Are Borrowers Overburdened?(consumer debt burdens, survey)

The analysts at Fitch Ratings recently studied consumer debt patterns to ascertain whether or not consumer debt burdens are too high. Among their findings: total consumer debt is currently at 113% of personal income, while the personal savings rate stood at 2.2% in the first quarter. This viewpoint is an excerpt from their report, titled "U.S. Consumer - Overburdened or Underestimated?"

Over the past five months, economic conditions in the U.S. have been positive with buoyant gross domestic product and broad-based employment gains across industries. Rising housing prices, higher tax refunds and the low interest rate environment, which has allowed consumers to take "cash out" from the value of their homes and pay down existing debt, has propelled consumer spending, leaving households in good shape. Or has it? Driven primarily by asset appreciation in home values, household net worth has risen 11.8% from $39.8 trillion in 2002 to a record $44.5 trillion at the end of 2003. At the same time, total liabilities have increased in lockstep from $8.8 trillion to $9.8 trillion, while the debt service burden at 18.4% in December 2003 remains at historically high levels. Moreover, while debt service costs remain at a manageable level, total consumer debt is at 113% of personal income, while the savings rate for the first quarter has stayed in the 2.2% range.

Low mortgage rates and rising home equity have supported consumer spending through a substitution effect, effectively trading home equity for cash while keeping monthly payments at a manageable level. Now that mortgage rates are rising again, refinancing activity is falling and so are cash-outs, what is the impact of higher interest rates on the consumer?

While difficult to determine whether consumers have stretched themselves too thin, with Fed rate hikes imminent, likely 100 to 150 basis points by this time next year, Fitch Ratings remains concerned about the potential impact on consumer behavior and collateral performance, especially in the subprime consumer asset-backed securities and mortgage products segments.

The immediate downside risk of rising interest rates is the impact on refinancing activity, home prices and collateral performance in the mortgage sector. Indeed, there has already been a sharp slowdown in mortgage refinancing. According to the Mortgage Bankers Association's weekly gauge, refinancing activity is down approximately 82% from its record peak in March 2003. Moreover, a potential correction in home prices is likely to further impair household cash flows. Overall, Fitch projects some stress for subprime residential mortgage-backed securities as a result of rising interest rates but no severe ...