Consumers trimming debt in struggling economy, Fed says

With economic uncertainty lingering, U.S. consumers are continuing to pay down their debts, according to a new report released Monday -- a trend many economists expect to last for years.

The report from the New York branch of the Federal Reserve on consumer debt and credit paints a picture of U.S. households that are still struggling to pay bills but working stubbornly to pay down credit cards, mortgages and other balances that topped out several years ago.

Aggregate consumer debt fell to $11.66 trillion in the third quarter of 2011, down $60 billion (0.6 percent) from three months earlier, according to the report. Mortgage balances fell by 1.3 percent, credit card limits fell by 0.9 percent and the number of open credit card accounts fell by 6 million, to 383 million (down 1.5 percent).

Michael Walden, an economics professor at North Carolina State University, says he's seen estimates that say households will continue to shed debt for another two to eight years. Although reducing debt makes sense for families in uncertain economic times, it can also stunt an economic recovery because it channels money away from consumer spending, which accounts for 70 percent of the U.S. economy.

"There has been slow improvement," Walden says. "We are moving in the right direction, but in my estimation, we've got some ways to go."

Bill-paying zeal
Walden says many consumers have accelerated their bill payments in response to continued weakness in the real estate market. Because housing prices have fallen, some homeowners owe more on their mortgages than their houses are worth, and paying down debt is a way to rebuild equity. A study this month by the real estate website Zillow found that 29 percent of homeowners owe more on their home loans than they could sell their houses for.

The New York Fed's study found an increase in the percentage of mortgage balances that were delinquent in the third quarter, which suggests that housing troubles are persisting. Average home prices are more than 30 percent below their 2006 peaks, according to the S&P/Case-Shiller home price index, which examines prices in 20 major U.S. cities.

Since the 2008 financial crisis, consumers have been steadily paying down the amounts they owe on a wide range of debts, including credit cards, mortgages, home equity lines and auto loans. Household debt has also decreased because banks tightened lending requirements and are extending less credit than they were just a few years ago. They've also stopped trying to collect more delinquent debts than in the past.

Warming up again to credit cards
Much of the reduction in debt stems from the way consumers use credit cards. The number of open accounts and average account balances are down about 20 percent from their 2008 peaks, according to Monday's report. But for two straight quarters, the number of credit inquiries (also known as "hard inquiries") has increased, suggesting that interest in new credit is once again on the rise and that consumers are feeling more comfortable taking on debt.

There has been slow improvement. We are moving in the right direction, but in my estimation, we've got some ways to go.

-- Michael Walden, economics professor,
North Carolina State University

Many consumers, though, seem to be taking the path of Stanley Ridgley, a Philadelphia author and educator. Four years ago, Ridgley, 56, found that his spending was beginning to outstrip his income, and his $30,000 in credit card bills had become a source of anxiety. He decided to spend less and channel money toward reducing those balances.

Today, his credit card debt is paid off, and he pays his balances in full at the end of the month and tries to pay cash for as much as possible. 

"It's a liberating lifestyle," he says. "It's much less stress. I'm living within my means ... Your credit is your reputation, and you want to make sure your reputation is not sullied."

See related: tips for paying down credit card debt, G.19 report: Credit demand up, even as debt falls

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Updated: 11-20-2017