When Americans hear the words “debt crisis,” they tend to think of public debt. With regular headlines and perpetual finger-pointing over which party or politician is responsible for it, America’s national debt is a well-known $18 trillion problem. However some analysts are more disturbed by a parallel debt crisis that often flies under the radar – the country’s spiraling household debt.
The statistics are formidable. Americans have well over $11 trillion in household debt. This total is dominated by long-term loans for purchases like mortgages, with over $8 trillion owed, and student loans, which have risen to record highs of over $1 trillion. It also includes an eye-popping $882 billion in credit card debt, along with comparable totals owed in auto loans.
In isolation, these numbers aren’t as worrying as they sound. While home values are subject to boom and bust cycles, they tend to appreciate over time, and financial regulations seem likely to prevent another financial crisis from occurring due to subprime mortgages. Similarly, student loans can be a major burden on young people, particularly in a weak job market, but a college degree is still a good long-term investment.
On the flip side, when you factor in shorter-term loans with higher interest rates for assets that usually depreciate over time, the situation looks far more precarious. Take the following into consideration:
- The average indebted household in the United States carries $15,611 in credit card debt, leaving only about half of all Americans with more emergency savings than credit card debt.
- Auto loans reached a record average size for both new ($27,799) and used ($18,576) vehicles in 2014, with the highest loans and monthly payments going to borrowers with subprime credit ratings.
- Borrowers are driving a boom in car title loans, whose 300% average annual interest rates and hidden fees put the most vulnerable consumers at risk.
High debt levels also hinder the economy, as consumers spend their money paying back banks rather than making new purchases that would drive growth. Debt can influence young people’s life decisions, delay their independence from parents, and warp the labor market, causing a greater reluctance to enter certain professions or pursue entrepreneurship opportunities. Some analysts even fear that personal debt could spark another economic collapse.
Yet, as serious as this issue is in America, the effects of excessive personal debt can be even more troubling in the developing world. In recent years, the countries with the largest increases in household debt have included emerging economies with expanding middle classes. This begs the question, when customers in these countries acquire widespread access to formal credit, giving new purchasing power to people who’ve long been denied it, what will the outcome be?
The experience of microcredit suggests one sobering possibility: in many markets, growing access to small loans at high interest rates has combined with aggressive marketing and loan collection tactics to push poor borrowers into a cycle of debt. Combined with the typical complexity of lending terms and the often-lower levels of education and financial capability among borrowers in the developing world, it’s easy to imagine this problem growing as financial access expands further. Even still, it’s important not to give in to cynicism and think that every banks’ sole motivation is maximizing loan sizes and interest rates. The truth is, over-indebted customers are not in the banks’ best financial interests. Beyond the negative social impact, unsustainable debt leads to defaults and losses for lenders – things that responsible banks are eager to avoid. That’s why financial services providers ranging from major banks to startups are actively searching for ways to address the issue of excessive debt.
Case in point, Visa recently supported the launch of three locally-developed mobile apps to promote financial capability in Nigeria, which is just one of its many initiatives aimed at helping consumers use credit responsibly. MasterCard has also implemented a number of financial literacy programs, targeting everyone from American college students to low-income communities in Latin America. Bank of America has partnered with the Khan Academy to make free financial education widely accessible, and financial capability is a major focus for Citi.
Some companies are even building financial capability into the design of their services. Meed, which will launch early this year, is partnering with banks to offer a suite of mobile-based financial products that make it easy to save – and harder to get into debt. It features a credit line linked to an interest bearing security savings account from which funds are drawn after the checking account funds have been exhausted, thereby helping members avoid the need for costly short-term loans. The security savings account provides members with a line of credit of up to 75% of their savings balance. Furthermore, the savings account is structured with restrictions on withdrawals until members approach age 60, incentivizing long-term savings. The company even provides a revenue source for members via its patent pending SocialBoost: partner banks return 50% of the credit interest charged to Meed users, splitting the return between their checking and savings account.
As consciousness grows around the problems of over-indebtedness, it’s likely that other companies, both new and old, will see the benefit of encouraging consumers to save and use credit responsibly. If they’re successful, perhaps future customers in established and emerging markets will avoid the burden of trillion dollar debts.