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Working Class's Growing Debt Load May Hit ABS, Moody's Says

  • Families in lower-income tiers have seen increased debt burden
  • Incomes for these households grew just 5% from 2013 to 2016

Working-class Americans devoted a growing percentage of their income toward paying their debts last year, the first increase since 2010 and a shift that is likely contributing to rising default rates, Moody’s Investors Service said.

The families’ debt burdens are still relatively low compared with earnings-- less than they’ve been for most of the last three decades, according to Moody’s, which released a report Tuesday that analyzed the Federal Reserve’s triennial survey of consumer finances. But the borrowers are accumulating more debt even as the economy continues its recovery, which could create problems for lenders if U.S. growth slows, said Jody Shenn, a senior analyst at the bond grader.

“We are seeing signs of the credit cycle turning,” Shenn said in an interview. It’s important to look out for signs of stress “and think about the implications when the economy does hit a rough patch.”

While total levels of consumer borrowing reached a record in the second quarter, for families at most income levels, earnings have been rising faster than debt payment obligations. The exception is households making between $25,300 and around $43,000, for which 15.6 percent of income went toward paying interest and principal on debt in 2016, up from 15.3 percent in 2013, the Fed’s survey said.

These families may have borrowed more in part because their median income grew just about 5 percent during the period, adjusting for inflation, according to Moody’s. That’s relatively modest compared to the 10 percent growth for all families, the ratings firm said. Their demand for credit was met with greater supply: underwriters have loosened their standards to win new business, the report said.

Cost Pressures

Working-class households face other pressures now, including rising costs for health care and rent since 2013, Moody’s said. These expenses could also spur more defaults in consumer debt, translating into higher risk for investors that buy bonds backed by these loans, the report said.

Some wealthier families are taking on more debt as well. A growing percent of households making $111,400 to around $177,000 are siphoning more than 40 percent of their income toward paying interest and principal on their debt. In 2017, 4.2 percent of these families were in that category, up from 3.9 percent in 2013, Moody’s said. But higher debt burdens tend to be less problematic for more affluent families, which can often rely on savings to tide them over during tough times.

Overall, U.S. households have “very manageable levels” of debt, Moody’s analysts led by Shenn said in their report. Growing wages, low interest rates and longer loan terms make servicing debt easier for most families. The “very low” unemployment rate should reduce the likelihood that consumers fail to make good on their obligations due to job loss, the analysts said. Stock and real estate appreciation also represent sources of wealth consumers could tap to pay their loans.

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