The much-anticipated and long-delayed Federal Reserve hike in interest rates could slow the economy a bit when it finally comes. But Americans generally appear to be in better shape to handle higher borrowing costs than even a few years ago.
Not everyone would be adversely affected anyway. A lot of people just don’t do much borrowing, from affluent seniors who have no need for loans to low-income individuals who couldn’t qualify. About 27% of Americans are unbanked or underbanked, according to Federal Reserve research, meaning they’re outside the financial system or tangentially connected to it, and thus not applying for conventional loans.
Nor would all types of loans feel the pinch. For example, 30-year mortgages are tied to yields on Treasury notes, which the central bank doesn’t directly affect. Their yields move more in response to inflation and inflationary expectations.
And more to the point, Americans gradually have been getting their finances in better shape, making them more resilient to a rate increase.
“I think people are better prepared than, say, five years ago,” said Bruce McClary, a spokesman for the the National Foundation for Credit Counseling, which represents 75 credit-counseling agencies around the nation. “Even though wages are relatively flat, people are doing a better job managing their finances.”
Probably the biggest reason for improvement is that more people are working than when the recession was in full swing. Job losses are key catalysts that push people over the financial edge. As employment has risen, bankruptcies have dropped sharply in recent years — nationwide filings in September were down 54% compared with September 2010, report the American Bankruptcy Institute and Epiq Systems.
Many newly hired individuals aren’t making much more money than they were years ago — personal incomes remain sluggish — but at least they’re drawing paychecks. After shedding 8.8 million jobs in the wake of the recession, the economy has added 13.2 million since then.
And there are other heartening signs. FICO credit scores have reached a 10-year high. Credit scores reflect both a willingness and ability of consumers to handle debt payments.
The most recent score of 695, on a scale of 300 to 850, is up from 687 five years ago. Perhaps of more significance, fewer people are scoring at the low end, below 550. That’s an encouraging trend that suggests consumers are managing credit responsibly, the company said in a blog. And more people are creeping into FICO’s top tier, with scores above 800.
And while it doesn’t always seem like it — and the gains haven’t been shared equally — Americans are doing a better job accumulating assets. Household net worth, which bottomed during the recession below $57,000, currently stands around $85,700, the Federal Reserve reports. Overall consumer debt payments now eat up 9.8% of personal income, down from 13.2% when the recession hit.
People with adjustable-rate loans would feel the impact of a Fed rate hike more than others. Credit cards are a good case in point, since cards generally come with variable rates. Yet credit card delinquencies have dropped significantly, with just 2.5% of bank cards 30 days or more past due, below the long-term average near 3.8%, reports the American Bankers Association. On eight other consumer-loan categories tracked by the association, delinquencies of 1.4% are down from a 15-year average of 2.3%.
“By paying off credit card debt, consumers have reduced their costliest debt burden and one that is set to become costlier when interest rates start to rise,” said Greg McBride, chief financial analyst at Bankrate.com.
Credit card reform legislation enacted in 2009 limits certain rate hikes on existing credit card balances while giving borrowers more advance notice. These changes could ease the bite from rising interest rates.
McClary cautions that credit card balances have risen significantly this year, but he also sees that as a sign of rising consumer confidence. Besides, he feels financial literacy has improved, with fewer distressed individuals seeking help from consumer-counseling agencies. “Definitely, there’s an increased awareness,” he said. “People are very much in tune with their budgets.”
Like mortgages, auto loans are another type of borrowing where fixed rates are more prevalent. That’s important because Americans have been adding auto-loan debt at a robust pace — the $932 billion in balances as of June 30 was up 24% over the past two years, reports credit bureau Experian. Nearly 86% of new vehicles are purchased with a loan, and the financed amount and average term have been creeping higher — to a recent average $28,500 finance amount and 67-month average term, Experian said.
Yet consumers so far have been up to the challenge. A modest 2.3% of vehicle loans are 30 days or more past due and just 0.6% are past due by 60 days or more, Experian added. Those figures have held steady over the past year.
Higher fixed rates on auto loans wouldn’t make that much of a difference to the typical budget anyway, assuming the change is modest. An increase of one-quarter of a percentage point would add just $3 to the monthly payment on a $25,000 loan, McBride said, referring to someone who waits until after a rate hike to buy.
Student loan costs eventually could push higher, but that won’t happen for a while. Several types of college loans are pegged to 10-year Treasury notes, with rates resetting each July 1. For the 2015-16 school year, undergraduate loans now carry a rate of 4.29%, down 0.37 of a point from the prior year. Rates on loans for graduate students and Plus loans taken out by parents also dipped by 0.37 of a point. Though fewer people are seeking credit counseling help for credit card debt, student loan inquiries are rising, McClary said.
With memories of the housing meltdown still fresh, anything that might unsettle real estate could prove worrisome. Sharply rising rates could dampen prices by discouraging potential buyers, but a big rate uptick isn’t likely. Home buyers with adjusted-rate mortgages would face higher payments, but these loans represent only a tiny slice of the market these days — about one in 14 new loan applications, reports the Mortgage Bankers Association. Fixed-rate loans dominate.
Housing affordability remains positive from a long-term perspective, and rates would need to rise a lot to discourage potential home buyers. The typical mortgage payment consumes 12.4% of household income, well below the 40-year average of 19.6%, according to JP Morgan Funds.
“By paying down debt, paying off debt and refinancing into fixed rates, Americans have reduced their monthly debt burdens as well as their sensitivity to rising interest rates,” McBride said.
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