Consumers cut down to the essentials and focus on paying off the debt they already have.
For the first time in six years, U.S. households have reduced their debt in the second quarter of the year instead of adding to it. From April to June, credit card balances decreased drastically, thanks to reduced non-essential spending simultaneously paired with paying down balances.
According to the New York Federal Reserve’s Quarterly Report on Household Debt and Credit, the drop in total household debt in the second quarter, which concluded June 30, was the greatest since the second quarter of 2013. More specifically, there was a $34 billion drop in household debt to $14.27 trillion.
The biggest contributor to this can be credited towards, well, credit: the report showed a $76 billion decline in credit card balances, which is the steepest decline since the Fed began tracking this data. In addition, consumers reduced their credit card debt by about 12%, or $110 billion, in the first half of 2020. About one third of the decline in debt can be attributed to reduced consumer spending in the second quarter, with the rest from households paying off balances.
In real estate, home loan refinancing has increased mortgage debt by $63 billion to $9.78 trillion, the most to date. This is due to record-low interest rates. Also in the second quarter, mortgage originations equaled $846 billion, the greatest since 2013. Almost all of the increase can be attributed to refinancing, most of which come from borrowers with prime credit scores (660 or higher).
Overcoming income challenges to pay off household debt
While this news is positive, paying off debt may not come so easily to certain households. It should be noted that many families still have members that are unemployed. Stalled reopening plans and the recent expiration of the $600 accompanying unemployment benefit will, if it hasn’t already, make budgeting challenging for households. Subsequently, this reduced income may pose challenges to paying off debt.
For those that fall into this predicament, credit counseling can provide effective strategies for becoming debt free. “Paying off debt can be a challenging process,” said President Gary Herman of Consolidated Credit. “However, it’s not an impossible goal to achieve and it can be done with a little adjusting. Working with a certified credit counselor, you can set a realistic budget and develop a strategy for repaying your debt.”
The dangers of refinancing your home to pay off credit card debt
Herman also warns that homeowners should be cautious of refinancing their homes to pay off high-interest rate credit card debt. While historically low mortgage rates can make this option attractive, but it can be risky in a time of such high economic uncertainty.
“An increase in mortgage debt at the same time we’re seeing a decline in credit card debt may signal that people are refinancing to cash out equity. Then they’re using that equity to pay off high-interest rate balances,” Herman explains. “However, given unemployment rates and the high level of uncertainty, this can be extremely risky. If your situation changes and you’re unable to make your new mortgage payment, you could be at risk of foreclosure.”
Herman recommends that any homeowners considering a cash-out refinancing strategy should talk to a HUD-certified housing counselor first. You can call 1-800-435-2261 to speak with a HUD-certified counselor for a free evaluation.