Debt and the Federal Reserve

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Debt and the Federal Reserve

Dec, 14th 2016

The most well-known question posed by actor Samuel L. Jackson was delivered in the classic film Pulp Fiction. In his role as enforcer Jules Winnfield, he asked a college drug dealer about his understanding of English. Trigger warning: He asks politely but forcefully, using an affectionate euphemism for emphasis.

But Jackson has another famous quote, one that may be more familiar to television watchers. In his role as a pitchman for Capital One’s credit cards, Jackson asks, “What’s in your wallet?”  

Unfortunately, the answer clearly is not a lot of cash, judging from the results of a newly released survey on debt.

American households are carrying credit card balances that average $16,061, according to a report prepared by the web site NerdWallet. The report used Federal Reserve Bank of New York and United States Census Bureau data to deliver its results.

In total, Americans now owe an estimated $747 billion on their credit cards. Total household debt, including mortgages, comes in at a whopping average of $132,529 per household.

The credit card debt represents a figure that’s just shy of the record high water mark card debt of 2008, which was the peak of the Great Recession years, a time when layoffs and financial hardship caused a lot of people to turn to plastic.

Today’s total household debt of $132,529 is up from $88,063 in 2002, when the annual NerdWallet survey began. That’s an increase of 28 percent, but it lags the cost of living, which increased 30 percent during the same measurement period and continues to outstrip wage growth.

Medical costs are particularly on the rise, inflating by 57 percent during that same period. Like to eat and drink?  Those costs are up by 36% in that same time span. 

THE FEDERAL RESERVE AND YOU

While any debt usually means more pain and strain on your financial situation, the debt load issue is particularly problematic as we head into 2017. After a long period where interest rates have been at historic lows, the Federal Reserve has begun to adjust interest rates upward.

The Federal Reserve determines the interest rates that banks and credit unions use to lend to other institutions, which has a ripple effect on your purchases. What that means is that it will cost you more to service your debts on credit cards and other things like student loans and mortgages.

The “Fed” announced on December 14 that it will raise its benchmark interest rate a quarter percentage point. It is anticipated that the rise, the first such bump in a year, will be followed by three more in 2017.

“Some further strengthening in labor market conditions and a return to two percent inflation” was cited as the reason for the increase by the central bank. The move to raise rates was not unexpected, even though it was only the second rise in interest rates since the 2008 financial crisis.

 The impact of the increase will be relatively small for each increase by the Fed. But cumulatively, they will be felt. By this time next year, those with big household balances may be feeling some pain from the lack of disposable income, as monthly mortgages could increase by anywhere from $50 to $100 or more, depending on your situation.

With the average credit card interest rate at 18.75 percent, according to NerdWallet statistics, upward bumps, even slight ones, can take a further chunk out of your pocket. Each household pays an average of $1,292 per year in interest on its debt load, and it is anticipated that rate increases can bump things up to an average of $1,309 in debt load.

That can mean you might have to burn several hundred dollars more per year just to maintain your existing debt.

THE RATE HIKE GOOD NEWS

There’s some good news hidden in potential rate hikes. Most of the debt accrued by Americans is for education and mortgages, NerdWallet says. Those are generally available at far lower rates than credit cards and carry added benefits.

Education costs, which have mushroomed in this century, carry the hope that you can get a better job. Housing debt at least provides the short-term benefit of shelter and the prospect of appreciation. Most of the pre-Great Recession debt was credit card debt, which usually reflects more ephemeral needs.

If you’re that rare breed of animal known as a saver, the anticipated rate increases mean you’ll get a higher return on your savings. Certificates of deposits have paid less than one percent on average. Long a favorite of the elderly, the certificate of deposit provides stable income to those on a fixed budget, returning a steady interest rate while keep your money Federally guaranteed in case of bank failure.

Any Fed increase may also make it easier to get a loan, as banks will need more revenue to offset the increased interest they’ll be paying out. That could also potentially stimulate the economy, making work easier to find.

There may also be a strengthening in the dollar’s value. That means imports may drop in price, and foreign travel may become cheaper.

Finally, stock prices may become less of a gamble and more focused on fundamentals, which will mean less volatility. And housing may experience an increase in interest from potential buyers who are anxious to get in the market while rates are still at historic lows.

But moving forward on savings and major purchases on houses can be hampered by any excessive debt load. So, your choice is clear - you can change your spending habits or increase your income. That may mean something as simple as one more meal at home and bringing your own coffee to work, or finding a part-time job as the economy moves into a “full employment” mode.”

Whatever happens, the goal is to spend less money on interest rates and more on the things that will get you ahead in life.

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