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Consumer Debt: Paying It Off Is Paying Off


A common concern among economy watchers is Americans' high level of credit-card, auto, and student loan debt. That, along with rising interest rates and energy costs, could put consumers in a perilous financial position. However, solid income gains and some restraint in piling up more debt mean consumers are still in good financial shape.

Look at the the Federal Reserve's latest financial obligations ratio among homeowners covering consumer debt outside of mortgages. This ratio is defined as principal and interest payments as a share of aftertax income, and it fell to 6.18% in the first quarter. That was the lowest since 1998.

Homeowners have taken advantage of rising home prices by tapping into their home's equity to pay down debts with higher interest rates, such as credit-card bills, as well as to fuel spending. As interest rates rise and refinancing activity dries up, this positive trend should begin to wane.

Even so, the monthly burden of consumer debt is unlikely to turn up sharply in coming quarters. First of all, wages continue to grow at a solid pace, as seen in the June employment report. What's more, consumers are being more cautious when it comes to racking up additional debts. In May, the Fed's measure of consumer installment credit increased 2.8% from a year ago. The recent pace of growth in install-ment debt is the slowest since the early 1990s.

The positive impacts of stronger wage growth and borrowing restraint also show up in the overall financial obligation ratio among renters. On average, about 70% of a renter's financial obligations consists of rent, with the rest consisting of consumer debt. Despite an uptick in rents, the ratio's first-quarter consumer debt level dropped to 24.3% of aftertax income, the lowest reading since 1993.

The declining burden of consumer debts racked up over the years is good news for consumer spending. For one thing, it lowers exposure to higher interest costs as credit-card rates move up. And with a smaller share of income going to pay down consumer debt, it also frees up some income to deal with elevated energy costs.

By James Mehring in New York


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