credit card debt, more education debt, and so on, wouldn’t they have bigger principal repayments and bigger interest expenditures? Interest and principal payments are collectively described as debt service payments.

That does not appear to be the case. The figure below depicts two data series. The first is the household Debt Service Ratio (DSR), which is the ratio of required households’ debt service payments to their disposable (post-tax) income. The second is the Financial Obligations Ratio (FOR) is a broader measure of households’ financial obligations, and includes debt service, rent payments, auto lease payments, homewoners insurance, and property taxes.

DSO

Households’ debt service ratio did rise between 1980 and 2007, but the rate of change is very modest. In 1980, the debt service ratio was 10.6%, and it peaked in 12.77% in third quarter of 2008. The overall size of household debt stock nearly doubled, but debt service obligations rise by about 20%. Concretely, this suggests that a fairly typical household – for example, one with a disposable income of $50,000, paid $5,300 in debt service obligations at 1980 rates and $6,385 at peak 2008 rates. This translates into about a $90 difference per month. And much of this increase debt service involves repayment of mortgages, which is partly a form of investment.

Why did the burden of servicing debts seem to rise so much more modestly than household debt? In part, it is a product of cheap debt. Credit is less expensive and more abundant today than in 1980. The market for non-traditional mortgages (for example, low-downpayment or adjustable rate mortgages) has developed considerably, and now lends money to people who might not otherwise be able to buy a home. Credit cards are very easy to acquire. The pay day loan industry has grown considerably.

The figure suggests that, if anything, this rise and debt has had a rather modest effect on households’ day-to-day cash flows. Although households are much more in debt, their debt is cheap and plentiful. Cheap, plentiful debt has also been in abundance during the Great Recession and its aftermath, and households have increasingly sought to pay down their debts. All of this has resulted in household debt falling back to the low range of where it stood in the 1980s. Overall, debt service obligations do not seem to be very volatile.

A similar story could be told with the Financial Obligations Ratio. One can really squint at the above figure to discern some very modest growth in household financial obligations between 1980 and 2007. However, it is a substantively mild rise, and it has fallen with debt service obligations since 2008.

The moral of the story? Although household debt is very high, this book has not dramatically affected households’ cash flows. Household finances are not being choked by debt service obligations. The cost of servicing debt has been reasonably stable within a confined range of about 15% to 18%. This is not an earth shattering growth in financial obligations. If debt has some kind of systematic negative effect on household finances, this effect is not manifesting itself as growing debt repayments, relative to incomes.


  1. Federal Reserve Board (2014) “CMDEBT_GDP” Data series from Federal REserve Economic Data set. Accessed in Spring 2014.http://research.stlouisfed.org/fred2

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