Between inflation and a turbulent economy, American consumers are rapidly accruing debt, increasingly turning to high-cost credit options, and beginning to default on credit balances, according to a June 2023 report from the Financial Health Network. This trend of increased debt, specifically high-interest debt, could signal serious economic trouble for many households in the coming year, the report’s authors concluded.
Ultimately the report’s authors are concerned the increase in high-interest debt is a sign that more consumers are finding themselves in a less-than-ideal financial health predicament as they rely on high-interest forms of debt to make ends meet.
For their report, the authors examined eight indicators of consumers’ financial health:
- Spend Less than Income
- Pay Bills on time
- Have sufficient liquid savings
- Have sufficient long-term savings
- Have manageable debt
- Have a prime credit score
- Have appropriate insurance
- Plan ahead financially
There are three types of classifications for a consumer’s financial health based on the eight financial health indicators:
- Individuals who are Financially Healthy: Consumers who are able to manage their day-to-day expenses, absorb financial shocks, and progress toward meeting their long-term financial goals. The report found 34 percent of the American population is financially healthy.
- Individuals who are Financially Coping: Consumers who are struggling with some aspects of their financial lives. The report found 51 percent of the American population is financially coping.
- Individuals who are Financially Vulnerable: Consumers who are struggling with almost all aspects of their financial lives. The report found 15 percent of the American population is financially vulnerable.
The concern for the authors of the Financial Health Network report is that as living costs and debt continue to rise, American households are overwhelmingly turning to high-interest forms of debt to afford the rising cost of daily life. Their concern is that a breaking point may negatively impact the financial health of a majority of Americans.
High-interest debt is expensive in itself, and the elevated interest rates are not helping. The Federal Reserve may have paused its aggressive interest rate hikes in June 2023, but that offers little relief for anyone with credit card debt as the central bank raised interest rates 10 times since last year — the fastest pace of tightening since the early 1980s — and that has caused credit card rates to hit an all-time high.
“Even though the Fed has hit the pause button on its rate-hiking campaign, the cumulative effect is significant,” said Ted Rossman, senior industry analyst at Bankrate.
Financial reports estimate the average credit card interest rate is somewhere between 20.69 percent and 24.61 percent. Despite sky-high APRs, Americans continue to use credit cards, even though they are unable to pay off the balance each month. According to a Bankrate report, nearly half of consumers with credit cards now carry a balance month to month.
“Paying down high-cost, variable-rate debt is an urgent priority for households,” said Greg McBride, chief financial analyst at Bankrate.
What’s Behind the Increase in Debt?
At the end of 2022, consumers held record levels of debt, which some are concerned is an early indication that more and more consumers are finding themselves in financially precarious positions.
Interest alone in 2022 reached an estimated $113.1 billion, which the report notes reflects both elevated card balances as well as higher variable interest rates.
In 2022, more than half of credit card users reported carrying a balance on their credit cards. The consumers most likely to carry a balance on their credit cards were those who were classified as financially vulnerable or financially coping. Consumers who are considered financially vulnerable are likely to have at least $5,000 in credit card debt and be paying higher interest rates than those who are financially healthy.
In other words, consumers who are struggling to stay afloat financially are most likely to have credit card debt and be paying higher interest rates on that debt than those who are financially healthy.
With the cost of credit card debt increasing, the report found 73 percent of families spent money from their savings to pay down debt or at least afford minimum payments in 2022, which makes them more vulnerable to financial emergencies. The report authors noted that this trend of tapping into your savings to afford minimum payments on high-interest debt is somewhat new as many of these families were able to increase savings during the pandemic, but now 26 percent reported they were carrying “unmanageable debt loads.”
The Financial Health Network report found that total interest and fees paid on a wide array of nonmortgage financial services skyrocketed in 2022, totaling an estimated $347 billion. This is a 14 percent increase from approximately $304 billion in 2021 or an increase of $20 billion.
In addition to credit cards, both unsecured installment loans and auto loans saw substantial increases in 2022. And even though many banks overhauled overdraft and insufficient funds (NSF) policies, removing fees, total fees spent on transaction and deposit accounts actually increased in 2022.
Consumers who were classified as financially vulnerable spent an estimated 14 percent of their income on fees and interest alone in 2022. For comparison, those who identify as financially healthy spent 1 percent of their income on fees and interest.
Part of the reason financially vulnerable populations spent so much more on interest and fees comes down to credit scores. The average APR for a consumer with good credit is around 20.51 percent. For those with poor credit, the average APR is closer to 27.61 percent.
To further illustrate how this affects your finances, let’s pretend you owe $5,000 on a credit card and have been making payments of $250 a month. If you have a poor credit score and an interest rate of 27.61 percent, you’ll pay off that $5,000 debt in 28 months and pay $1,776 in interest. But if you had a good credit score and were offered a lower APR of 20.51 percent, you would pay off that debt three months faster – it would take 25 months instead of 28. And you would pay $605 less in interest payments, paying $1,171 instead of $1,776.
How Consumers Are Using High-Interest Debt
More than half of consumers with a general-purpose credit card reported carrying a balance in 2022. The increase in interest fees is responsible for at least $5 billion of the increase in credit card fees and payments, the Financial Health Network report found.
Consumers who identify as financially healthy reported not carrying a balance on their credit cards, compared to 10 percent of cardholders who identify as financially vulnerable. Almost half (46 percent) of financially vulnerable cardholders who did report carrying a balance reported having more than $5,000 in credit card debt, which is far higher than the debt load reported by financially healthy cardholders (7 percent). Around 24 percent of consumers who were classified as financially coping carried at least $5,000 in credit card debt.
In other words, elevated interest rates are impacting consumers who are already struggling financially in a disproportionate way. And this has led to an increase in the number of consumers missing payments and those transitioning to 90+ day delinquency at rates higher than before the pandemic.
Buy Now, Pay Later
As the availability of Buy Now, Pay Later (BNPL) continues to grow, more and more consumers are relying on these installment loans to purchase goods and services. But the concern around BNPL affordability is growing as at least 33 percent of consumers reported having multiple concurrent BNPL loans, raising concerns about loan-stacking and consumers’ ability to afford these BNPL payments once combined.
At the end of 2022, monthly car payments on newly originated loans were around 25 percent higher than they were at the end of 2019. Loans for used cars reached an estimated $66.4 billion in 2022, a $10 billion increase from 2021. And interest on new vehicle auto loans also grew dramatically, reaching $30.4 billion. The increased cost of the vehicle, plus rising interest rates on auto loans, have sparked questions about borrowers’ ability to afford auto loan payments, especially as delinquencies began to surpass pre-pandemic levels.
Thanks to the moratorium on federal student loan repayments and interest, total interest and fees for federal student loans in 2022 remained far below pre-pandemic levels, around $7.8 billion compared with $28 billion in 2019. Although just 7 percent of outstanding student loans are private, the interest and fees from private student loans outpaced that of federal student loans, given the lack of a moratorium – reaching an estimated $9.1 billion in 2022.
With federal student loan repayments set to resume during the summer of 2023, the report’s authors expressed concern that with consumers already struggling to afford other high-interest debt payments, adding student loan repayments is likely to further strain consumers’ budgets. Nearly 60 percent of survey respondents said that restarting student loan payments would be somewhat or very difficult for their budget.
Unsecured Installment Loans
More and more households turned to unsecured installment loans in 2022, such as rent-to-own, refund anticipation checks, title loans, and payday loans. Total spending on unsecured installment loans increased 25 percent in 2022, totaling an estimated $36.7 billion. Most of the increase in unsecured installment loans is attributed to an increase in the number of loans as well as the average loan size rather than interest rate hikes. Still, delinquency rates have risen higher than pre-pandemic levels.
Are you struggling with high-interest debt? Learn more about DebtWave’s credit counseling and debt management services and schedule a complimentary budget analysis with one of our certified credit counselors here.