The Big Idea

A fresh look at household debt service

| January 24, 2025

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The Federal Reserve has long issued quarterly data estimating the debt service burden of households. Last year, Fed staff revamped the methodology and reissued historical data under the new data definitions. The most recent figures show that while debt service payments are rising as a percentage of income, they are still running somewhat lower than during the pre-pandemic period.

A new methodology

The old Federal Reserve data, which extended back to 1980, estimated debt service payments by using calculations of outstanding balances, average interest rates, and time to maturity gleaned from a variety of sources and then reported the resulting required debt service by disposable personal income.  This produced a rough approximation of what percentage of household’s disposable income was eaten up by required debt payments, but the methodology required a number of assumptions and offered only an indirect read.

Last year, Fed economists developed a new approach.  The current methodology estimates payments on mortgages, consumer loans, and lines of credit using scheduled required payments reported from credit bureau data.  As before, this sum is divided by disposable personal income to yield a ratio, the percentage of income that must be dedicated to debt service.  This approach offers a much more direct method of approximating the debt service burden and therefore should be more accurate than the old data.

One notable difference between the old and new methodologies is that the new approach includes escrow payments for mortgage borrowers—that is, mortgage insurance and property taxes if they are bundled into the monthly mortgage payment—while the old method did not.  As a result, the new series shows a somewhat higher mortgage debt service burden than the old series, though, for our purposes, the important comparisons are going to be for the new series over time, not between the old and new numbers.

One other detail to point out is that the new series only extends back to 2005, based on limitations in the source data.

Exploring the new data

A brief narrative of the history of the new series would be that the debt service burden fell sharply in the years after the Global Financial Crisis, as a new lower level of interest rates gradually spread through the economy to consumer debt obligations (Exhibit 1).  After a long period of stability in the late 2010s, the debt service burden fell substantially further during the pandemic, reflecting a combination of rock-bottom interest rates, a marked paydown of some consumer debt, most notably, credit card balances, and forbearance, including a moratorium on federal student loan debt. The ratio bottomed out in early 2021 and has been trending higher since then, reaching 11.3% in the third quarter of 2024.

Exhibit 1: Total household debt service ratio

Source: Federal Reserve.

The latest reading is still slightly lower than the prevailing level in 2019 of about 11.6%.  This is a striking result, considering that interest rates on mortgage and consumer debt are sharply higher today than they were in 2019, when 30-year conforming mortgage rates averaged below 4% and the funds rate ended the year below 2%.

Similar to the total series, the debt service burden for mortgage borrowing shows a sharp drop during the pandemic, followed by a gradual uptrend since 2021 (Exhibit 2).  The latest reading of 5.8% is quite close to the 2019 average of 5.9%.  It is worth noting that the 2019 readings were, at the time, all-time lows going back to the inception of the series in 2005.

Exhibit 2: Household debt service ratio for mortgages

Source: Federal Reserve.

As time passes, an increasing proportion of households will be forced by circumstances to move, in many cases begrudgingly giving up a 3% or 4% mortgage obtained before or during the pandemic—in many cases by refinancing—for a new mortgage at a 6% or 7% rate. We should expect this ratio to continue to slowly creep higher over time.

Finally, households have a debt service burden for consumer debt, which includes mainly credit cards, auto loans, and student loans.  Again, the narrative is similar.  The debt service burden plunged during the pandemic, in this instance reflecting households using a portion of their windfall to pay down credit card balances and the hiatus on student loan payments (Exhibit 3).  It has rebounded since then but remains somewhat lower than in 2019.

Exhibit 3: Household debt service ratio for consumer credit

Source: Federal Reserve.

Conclusion

The Federal Reserve’s new and improved household debt service burden data show that the run-up in interest rates has not yet led to widespread stress of consumer finances.  The debt service ratios are finally, after several years, getting back to about where they were in 2019.  If these trends continue, then we may be a year or so away from seeing debt service burdens that modestly exceed the prevailing levels in the late 2010s, which, to be fair, were at the time the lowest on record going back to 2005.

In a sense, however, even that would be a remarkable result in light of the sharp difference in the level of borrowing rates now compared to the 2010s.  The fact that household debt service ratios have stayed so low for so long despite the sharp increase in interest rates testifies to the prevalence of fixed-rate debt (mainly in the mortgage space).

The other part of the story lies in the denominator of the ratio.  A robust labor market over the past few years has driven rapid increases in disposable personal income, making it easier for households to carry a larger nominal debt load without excessive strain.

Thus, if the economy and in particular the labor market slow going forward at the same time that interest rates stay near current levels, the stress is likely to build.  Many households at the lower end of the income scale have already been dealing with this situation, as evidenced by the rise in credit card and in particular auto loan delinquency rates since the pandemic. It remains to be seen whether this stress spreads more widely in 2025.  In any case, even if these ratios continue to creep higher this year, they are likely to remain historically low compared to the 15-year run of data available prior to the pandemic.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

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