US Households Racked Up Record Levels of Credit Card Debt. Should Markets Be Worried?

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Key takeaways

1. A recent report revealed, outstanding US credit card balances increased to a record $1.03 trillion in Q2 2023, up $45 billion from the first quarter. In addition, the proportion of credit card debt entering severe delinquency (90 days or more overdue) increased to 5.1% in Q2 from 4.6% in the quarter prior, raising concerns over the US household debt market in recent weeks.

2. Household excess savings have fallen to around $350-400 billion in Q3, but easing price pressures and rising wages are helping to stabilize savings rates at still-elevated levels.

3. Although higher US interest rates are weighing on individuals’ credit scores, around 70% of household debt consists of fixed-rate home mortgages—the majority of which were renewed in 2020-2021 when interest rates were at rock bottom and have been insulated from recent rate hikes—while credit card debt represents just 6% of overall household debt as of Q2 2023.

4. Overall, the recent rise in US credit card delinquency rates should not be a cause for concern in the short-term. Longer term, a rock-solid labor market and relatively strong disposable income growth should underpin excess savings, household spending and debt repayment capabilities.

Introduction

The US economy has remained incredibly resilient in 2023, driven by strong consumer spending. However, concerns are starting to build over how long household consumption can continue to pillar US economic growth. Recently, Macy’ Inc.—one of the largest retail shopping outlets in the US— reported an unexpected decline in revenues for Q2 mainly because of unpaid customer credit card balances. This reignited worries over household debt as it followed up a report from the New York Fed that painted a relatively poor picture of the US household debt market—outstanding credit card balances increased from $986 billion in Q1 to a record $1.03 trillion in Q2, while severe delinquency rates rose to 5.1% in the second quarter from 4.6%. In this analysis, we take a look at the US household debt situation up to now and determine whether the recent fret over credit card delinquency rates is warranted.

Household Debt: consumers are feeling the pinch, but large scale credit card defaults are not on the cards

According to Moody’s—one of the largest credit rating agencies in the US—the massive stimulus measures unleashed by the government to combat the economic fallout from the pandemic, allowed consumers to significantly reduce their reliance on credit cards. From debt deferment and forbearance, wage subsidies and even cash handouts, households were able to cut their spending while keeping their incomes relatively intact, consequently credit card utilization rates dropped below 20%—the lowest level in the past decade. Nevertheless, as the pandemic past and fiscal stimulus programs came to an end, inflation ran rampant and interest rates started to surge, which forced consumers to rely heavily on credit cards once again at much higher interest rates—average credit card interest rates are now above 20%. This is having a knock-on effect with credit card delinquency rates, and in turn the outlook for economic growth. However, we believe US households are well-equipped to navigate a higher interest rate environment and more than capable of keeping consumer spending trotting along, boding well for US economic prospects.

1. Credit quality is the best in a decade, defaults concentrated among low credit score groups

Since the financial crisis, the number of individuals with high credit scores, also known as Prime, has steadily risen, leading to a national average credit score of nearly 700. Moreover, delinquency rates among those in the lowest credit score grouping have only now returned to their pre-pandemic levels, with delinquency rates for those in the medium to high credit score groupings remain comfortably below their pre-2020 levels. This suggests that the Fed’s unprecedented rate hiking cycle is primarily impacting low credit score individuals, but the extent of the impact is nothing out of the ordinary.

2. Home mortgages pose little risks to household debt levels this year

Approximately 70% of US household debt is in the form of home mortgages—credit card debt accounts for just 6% of total household debt as of Q2 2023. Unlike credit card interest rates, which can change frequently, most US mortgage rates are locked in at fixed rates. In addition, the majority of those fixed rates were renewed during the pandemic, when the Federal Funds rate hit rock bottom, which means around 80% of all US mortgages have rates below 4.0%. Consequently, mortgage default rates have barely budged since the Fed began hiking rates in early 2022. Furthermore, although 30-year mortgage rates are now sitting at multi-decade high levels, the housing market has shown signs of a recovery in recent months, with home sales growing, which suggests households have ample resources to navigate this high interest environment.

Household assets: savings rates look likely to rise, boosted by wage growth

The decline in excess savings that were accumulated during the pandemic has also started to raise concerns around private consumption prospects. To analyze the outlook for excess savings over the medium term, its necessary to breakdown disposable income, which contributes to the rise or fall in savings. Around 70% of disposable income comes from wages, while the remainder comes from transfers, assets and rental incomes, minus interest payments and taxes. The excess savings accumulated during the pandemic were mainly driven by transfer income in the form of cash handouts from the government, which is no longer available. We refer to two Federal Reserve papers, "Excess Savings during the COVID-19 Pandemic" and "Accumulated Savings During the Pandemic: An International Comparison with Historical Perspective," to assess this issue.

1. Excess savings have fallen, but still remain at historically high levels

By estimating savings rates during normal times, based on 2020 when there was no pandemic and no massive stimulus policies, and subtracting actual savings rates from these estimates, we derive our estimate of excess savings. As of Q3, there are still $350 billion to $400 billion in excess savings, which remains higher than pre-pandemic levels.

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